Are You Getting a Fair Price? By Andy Parker; Twenty-First Securities Corporation
Over the last twenty years, by most measures, the process of buying and selling securities has become much more efficient. Stock commissions have dropped dramatically, bond prices have a much greater level of transparency, and Wall Street has invented many new products to help investors gain access to markets generally not available in the past. Asset classes such as commodities, master limited partnerships, and even market volatility levels are now readily available in the form of exchange-traded funds. By and large, the news for investors is good. Furthermore, the story seems simple – competition and creativity are up and prices are down. Behind the scenes however, the story is much more complex. In the 1980’s, Wall Street was a fairly small place and was largely controlled by the top ten or fifteen firms. The “facilitation” of stock and bond trading for clients was quite profitable and the larger securities firms committed significant amounts of capital to that enterprise. Since those days, the world has changed dramatically. Now, instead of a small group of Wall Street firms controlling the business of securities trading, the process has been fractured amongst a wide array of participants. Market liquidity is now provided by large brokers, banks, hedge funds, options traders, futures traders, quantitative (high frequency) traders, and a long list of other market players. A critical piece of this story is that the “facilitation” of client trading has essentially disappeared. Any capital committed to the business of buying or selling securities is done purely for trading profit – commissions are so low that they essentially don’t matter any longer. In recent months, perhaps spurred by Michael Lewis’ book “Flash Boys”, there have been a number of articles1 written on the value of human intervention in security order execution. In our experience, trade execution purely by a computer keystroke can be costly. And while this is true with most security trading, the issue grows dramatically as transactions expand in size and complexity. An example is worth sharing. A few weeks ago, we were asked by a client to price a two-year hedge on a roughly $90mm equity position. We asked 8 dealers to bid on this transaction and the values took the form of a percentage of the “floor” the dealer would be willing to “advance” to the client. The ancillary details of the transaction are not important but the bids we received are seen to the left. Each one of these prices came from a major financial institution. Importantly, there was no pattern to the pricing and our experience is that pricing is very “name-specific” – a dealer can simultaneously have the best price in one security and the worst in another. Pricing is driven by existing dealer positions, existing client orders, perhaps a trader’s market view, etc. Yet on a 2-year, $90mm transaction, the spread between the best price and the worst was over $8.5mm. Perhaps more important, the spread between the best price and the median price was nearly $1.9mm. Stating the obvious, this is strong evidence of the value of competitive bidding (and pays for quite a few dinners with your favorite broker). Also critical, our experience is that counterparties sometimes base their pricing on their perception of the client’s level of knowledge. At Twenty-First, we spend considerable time monitoring market pricing levels. Dealers recognize that we’re an educated customer and their pricing is reflective. Acting as our client’s advocate is what we do at Twenty-First Securities. Getting competitive pricing on complex transactions is a key component of what we provide. We also believe that taking the time to add value through careful order execution can create important incremental returns. We have multi-year relationships with many dealers. We know them well and have developed a mutual respect as well as a deep understanding of appropriate business practices. At Twenty-First, we focus on finding the best solutions for our clients. As always, we welcome your questions and comments. ______________________________________________________________________ 1. Ludwig, Olly, “Trading Upstairs”, ETF.com, Sept. 3, 2014, trading_upstairs_Ludwig_ETF.com Twenty-First Securities ? 780 Third Avenue, 24th Floor ? New York, NY 10017 ? 212.418.6000 ? http://www.twenty-first.com
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