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January 30, 2008

Buyside Ups the Ante in Program Trading

By James Ramage

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Program trading is booming, but the share of flow reaching the sellside is in decline. With business up so strong overall, though, brokers don't seem to mind. Armed with increasingly sophisticated technology, the buyside is doing more trades in-house, rather than shipping them out to brokers.

The steady change over the past year or so has begun to alter the relationship between the buyside and their brokers. The trend has also changed how execution management system providers design the buyside's trading tools.

And when the buyside does send its orders to the sellside, it is increasingly bypassing the program trading desk and using the firm's algorithmic trading services. "The buyside has grown substantially as more money has flown into their investment vehicles," says Andrew Silverman, Morgan Stanley's head of sales and distribution for electronic trading. "In order to handle the flow, we see many traditional money managers now utilizing program trading strategies."


The trend of more do-it-yourself trading of single stocks is now expanding into the program business. Seven or eight years ago, industry pros say, buyside traders directed 100 percent of their program trades to sellside desks. Today that figure stands at about 75 percent.

Data gathered between November 2006 and February 2007 for the latest Greenwich Associates portfolio trading study showed that the buyside will trade 25 percent of all program trading volume itself this year, compared with 21 percent in the same period a year earlier. Although the buyside increased its level of self-trading for programs by 4 percent in a year's time, which might not seem like much, that still represents a 19 percent increase.

The increase occurred at a time of exploding program trading volume. According to the Greenwich study, the average buyside shop saw a 50 percent increase in the dollar amount of program trading it executed in 2007, compared to the previous year.

Marketwide, total portfolio trading volume jumped 52 percent to $2.1 trillion, from $1.38 trillion the previous year, the study reported. Greenwich attributes these enormous increases to cost, and how institutions viewed the program business as a way to lessen their average cost of trading, or "blended rate."

And according to the 135 institutional equity buyside desks the Greenwich study surveyed, program trades represented roughly half of their total equity trading volume.

Million-Dollar Trade

Program, or portfolio, trades are defined as those involving 15 or more stocks valued at more than $1 million. There are two kinds: agency, where brokers work baskets for a commission, or the buyside handles the order itself; and principal, where a broker commits capital and takes on the client's risk at a predetermined price. Agency trades are the most popular, constituting roughly 75 percent of all executed programs.

The buyside's move to handle more of its own trading-whether single-stock or program-is happening for a number of reasons, says David Liles, global head of electronic trading at agency broker Sanford C. Bernstein.