Trading Net Alpha: Last Call for the Equities Status Quo

In a market where alpha is becoming scarcer, the buy side has even less money to pay for it. Across the buy side, fewer commissions are being allocated, and to a shrinking pool of core brokers. In addition, there are even less commissions available to the tail end of broker lists, which will inevitably become much shorter. The challenge they face is how to most accurately pay brokers while still working within budgetary constraints. There is a continuous tension between divvying up a slender pot while remaining relevant to core brokers. Fortunately, there are now tools available to help improve the strategic use of commission budgets. These tools allow for a more calculated way to track, measure, and value services.

Having a more quantitative way to measure services is not only beneficial for the buy side but to sell side as well. It helps both parties to better set expectations and maximize resources efficiently. By no means will the qualitative portion of this valuation process be done away with completely. The buy side and sell side still need to be fully engaged and share more information about their valuation and profitability models in order to come to a mutually beneficial agreement.

We cannot ignore that the increased quantification of brokerage value poses a threat to the institutional equity brokerage status quo. In response, brokers are fine-tuning how they measure client profitability, price their offerings and calculate payouts internally. For brokers, this means not only getting feedback from clients, but also leveraging that information as effectively as possible. More transparency into the value of services will lead to an increased ability to tailor services to custom fit each client.

The buy side is well aware that having strong relationships with full-service brokers is essential. We are a far reach from having all research and trading decisions determined by a strict formula, but every decision process within the ecosystem is becoming increasingly quantitative and less humanistic. By no means is the value of the relationship is over. However, a more quantitative approach only adds validity to commission payout decisions.

The TABB Group Vision Note Trading Net Alpha: Last Call for the Equities Status Quo examines the ways in which the buy side is applying a more rigorous approach to valuing brokers’ alpha contribution to the investment and trading process. This includes the progression of CSA usage, alpha capture tools, research management platforms, and transaction cost analytics. The report also takes a look at how working to better understand where they can add the most value to better service their clients.