The Great Migration
From the Jan-Feb 2006 issue of Advanced Trading
It's been happening since the beginning of history - the Pilgrims left England for a better life in America; settlers hit the Oregon Trail to seek gold in the Wild West; and now, sell-side traders, lured by excitement and incentive, have begun to make their own journey - to the buy side.
Historically the haven for trading, the sell side has seen momentous change in recent years, as automation has made its job significantly less labor-intensive. No longer are humans necessary for each trade; technology has enabled computers to execute a trade in a matter of milliseconds - and at best execution - with virtually no manual intervention. While the phenomenon was approached cautiously at first, broker-dealers increasingly are relying on technology and, as a result, releasing traders from their duties.
In fact, Goldman Sachs, one of the largest players on the sell side, laid off 30 traders last June, transferring their responsibilities to either electronic-trading systems or sales traders who were more qualified to offer expertise with execution. And another major sell-side player, the Swiss investment banking firm UBS, followed suit in August, eliminating 30 traders, or 10 percent of its equities sales and trading staff, allowing technology to do the job.
Meanwhile, asset-management firms have become increasingly technology savvy. Many have allotted large segments of their IT budgets to trading technology, enabling buy-siders to use algorithmic and block trading, crossing networks, and direct market access to execute their own trades.
"It's no secret that the trading environment on the sell side has been rough," says Sang Lee, managing partner at Aite Group. "As the buy side continues to take control over execution activity, we'll see a certain level of migration from the sell side to the buy side. [Sell-side traders] bring a certain knowledge to the marketplace, and it's just not something you can create from scratch at a buy side firm in a short amount of time."
Re-Pledging Allegiance
Change on Wall Street always is met with some reticence, but, in most cases, it's inevitable. Justin Kane found that out early in his career. The former junior market maker at National Discount Broker, an over-the-counter market-making firm, says he found himself at a crossroad in 2000 with the advent of decimalization. The reduction of spreads cut into the profitability of Nasdaq market makers like NDB, he explains, and, "The business model just didn't work anymore."
Meanwhile, automation was blossoming in the equities market, enabling new opportunities for buy-side traders. Suddenly, buy-side desks could bypass the sell side for many trades, using algorithms, crossing networks and electronic communication networks (ECNs). With the portfolio manager working so closely with its own set of traders, benefits emerged, including enhanced control of the order flow, increased confidentiality and quicker trade times without an extra trader added to the process. Buy-side trading also eliminated conflicts of interest that arose when sell-side traders had their own broker-dealers' interests in mind. So, who better to initiate buy-side trading than those that had been doing it for years - sell-side traders.
Kane took advantage of the new opportunity on the buy side and made the jump to Rainier Investment Management, a Seattle-based firm with $5 billion under management, where he is now the director of equity trading. Prior to his arrival, the firm didn't have an in-house trader, he says. But Rainier was keen to hire Kane as technology advances continued to empower the buy side to take control of its own trading. "Before I came in, the portfolio manager felt that they could best convey to the sell-side trader what they wanted done," Kane says. "But, with all the changes going on, they realized they could take on a whole new approach to trading."
Like all buy-side firms, Rainier could have trained its existing team to become more knowledgeable in trading. But, Kane points out, "There's a big learning curve. You can either teach someone from scratch, or you can hire someone from the sell side that can hit the ground running."
So Kane's greatest asset was his trading experience, as trading can be daunting to a portfolio manager. "There are so many tools available to you on the buy side now, and it's a challenge to get over the fear of just executing your own trades," he explains.
Sell-side traders also enhance a buy-side firm's view of the Street, explains a recent buy-side arrival who swapped his sell-side trading job for a position as the head of an equity desk at a Connecticut-based traditional investment management firm with $1 billion under management. The executive, who requested anonymity, says, "There's a flexibility that comes from sitting on the sell side - you get to see all the different investment managers that are out there, with all their different processes." In exchange for their trading insight, sell-side transplants have the opportunity to learn about the big picture of the investment portfolio, an enticement for a trader who previously had been entitled to affect only his single trade, the head trader adds.
In addition, compensation on the buy side is beginning to rival pay on the sell side. While the sell side may have had a financial advantage for traders with its reputation for lucrative paychecks, many industry insiders believe the scales are evening out.
According to a May 2005 report from Greenwich Associates, buy-side CIOs' earnings in 2004 rose 15 percent over 2003 levels, to an average of $875,000. Equity portfolio managers on the buy side took home an average of $590,000 in 2004, up 12 percent from 2003, the report says, and head traders' compensation was up 10 percent, to $350,000, while traders earned $240,000, up almost 5 percent from the previous year. Further, Greenwich Associates contends that at hedge funds, compensation stands to be even more rewarding - portfolio managers at the average hedge fund earned more than $1.1 million in 2004.
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