What Is 'Best Execution'?
In addition to the daily trade review conducted by each regional head, the oversight committee looks at the 15 worst trades, per trader, per benchmark, each quarter, considering factors such as the broker, country, discretion with which the order was placed, order size and overall performance, Stephenson relates. To avoid jumping to conclusions, he notes, the particular circumstances of each questioned trade have to be analyzed and considered.
"We look for the trends," Stephenson explains. "If the numbers for a particular desk are low but improving, there may have been external circumstances that made it negative to begin with." In general, outliers, or extraordinary trades, get the most attention, but it is the trends that tend to lead to policy changes, he says.
Franklin Templeton does have a boilerplate definition of best execution: "The best combination of price and intermediary [i.e., broker] value given our strategies and objectives from the inception to the completion of the order." But even this apparently straightforward sentence begins to reveal the complexities of the best-execution committee's charge once the word "value" is dissected. "That value could be research, execution, trade ideas, capital commitment, information flow and other potentially unquantifiable services," Stephenson says.
According to research from Celent, institutions value trade executions and a salesperson's responsiveness the most. Analytics services and algorithmic trading programs are at the bottom of the list.
Adding to best-execution committees' challenges, many buy-side firms are facing overhead-reduction demands from their institutional customers and are looking to reduce the number of brokers with which they work, according to Stephenson and TowerGroup analyst Gavin Little-Gill. A 2005 Celent report found that 73 percent of asset managers plan to decrease commission payments.
"Our board's responsibility is to work with our global head of trading to review trading activity in explicit cents per share and implicit costs, such as market impact, and look at brokers we are using to execute those trades, and look at everything they can to keep costs down," says the head trader at a large fund manager who requested anonymity because he is not authorized to discuss his firm's strategies.
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