Best execution is not necessarily the best price. It is not something that can be measured on a trade-by-trade basis. Instead, it is a process that is not quantifiable, but is a set of quality standards, according to an industry trade group.
"Best execution for firms refers to a trading process firms apply that seeks to maximize the value of a client's portfolio given each client's stated investment objectives and constraints." This is part of a report and a set of trade management guidelines recently issued by a task force of the Association for Investment Management and Research (AIMR).
"We are trying to find a best practices standard that the rest of the industry can follow," said Wayne Wagner, chairman of the Plexus Group and a member of the AIMR task force, which wrote the report and guidelines. Wagner estimated that no more than 10 percent of firms today follow all the AIMR guidelines.
"It [best execution] is a process that is tied to each firm," according to Ted Aronson, the chairman of the AIMR committee that wrote these guidelines. He is also managing partner of Aronson+Johnson+Ortiz in Philadelphia. Aronson stressed that best execution is tied to portfolio-decision value and can't be evaluated independently.
[Best execution] "is a prospective, statistical, and qualitative concept that cannot be known with certainty ex ante… it is interwoven into complicated, repetitive and continuing practices and relationships," according to the task force's report.
The guidelines are not regulations, but are recommendations that AIMR officials hope will either be voluntarily accepted or possibly be enacted into rules by the Securities and Exchange Commission. "Speaking only for myself, I dream that the SEC might just decide to take these recommendations lock, stock and barrel," Aronson said.
Techniques Used
Indeed, a buyside trader for a large institution told Traders Magazine that his colleagues have complaints about quantitative transaction cost management techniques used by vendors. Some believe many of the AIMR requirements are too rigorous. The buyside pro said trading is often more art than science. "The complaints," he said, "are that the numbers are hard to understand; that they don't jibe with our gut feelings about certain trades."
Trading, he added, involves so many qualitative factors that a useful quantitative look is almost impossible. He claimed that none of his clients are even interested in the best execution process. Nonetheless, another buyside trader, also for a large firm, said that in today's bear market environment the AIMR guidelines generally made sense. Many desks monitor execution quality and should study the guidelines, he suggested.
That could be sound advice because the regulators may give the guidelines serious consideration. Aronson, for example, noted that an SEC official acted as an observer of the AIMR task force, which also had representatives of both buyside and sellside firms. These guidelines, which might qualify as a kind of Good Housekeeping seal of approval for trading pros, include recommendations on recordkeeping, disclosures and processes.
Wagner, whose own firm offers transaction cost measurement services, said the level of documentation required will probably raise some objections. "So many trading desks are used to operate independently; to solely work with brokers. We're saying that desks must learn how to operate as part of the firm and work with the goals of management," Wagner said.
One task force member privately told Traders Magazine that the documentation of commissions will likely be "a difficult area." For example, one section of the AIMR guidelines recommends that firms do an analysis of brokerage commission trends. Then they should conduct a comparison of brokerage commission forecasts with actual brokerage commissions paid.
"Any significant variances between projected and actual amounts," according to the task force report, "should be evaluated to determine, for example, whether there are exceptions to the firm's trade management policies and procedures, or whether the projections should be revised."
Commission Range
Another part of the guidelines asks firms to establish an acceptable commission range for trades. This section also calls for "maintaining appropriate documentation when the commission paid exceeds the acceptable, preestablished range and describing the circumstances that caused the deviation."
The task force, which spent some three years studying the issue, used seven different ways of measuring transaction costs. Nevertheless, given the many problems faced by traders, it is another area in which there is likely to be disagreement. The entire report and guidelines are available at aimr.org.
