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September 10, 2007

Balancing Act: High vs. Low

By Gregory Bresiger

Trading is up and research is down when it comes to the commission spending at the industry's biggest money managers.

A new study reports the percentage of the average institutional commission dollar attributable to trading is rising in era of declining commissions.

Greenwich Associates annual cash equities markets study, "U.S Equities Balancing Act: Cheaper Trades vs. Sell-Side Service," questioned 218 U.S. equity fund managers and 271 U.S. equity traders.

Greenwich reported that total U.S. equity commissions dropped from $10.8 billion to $10.3 billion in the 12-month period ending in the first quarter, compared to the previous year.

But the allocation for the trading desk-broker sales trading, agency execution and capital commitment-is growing.

The trading desk now constitutes 40 percent of the average institutional commission dollar. Last year the average was 35 percent and the year before that it was only 31 percent, according to Greenwich.

"In these last few years, we've seen more attention paid to best execution and to paying brokers for superior agency execution," said John Feng, a principal with Greenwich.

Meanwhile, the part of commission dollar spent on broker equity research held steady at 42 percent, according to the study. Greenwich said this figure includes the research part of commission sharing arrangements, but excludes third-party research paid for through soft dollars.

So if research held steady at 42 percent, which category is getting fewer of the buyside's commission dollars? The survey found declines in most other categories: compensation for capital commitment; third-party research services; commission recapture; and other services.

The rising trading-trend was more pronounced among some sub-categories surveyed. These included mutual fund managers and hedge funds. Mutual funds increased their spending on sales trading and agency execution to 45 percent of the average commission dollar from 21 percent two years ago. (Those figures do not include capital commitment.)Why and how did fund managers and large traders spend more of the average commission dollar on sales trading and agency executions?

In part, they did it by spending less of the commission dollar, 26 percent, on research. That number for this group is now about half of what mutual funds spent three years ago, Greenwich found. Feng says some of this is big fund families opting to use in-house research.

Hedge funds, the report found, now use 25 percent of the commission dollar for compensating brokers for sales trading and execution. That's up from 15 percent two years ago.

A continued increase in electronic and portfolio trading was another trend noted by Greenwich. A year ago respondents said it constituted about a third of trading volume. Today, respondents said, it is 37 percent. Traders expect half of their trading to be done electronically by 2010. If that remarkable projection comes to pass, it would mean electronic trading in the United States would have increased by about 35 percent over three years.