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February 24, 2006

Growth of Buyside's Self-Trading: Expected to Moderate This Year

By Michael Scotti

Wagner believes that electronic trading seems to have reached a plateau. But that could change if a new technology develops or Reg NMS pushes institutional clients toward electronic trading, he said. "We need to see how this plays out, but many are predicting the New York's floor will be diminished [under Reg NMS] and if that comes true, we'll see additional electronic trading," Wagner predicted. But as it stands right now, Wagner said traders appear to be using electronic trading about as much as they can. "We're at the point of saturation right now," he added.

Peter Weiler, a senior vice president in Abel/Noser Corp's investment management area, also believes DMA has reached a saturation point. "A lot of order types don't support an electronic strategy," said Weiler, who expects a pickup of activity at upstairs trading desks due to recent volatility. "Any volatility would require more traders and less electronics," he said.

Still, a June 2005 Tabb Group report on electronic trading predicts strong growth, according to Robert Iati, a partner with the firm.Tabb surveyed the buyside and found that firms were executing about 25 percent of their flow electronically at the time. That figure is expected to grow to 31 percent this year and to 43 percent in 2007. "The pace of growth for electronic trading is more steady than dramatic," Iati said.

He pointed out there is some subjectivity to describing growth when not quantifying it on a percentage basis. Iati said he would characterize Tabb's findings in the context of Traders Magazine's survey as between "slightly increase" and "dramatically increase."

The Survey

The buyside respondents disclosed their current percentage of volume that is self-traded: More than one-third-35 percent -said that less than 5 percent of their order flow is self-traded; one-tenth of the respondents self-traded between 5 and 10 percent of their order flow; one-fifth said they traded between 10 and 20 percent themselves; one-tenth self-traded between 20 and 30 percent of their flow; and just over one-quarter said they self-traded traded greater than 30 percent of their order flow.

Slightly more than half of the "greater-than-30-percent" group is comprised of hedge funds. Interestingly, about the same number of hedge funds (15) self-traded less than 5 percent of their flow, indicating their trading preferences more closely mirror those of traditional funds. About half of the firms that execute more than 30 percent of their volume electronically expect no change in their trading practices in 2006.

Drill Down

*Five of the eight respondents planning to "dramatically increase" their self-trading worked for hedge funds. The other three worked for traditional managers. Furthermore, those five hedge funds respondents already execute more than 30 percent of their flow electronically, according to the survey. "The firms that are using electronic trading the most appear to be increasing it the most," said Wagner, the consultant.

*Seven out of the nine firms with greater than $100 billion in equities under management said they expected to see their self-trading "increase slightly." Five out of the six participating firms with between $50 billion and $100 billion in equities also said they expected to see their electronic trading "increase slightly."

*All of the six firms that said they would decrease their electronic trading managed less than $5 billion in equities. Interestingly, four of the six were hedge funds. Two were traditional managers.