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January 1, 2007

TCA's Importance to Grow

By Michael Scotti

Get a group of buyside traders together, and the topic of trade-cost analysis can easily turn into a heated discussion. One issue certain to come up is whether it is possible to accurately measure trading costs in a dynamic marketplace. Throw in the concept of linking traders' compensation to trade-cost analysis rankings, and the conversation can get downright ugly.

The results last month of a Traders Magazine survey show that trade-cost analysis plays a role in trader compensation at 39 percent of the firms that responded. The discipline of TCA, which seeks to measure implicit trading costs such as market impact and opportunity costs, also will play a larger role in the future. That's even true for firms that don't put much faith in measuring trading costs, the data suggest.

The anonymous survey went out to 1,353 buyside trading professionals with 99 completing the eight questions-a response rate of 7.3 percent.

"If what you do is worth an above-average salary, you better be prepared to be measured," cautioned one survey participant at a large pension fund. This trader believes trade-cost analysis is "mostly reliable" if the data are correctly captured from the order management system. The trader added, "If you do not like being measured, you should ask yourself, why not?' "

Survey respondents included "traditional managers" (81 percent), hedge funds (16 percent) and pension funds (3 percent). Interestingly, only 4 percent of those who responded characterized trade-cost analysis as "very reliable," while 22 percent deemed it "mostly reliable." The middle ground-43 percent-said it is "somewhat reliable." The final choice brought out a group of TCA non-believers: Nearly one-third said trade-cost analysis is "unreliable."

About one out of five survey participants were large firms: shops with equity assets greater than $50 billion. Here, just under half of these large firms (45 percent) factor in trade-cost analysis at bonus time.

Despite the skepticism, there is optimism that the usefulness of this discipline will improve. About 48 percent of the respondents said they believe trade-cost analysis tools will not only improve, but will also play a greater role in trader compensation in the future; another 29 percent said they could also see trade cost-analysis improving, but they doubt it will play a larger role in trader compensation. The naysayers who say trade-cost analysis will not improve came in at 22 percent. Nearly half of them-10 percent of the total sampling-say it will play a greater role in future compensation.