Tabb Group Report - Buy-Side Firms Want More Alpha-Generating Content

8th February 2009

A new survey of buy side traders by industry consultant TABB Group has found a significant increase in demand for targeted, high quality, alpha generating trade ideas, in order to re-build assets and performance records. “US Institutional Equity Brokerage 2010: Assets, Commission Management and Concentration” was based on in-depth, 1x1 interviews with 66 head traders at traditional asset management firms, including most of the largest mutual fund and investment advisory firms in the US. The firms manage an aggregate $12.1 trillion in assets, or about 40% of US equity assets under management.

The report found the number one business driver in a buy side firm’s decision to do business with a broker has shifted to alpha-generating content (cited by 69% in the 2009 survey), from liquidity (cited by 32% in the 2008 survey). Moreover, absolute interest in alpha-generating content increased more than six-fold.

“US equity managers have watched years of performance track records go up in smoke and billions in assets walk out the door,” author Laurie Berke, principal at TABB, writes in the report’s Executive Summary. “The name of the game in 2010 is to generate positive relative performance.”

The way to win that game, according to Ms. Berke, is to pay the right brokers for the right alpha-generating research and ideas as well as for access to the underwriting calendar at investment banks.

“Brokers will need to deliver those services with pinpoint accuracy to the right clients at the right price,” she is quoted in a news release about the report.

Major Trends

In a video accompanying the report, Ms. Berke explains the three market forces supporting her conclusion.

1. The outflow and flight from risk that has resulted in 30-40% reduction in assets under management and the decimation of long term performance records.

“When we talk to…head traders, their number one concern going into 2010 is not so much transaction cost analysis and not so much determining how many basis points can be added or saved with good and superior trading. It was more, ‘How do we generate alpha? How do we generate that positive relative performance to our peers and bring back those assets under management.’ That means the consumption of content.”

2. The growing use of Commission Sharing Agreements (CSAs) and the formal unbundling of buy side equity commissions.

“What is going to be happening, and what has been happing on the buy side, is an increased trend toward the use of CSAs to optimize commissions to pay for content. This trend is reinforcing and supporting the formal unbundling of commission rates. Traders are now accustomed to identifying the explicit execution component of a transaction relative to the research component…A greater percentage of their gross commission budget will flow through CSAs in the future…[but] the percentage of the total commission that stays with the executing broker – the CSA broker – will go down by 2011.”

3. The increasing concentration of order flow.

“In 2009, on average, buy side firms traded with 12 core brokers…[that] comprised 71% of the total commission budget paid to the Street. This trend of concentration of order flow will continue. The number one business driver…going forward into 2010 for paying these core brokers has flipped…In 2008, when we asked, ‘Why do you pay your top brokers? What is the most important thing they can provide you?’, the number one answer was liquidity and flow. A year later…the number one answer is…the provisioning of value added, alpha-generating research.”

Looking Ahead

Ms. Berke concludes that the revolution in trading that brought the buy-side desk from telephone and working orders to algorithm and smart order router is effectively complete.

“The sell-side has innovated and the buy-side has soaked it all in,” she writes in the Executive Summary. “Now it’s a question of delivering alpha to the US equity investor who is highly disenchanted by the crash. It has always been the role of the broker dealer to deliver the means to capture alpha to the buy-side money manager. In that way, the electronic revolution is over and it is indeed back to business as usual.”

“The challenge to the buy side will be to make the right choices optimizing the commission spend to obtain the best suite of services across the buy-side organization by choosing the best match available from a limited number of sell- side brokers.”

youDevise Comment

The TABB Group study documents the trend youDevise began to see in 2009. That is the formalization on both the sell and buy sides of the production and consumption, respectively, of alpha-generating trade ideas.

The number of sell and buy side firms using the TIM increased 156, or 37%, to 581 at year end 2009, with about one third buy side, two thirds sell side.
The number of ideas in the TIM’s database at December 31, 2009 increased 83%, to 800,249, from a year ago.
Based on a survey of our client base, commissions paid industry-wide by the buy side for ideas increased 40%, to $500 million in 2009, from $300 million in 2008.

We saw this happening between institutional brokerage firms (ranging from bulge to regional and boutique) and their institutionally oriented hedge fund clients. The fact that TABB found that more traditional mutual fund and investment advisory firms are now interested in ideas indicates that the market is about to experience a new surge in growth.

The TABB study also validates the approach youDevise has taken to trade ideas with the TIM.

The buy side pays brokers for ideas, typically based on performance, not for the TIM. Brokers pay for the TIM.
The buy side receives only ideas from brokers they have pre-approved. Investment managers also can set idea parameters to receive only the kind of ideas they want.
The buy side can instantly analyze the performance on a relative basis of all ideas from each author and each brokerage firm to determine who is truly generating value.

To help the sell side develop more ideas for today’s market, youDevise recently introduced pairs and baskets, which facilitate the creation and tracking of ideas that are not necessarily market dependent.

Resources

Tabb Group: http://www.tabbgroup.com

Video: http://www.youtube.com/watch?v=cAbZsQOGY88

News Release: http://www.tabbgroup.com/PageDetail.aspx?PageID=16&ItemID=874

Article from Advanced Trading: http://www.advancedtrading.com