Buy Side Could Seek Alpha in Post-Trade Data

With lower volumes and cost pressures, buy side firms are scrutinizing their commission bills they pay to brokers with an eye on tightening their expenses. But with not much fat left to cut, a provider of revenue management and fee billing software suggests that the next step is to look at post-trade data.

"A lot of people focus on best execution and trade cost analysis,” said Terrence Faherty, head of product strategy for Bonaire Software LLC, a revenue management and fee billing solution for institutional asset mangers, wealth managers, banks and brokers. “That’s really pre-trade analysis but after the trade is done, there is a lot of cost that goes into the execution,” said Faherty.

Bonaire’s Revport system enables institutional fund managers to look across all of their relationships with brokers, giving them transparency into the costs and whether they are getting the correct volume discounts.

“If they are routing the trades to the proper broker dealers they can drive down their costs or generate direct costs to the funds’ expenses, or soft dollars they can use to pay for technology or research,” he said. “That’s a way to find alpha through reduction of costs,” added Faherty.

The buy side has negotiated an all-in-rate that incorporates all those post-trade costs, whether settlement or exchanges fees, but they may not have transparency into those components, Faherty suggests. “Where the buy side can get instant cost savings is making sure that the contracts with the broker-dealers are being enforced.”

For example, asset managers that negotiate volume discounts with particular brokers need a system that maintains what those discounts are to make sure they are getting the proper discounts, said Faherty. "A lot of times, they don’t get those discounts and that can add up to millions of dollars of cost," he insisted.

Commission recapture is another area to watch, he said. “They need to reconcile the commission recapture and make sure it’s accurate,” he said. This is viewed as alpha. Any cost reduction increases performance,” he said.

Since buy side firms have already made cost reductions in their firms in terms of headcount, there is nowhere else to cut, so Faherty said the next step is to look at post-trade costs associated with settlement and operations. “If you can save 25 basis points there, it directly affects the return on your performance,” he said.

Bonaire creates a database of historical information that allows them to mine their data to check that they are executing that business as efficiently as possible, he said. Dashboards provide visibility into the information and can generate business intelligence reports.

The buy side has all the contracts and agreements with brokers and then based on volume levels, the buy side will know what commission they should be paying their broker-dealers or commission recapture they should receive. They can reconcile their payments and discounts vs. their volumes to make sure their invoices are accurate. “Then they go back and see which relationships are advantageous,” said Faherty. Once they have visibility into the data, they can renegotiate with particular brokers," said Faherty, telling them, “This is what I expect," or “These are the terms I have with competitors,” he added.

The move is an example of finding alpha in Big Data, said Faherty, noting the system maintains a central database and all the contract details are scanned in. Now that Bonaire’s system is able to look at massive amounts of data, it can perform reconciliation and check down to the lowest level.

The firm is doing a lot of work in the mutual fund distribution industry. “If you have 10 funds and 100 intermediaries it can be very complicated who you owe what to,” said Faherty. Bonaire uses the same technology to basically manage the intermediary fees and make sure they are accurate, he explains.

While tracking the expenses associated with fund distribution is not the same as trading, Bonaire is starting to see interest on applying the same methods to trading costs. It’s working with one investment manager who has done work with the TCA and best execution, but that doesn’t give you a full picture of the cost of trading, said Faherty. By bringing Bonaire in, they’re now able to look at the full transaction cost, he said.

“It’s a growing trend on the buy side,” contends Faherty who compares this to managing a household budget. All the focus has been on getting refinancing the mortgage, but then people need to cut more so they look at the number of cable boxes and the cell phone bill.

Similarly on the buy side, all the attention has been on TCA, so now it’s time for the buy side to look at the overall household budget, he said. “There aren’t many more places for them to look for cost reduction,” said Faherty. “What they’re finding is looking at the post-trade costs, they never had transparency into it, but there is alpha to be found there. “

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio