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October 1, 2012

Mr. Limit Order

Gus Sauter is at the Vanguard of Roping In Trading Costs

By Gregory Bresiger

In 1987, George U. "Gus" Sauter was an obscure investment trust officer with little trading experience. He had just joined the crew of an investment company with a piddling $1 billion in assets under management.

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Twenty-five years later, the Vanguard Funds have $1.6 trillion in assets. It's the largest mutual fund complex extant, surpassing Fidelity Investments two years ago.

Sauter is about to leave his post as its chief investment officer, which he took in 2003. In the quarter century he's been with Vanguard, the trading industry's market structure has dramatically changed. Where 300 million shares used to be traded on three national exchanges each day, 4 billion a day get traded now, on 10. More than half of trading is automated. Roughly 40 dark pools and alternate trading systems now operate. And the cost of a trade has, in the last decade alone, fallen by 70 percent.

That's where Sauter, with the support of his fanatically cost-conscious employer, has been a driver of the change.

In filings with the Securities and Exchange Commission and in public comments, he has consistently argued for publicly displayed markets in which investors can see the costs of their orders.

He also believes that limit orders, unlike market orders, expand liquidity. He has held to these principles so consistently over the years that some in the industry have taken to calling him "Mr. Limit Order."

"I don't have any objection to that. I believe limit orders do make the market," said Sauter, who will leave his CIO position at the end of the year.

Cutting Costs

Displayed limit orders, Sauter said, drive down costs by allowing asset managers to put a ceiling or floor on the price they will pay in a transaction. The use of thresholds limits financial risks, and as a result, more orders come to rest in the market.

The expanded order book creates more liquid markets, almost by definition, and provides reassurance to investors that they will obtain better prices on the execution of their trades.

Limit orders, in effect, beget more limit orders. As a corollary, the liquidity creates more liquidity. And the increased competition for orders leads ... to more orders.

"If you are an investor who wants to trade immediately, you have a great option that has been granted to you by that limit order. You know you can trade against that limit order. So that is a good service that has been provided to you. And that's why I think we need to entice the creation of limit orders," Sauter said.

The byproduct? Lower costs.

"Competition among limit orders creates narrower spreads and additional depth of book, both of which contribute to a reduction in transaction costs for all investors," Sauter wrote in an April 2010 comment letter to the SEC.