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January 2, 2012

Cover Story: Bridging the Gap

Narrowing the gulf between today's transaction cost analysis and tomorrow's real-time measurement

By Mary Schroeder

Transaction-cost analysis is in the process of evolving into a set of powerful tools providing real-time information and decision support capabilities that are expected to give traders a leg up to find the most liquidity at the best price.

Long gone are the days when transaction-cost analysis involved sorting through reams of Excel spreadsheets. Despite its current shortcomings, TCA has matured as a tool recently and now helps shave execution costs for firms that have looked to better understand their trading process.

"What you are looking for is information that helps you understand the impact of certain factors on trading costs, such as the trading methodology, unique portfolio manager behaviors or the performance of broker-dealers across sectors, to name a few," explained Brian Fagen, Deutsche Bank's head of sales for North American execution services.

Brian Fagen, Deutsche Bank

Still, there is a wide gulf between the money management firms at the top of the food chain that are enhancing their trading performance with TCA and those further down the continuum that are simply using it to fulfill a compliance obligation for boards of directors. That gap between the two could narrow soon, however.

A few large money managers, as well as quant-oriented firms such as Batterymarch Financial Management, have built customized systems that provide traders with a trading strategy, plus the best brokers or algos to choose from for a particular stock. Now off-the-shelf solutions that provide similar capabilities are coming to market.

Decision Support

ITG has just rolled out a decision support tool that suggests specific algorithms or brokers at the point of trade. Markit, which recently acquired QSG, has a product that allows traders to determine the best broker algo for a particular order based on past experience in a very similar trading scenario or situation.

Meanwhile, both vendors are planning to roll out real-time pre-trade systems in the first half of this year based on entirely new methodologies.

TCA vendors currently provide pre-trade cost estimates, but they are based on data from up to the day before. The new pre-trade systems being developed by ITG and Markit will deliver cost estimates based on information that includes trade data from the same day. A few buyside firms have this capability now, and observers say that in addition to ITG and Markit, this type of service is likely to be developed by EMS providers working with TCA vendors that have the expertise to build an analytic model. 

As recently as two or three years ago, TCA "was seen as an exercise that led to a step change in trading behavior or as part of a periodic review with a broker or stakeholder," said Mike Googe, global head of Bloomberg's TCA product. Now, he said, the focus is on making TCA outputs actionable and linked to quality data, so the product can provide decision support.

SIDEBAR: Building a Better Benchmark