Despite widespread usage, the buyside has mixed feelings about transaction-cost analysis and its effectiveness. A Greenwich Associates report on transaction-cost analysis, or TCA, released last month outlines its benefits, shortcomings and how firms are using TCA. Greenwich based its report on a survey of 104 buyside institutions it conducted between May 4 and May 9.
One unexpected finding, according to the report, shows that 19 percent of the survey sampling does not use TCA to measure its trading costs. "We were surprised to see such a large proportion of institutions not using TCA, in light of its importance from an ERISA and regulatory perspective," says John Feng, a Greenwich consultant who worked on the report.
Little or No Role
The Greenwich study shows that 80 percent of those institutions surveyed use some form of TCA–the tool asset managers use to measure how their trading desks perform in their equity trading operations. But TCA’s ability to help generate additional returns to investors strongly divides the survey respondents.
"When it comes to the question of how important TCA is in determining investment results," says Jay Bennett, a Greenwich consultant who also worked on the study, "35 percent say TCA plays little to no role, and an equal share say TCA is very important or extremely important."
TCA is designed to measure how well an asset manager’s order was executed, according to a specific benchmark the firm sets. It measures how well the order was executed whether done so ultimately by the buyside trader, the sellside trader or a combination of both.
For the most part, the buyside sees the benefits of TCA when it comes to measuring their own desks and for compliance. But 12 percent reported that TCA adds "little" value in either area.
The report notes that the need to understand and rein in trading costs has risen in recent years, as the buyside has taken greater control of its orders with electronic trading tools. These factors have put a spotlight on TCA, which is the only option right now to measure trading costs and help to better understand the trading process. Overall, the study says traders see "potential" in TCA, but it currently has some weaknesses and needs improvement.
Traders are "generally" pleased with their TCA systems. But even here there are divisions. Exactly 43 percent of those surveyed say their systems are "very effective or extremely effective," 31 percent say their systems are "moderately effective" at measuring the desk, and about 25 percent reported that their systems are "somewhat or not at all effective."
TCA has been around since the 1980s. It uses analytics and a benchmark process, including standards such as implementation shortfall or volume-weighted average price, to attempt to measure how successful traders are at achieving the best results.
Missing Factors
The TCA system of choice is from a third party, according to the survey. Roughly two-thirds of the respondents use a third-party vendor. Of this group, about half use ITG and about a quarter employ Abel/Noser. Those using proprietary systems, at 11 percent, and those using broker analytics, 8 percent, comprise the balance of TCA users.
The survey also looks at how the buyside views TCA in relationship to broker performance. One-third of those surveyed report that TCA is "extremely effective" in measuring brokers, one-third say TCA is "moderately effective," and one-third say TCA is "somewhat or not at all effective."
Jon Wilcox, a trader at Munder Capital Management, in Birmingham, Mich., says it is unfair to measure brokers with TCA and not include other factors that go into a trade. These include the time horizon, the stock’s liquidity and average daily volume, the stock’s momentum, news and general market volatility.
Mark Schlarbaum, director of equity trading at Global Capital Management, in Conshohocken, Pa., agrees. Both say they use ITG’s TCA, and use methods other than TCA results to vet their broker lists.
"The brokers who look good in TCA usually are the ones we give the easiest orders to. And the ones who look bad are the ones we give the hardest orders to," Wilcox says. "We know which brokers are doing well and which are not. So we don’t use TCA for that."
Knowing the Score
In fact, Munder Capital uses TCA to get a sense of how well its internal investment and trading process works, Wilcox says. They monitor their trading quarter by quarter, rather than daily. "Because if we’ve just done a trade, we know why we did well or why it did poorly," he says.
The survey polled 68 institutional money managers, 12 hedge funds and a smattering of mutual funds, pensions, endowments and banks in the U.S., Canada and Europe. Those who responded consist largely of traders and head traders, but also include chief investment and chief operating officers, according to the report.
Buyside participants are mostly pleased with the data delivery systems, data and consulting services of their TCA providers, the report says. Still, Greenwich compiled a list of areas that could be improved. They include:
* TCA systems should provide faster and "real-time" data.
* TCA should adjust for changing conditions across the life of an order.
* The systems should cover more asset classes.
* They need to involve data from trading sources beyond the primary markets.
* They need to do a better job of showing how outliers can skew overall results.
In what is referred to in the study as a "striking finding," many buyside respondents reported that they would change their trading style if TCA became a larger component of trader compensation. Of 73 respondents, 57 percent–or 42–say they would alter their strategies and practices.
"In addition," the report notes, "some traders would be tempted to game the system to produce results that maximize compensation."
They note to the report’s authors that the drivers of TCA results aren’t always in line with "client goals and shareholder interests." Traders say it wouldn’t be good to concentrate on beating benchmarks rather than efficiently implementing investment ideas.
In fact, 23 percent of the respondents say TCA should play no role in trader compensation. At the other end of the spectrum, 20 percent said it should play a "large or extremely large role."
The report concludes by saying that the buyside would get more out of TCA if it were better integrated into the overall investment process. "Doing so will require institutions to include everyone who participates in the investment process into the TCA process," the report says, "and to train them in how to properly interpret and act upon results."
"I’d rather have it"
Schlarbaum agrees, but adds that it could be difficult in practice. In some cases, portfolio managers and trading desks have been working together a specific way for sometimes 20 years. "You’ve gotten into the habit of doing things a certain way," he says, "and it’s very difficult to change those ways."
Stepping back from the survey, Bennett told Traders Magazine that traders are torn on a variety of issues relating to TCA. They accept the regulatory and fiduciary responsibility to demonstrate best execution. But they also reject any notion that they didn’t live up to a model’s expectation, he adds.
Bennett says that it is also difficult today for a buyside shop to determine how aggressively to apply a system that doesn’t deliver "perfect information" in real time. However, he also offers an assessment of TCA.
"If I were running a buyside trading desk, would I rather have it or not have it?" he asks. "I’d rather have it."
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