Green Light Special: Automating Decisionmaking
June 6, 2011
For a fund manager, picking stocks to buy or sell means sifting through hundreds of pages of reports, a like amount of e-mails and countless phone calls, every day. That's before choosing what algorithm and trading venue to use.
Afterward, the fund manager has to figure out which firms provided the best research and allocate commissions to those brokerages and other research providers. Last, but not least, the fund manager needs to keep track of who was paid how much and when.
The answer? Automate as much of the process as possible. Upgrades in technology are making this possible for portfolio managers, traders, analysts and operations executives, according to Tabb Group, a New York research and advisory firm.
Using so-called "alpha capture" systems, a fund manager can track the performance of all its investment ideas from broker-dealers, explained Adam Sussman, Tabb's director of research. Such platforms can provide numeric bases for fund managers to decide which stocks to buy and which broker-dealers to use.
In his report on the future of alpha-capture systems, Sussman cited four third-party platforms as examples of alpha capture systems. London-based youDevise's Trade Idea Monitor; Bloomberg's Alpha/TMSG; New York-based FactSet's Alpha Network; and Canada's First Coverage's The Community, which just merged into youDevise. Broker-dealers such as Morgan Stanley; Deutsche Bank and Nomura Securities have also built their own alpha-capture platforms which often feed into the third-party platforms.
Next up: using global commission management platforms.
These allow fund managers to not only keep track of where the research dollars should be distributed but also use multiple broker-dealers and research providers around the world, said Cheyenne Morgan, an analyst at Tabb Group, who co-authored a report on commission sharing agreements.
She did not cite the providers of commission management systems but fund managers queried by Money Management Executive gave Instinet, Convergex Group and ITG as examples.
Allocating commission dollars can be pretty inefficient. Many fund managers typically rely on an array of systems they either have built in-house or deployed from their broker-dealer to determine the right trading strategy to use and who to use to execute it.
However, investment departments often award broker-votes-just who they will give their research dollars to - based on their recollection of the performance of the broker-dealer's research. Just as bad, fund managers might miss out on an investment idea because they can't keep track of all the faxes, emails, phone calls and research reports they receive.
"Alpha capture systems take the noise out of idea generation and streamline the process," explained Tim Murphy, director of YouDevise in the Americas. "They help fund managers implement rules on which stock ideas they want to receive from which broker-dealers feeding the platform, measure the relative performance of those ideas, rank the broker-dealer against a set of benchmarks and create an audit trail."
Fund managers can use YouDevise for free but must sign contracts with their broker-dealers to receive the ideas through the Trade Idea Monitor. YouDevise, in turn, charges broker-dealers a "per-seat" fee while they can also earn extra commission dollars based on the value created by their ideas. The cost savings would come out of the more than $500 million a year youDevise estimates that buy-side firms pay their brokerages for trade ideas.
Armed with a quantifiable metric of which broker-dealers ideas performed the best, the fund manager can then decide where it wants to allocate its research dollars. Those dollars are part of the commission payments which the fund manager has dedicated to executing its investment strategy.
"Fund managers can house their CSA accounts with a handful of broker-dealers. Those broker-dealers, in turn, will distribute those commission dollars to other broker-dealers and research providers," Morgan said. "The fund manager can consolidate CSA accounts and pay out research dollars through a commission management aggregator."
For global fund managers trading in multiple markets, a global commission management platform can also reduce the need for an investment firm to administer multiple commission management programs-one for each region. The fund manager can allocate research credits collected in one region to another.
"Dealing with multiple commission management systems becomes a hefty administrative burden and increases the potential for error," said Luke Mauro, director of global operations for Instinet. "The fund manager has to ensure that each broker-dealer with which it has a commission sharing agreement has the right technology and operations in place to pay multiple research providers. It could end up losing some research credits."
So just who has embraced the new technology? Alpha capture systems appear to have won favor primarily from quantitative hedge funds in the United States and conventional asset managers overseas. YouDevise said that 200 managers receive trading ideas from about 600 broker-dealers through the Trade Idea Monitor.
"Electronic alpha capture is more relevant for short-term trading ideas and does not help quantify the type of ideas and access that help fund managers generate long-term alpha," Sussman explained. "Fundamental managers also want only a few ideas each week and they consider each idea generated by the broker dealer as a single trade." By contrast, quantitative firms typically want every single idea that can get their hands on so they can quantify market sentiment and create a signal to be fed into a quant trading model.
Regional differences also come into play. Adoption of alpha capture systems began in the U.K and Europe about five years ago and didn't catch on in the U.S until two years ago; Asia-Pacific is now showing interest. "As more U.S. brokers join the network and start entering their ideas, fund managers will follow suit," said Sussman."The larger the network of ideas, the more attractive it is to the investment management community."
Global commission management platforms also don't appeal to all fund managers. "Those which use only a handful of broker-dealers may not think they need an aggregated platforms," Mauro acknowledged.