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November 8, 2005

The Incredible Shrinking Brokerage List

By Nina Mehta

Numeric's Hamilton believes order flow is likely to consolidate amongthe larger brokers, perhaps at the expense of some of the mid-tier shops. Bulge-bracket firms tendto havethe huge budgets necessary to spend on R&Dfor new algorithmic trading products. "To some extent it's a scale game in the sense that a lot of these shops employ anonymousinternal crossing networks," Hamilton says. "So if they have a client wanting to go one way and another client wanting to go the other way, often they can save clients the market impact of those two trades."

All this change on the brokerage distribution front adds up to a tough time for many brokers, who are already hurting from declining commission rates. "We monitor over 800 brokers," adds Konstance. "Will there be 800 brokers in a few years?"

A crystal ball isn't necessary to answer that question.

Agency Shops Thrive at CREF

TIAA-CREF, the massive pension fund, is taking a different approach toward its research needs. For the last 10 years, the retirement and mutual fund complex, which has $150 billion in equity assets, has executed 50 percent of its domestic equities trading through agency-only firms. The firm is now moving one-third of the remaining 50 percent into the execution-only space, says Paul Davis, managing director in quantitative portfolio management and trading. TIAA-CREF is also in the process of adding 20 new analysts to its internal research staff to supplement the Street research the firm uses.

Compliance Vs. Performance

As part of stepped-up efforts to achieve best execution, buyside firms are also examining the quality of broker executions more closely. Some firms pay for third-party transaction cost analysis reports merely to please their compliance departments, says Marie Konstance, director of sales and product management at Plexus, but most are drilling down into trade details.

Ian Domowitz, global head of research at ITG, adds that "buyside traders increasingly operate in the mode of managers and strategists, and are responsible for delivering trading performance and controlling costs." This has also driven the use of transaction cost analysis to help determine how well their brokers are performing.