U.S. Money Managers Cut Wall Street Firms Out of More Trades
By Josh Hamilton
Chicago, May 28 (Bloomberg) -- It's 9:05 a.m. on a recent Wednesday, and Kevin Connellan has an assignment he isn't eager to entrust to Wall Street.
Northern Trust Corp.'s head trader has just received a fax instructing him to sell a million shares of a financial company included in the $330 billion of investments the firm oversees. Moving that much stock -- an amount equal to half the company's shares bought and sold on a typical day -- could easily drive down the price, cutting into proceeds.
By lunchtime, he has found buyers for almost half the shares without calling Merrill Lynch & Co., Goldman, Sachs & Co. or any of the securities firms that have long dominated U.S. trading.
``The institutional investor is much more in command,'' says Connellan, who spent three decades on brokerage trading desks.
He is part of a new wave of investors at mutual funds and other money-management firms who are doing more of their trading off Wall Street. Tapping into electronic networks linking buyers and sellers, they are costing brokers revenue they can ill-afford to lose as the securities industry struggles to rebound from the deepest slump since 1994.
The share of trading in New York Stock Exchange equities eluding Wall Street firms will almost double this year, says consulting firm Greenwich Associates.
``That's going to continue to grow,'' says Leo Smith, head equity trader of Putnam Investments. The fourth-largest U.S. mutual-fund company, which manages $314 billion, has an interest in Liquidnet, a year-old trading system that excludes brokers.
`Double Whammy'
Much of the business money managers continue to funnel to Wall Street takes the form of low-profit program trades. With program trading, large baskets of stocks are grouped together and processed by computer, generating brokerage commissions of as little as a penny a share.
Over the past two years, the percentage of institutions using program trades has risen by half, to 45 percent from 30 percent, Greenwich Associates says. Programs handled 32 percent of all NYSE trading volume the week of May 13 through May 17, according to the most recent exchange data, up from 26 percent a year ago.
``It's a double whammy -- the loss of profitability while new competitors force down commissions and take market share,'' says William Schneider, who oversees equity trading at UBS Warburg LLC. ``How thinly can you slice a tomato?'' he asks. ``At some point, all you're getting is water.''
Record Trading
Record trading volume helped make selling and trading stocks and their derivatives the most profitable part of the securities business in the late 1990s. Margins averaged almost 48 percent between 1996 and 2000, according to the Securities Industry Association. That compares with about 20 percent for bond sales and investment banking.
With total trading on the three major U.S. stock markets -- the NYSE, the American Stock Exchange and the Nasdaq Stock Market -- down 7.4 percent this year, that level of profitability may be difficult to sustain.
Last year, 16 percent of Nasdaq trades and 10 percent of trading in Big Board stocks were handled on alternative systems, according to Greenwich Associates. This year, an estimated quarter of Nasdaq trades and 18 percent of NYSE volume will bypass Wall Street trading desks.
`Serious Threats'
``Alternatives are serious threats, and it's accelerating a trend we've already seen to cut out the broker,'' says Brad Hintz, a brokerage analyst at Sanford C. Bernstein & Co. who was Morgan Stanley Group Inc.'s treasurer from 1992 to 1996 and chief financial officer at Lehman Brothers Holdings Inc. from 1996 to 1998.
Bloomberg News parent Bloomberg LP owns Bloomberg Tradebook LLC, which competes in the business of matching buy and sell orders.
The two systems Northern Trust's Connellan used that Wednesday -- ITG/Posit, a joint venture of Investment Technology Group Inc. and Barra Inc., and Liquidnet -- have experienced growing order flow.
New York-based Liquidnet, which matches orders anonymously between big investors, says its average trade is 60,000 shares, the largest in the industry. The firm, whose user list has grown to 99 institutions from 38, says it traded 1.1 billion shares in its first year. ITG/Posit, which began operations in 1987, saw its volume grow 19 percent last year to 9.3 billion shares.
Both systems charge commissions of 2 cents a share, compared with the 5 cents to 6 cents a share institutions generally pay to buy or sell stock through a major brokerage firm.
Both Sides Pay
``Do you need to pay 6 cents a share instead of 2 cents to sell 60,000 shares of Coca-Cola? No,'' says Dave Briggs, head trader for Federated Investors Inc.'s $19 billion equity portfolio. ``About one-quarter of our sales are done electronically, probably double from a couple years ago.''
The largest investor in Liquidnet is TH Lee Putnam Ventures, a New York-based venture capital fund affiliated with Thomas H. Lee Partners and Putnam Investments. That may help explain Smith's aim to double the 7 percent to 8 percent of his trading that now goes through alternative systems.
Trading between 35 million and 45 million shares a day, Putnam would generate brokerage commissions of about $400 million a year at 5 cents a share. That's $800 million considering brokers charge both the buyer and the seller.
Beyond the direct savings, Smith cites the need to safeguard information. ``There are a lot of points where people can find out what you're up to and use the information against you,'' he says.
Working the Trade
That's just what happens to Northern Trust's Connellan as he works to unload the 1 million shares.
By noon, he has sold 438,000 shares -- on Posit, Liquidnet and through a small non-NYSE-member West Coast broker he finds on Thomson Financial Corp.'s AutEx, a system that displays orders.
None of the shares goes for less than the stock fetched when he began selling.
Then, almost immediately after he calls a broker with an order to sell 50,000 shares, the stock's price starts to fall.
``In the old days, the desk just got an order and turned it over to the brokers,'' says Connellan, who came to New York from Dublin as a drummer with a rock band and got a day job working as a clerk on the floor of the New York Stock Exchange. He joined Northern Trust in 2000, after running trading desks for Drexel Burnham Lambert and Schroder & Co.
Now, he says, money managers are making ``a huge push to get best execution on trades because it does go to the bottom line.''
While that doesn't mean Wall Street is going to have to fold its tent, it suggests brokerage firms will face a tougher fight for their commission dollars.
``Margins have gotten thin, and the only way to be a player or survivor is to garner a larger piece of the volume'' says UBS's Schneider. ``Whoever has the best technology will remain standing.'' |
