US Institutional Equity Trading Study 2017: In the Eye of the Storm

2017 is proving to be an exciting and dynamic time for US equity markets. A new president has promised less regulation and the market has rallied to new highs. And yet, despite the expectations for dramatic political change, volatility is at historic lows. In fact, the average close of the CBOE Volatility Index (VIX) in February was 11.5, the lowest in 10 years.

However, this relative market stillness could just be the calm before the storm. With significant elections across Europe, expected interest rate hikes, and the uncertainty around the policy implications under US President Donald Trump, the coming months could be a shaky time for capital markets. Given the influx of political and macroeconomic uncertainties, the buy side expects volatility to increase in 2017 compared to 2016.

Besides these largely external and political challenges, serious changes are also coming from within the industry, specifically around MiFID II (Markets in Financial Instruments Directive) and the growth of passive investing and exchange-traded funds. When TABB Group asked participants if these factors were impacting their businesses, 96% said the shift to passive had impacted them and 76% expected to be affected by the MiFID II unbundling rules.

While these issues are undeniably transforming the industry, the reaction from large and small buy-side firms is radically different. Large firms are reorganizing their business, investing in new technologies and adapting their processes. In contrast, the majority of small firms are waiting and watching to see how these changes pan out.

Since small firms are less likely to have global businesses that touch Europe, MiFID II will likely not affect them directly, which explains part of the reason behind their waiting and watching strategy. However, another reason behind their reluctance to act is related to the size of their firms and allocation of resources. While large firms can devote their energy and create dedicated teams to brainstorm proactive strategies around regulatory events or the evolving market environment, many small firms are already under-resourced and strapped for cash.

Additionally, given an environment with so much change, moving in any one direction can not only be daunting from a resource perspective but dangerous as well. Investing in one strategy may not be as effective if the tides turn. But with businesses under significant pressure, staying still is not an option either. In this way, small firms are in a no-win situation.

Although large firms have always enjoyed the advantage of size — more access to resources, economies of scale, greater diversification and specialization — the power of being larger has become even more pronounced. Large firms are turning toward innovation — experimenting with artificial intelligence, working with partners to explore new data sets, intricately customizing their algos and working across the buy side and sell side to find ways to collaborate. For both large buy-side and sell-side firms, the ability to adjust by leveraging their spending power at this delicate time of transition will widen the gap between small and large even further.