Scott Kurland, Director, Investment Technology Group
Abstract
It is well documented that high fund expense ratios, over time, can cripple investment growth potential and there is increasing evidence that institutional investors are paying closer attention to the expense ratios of investment managers. Recent fund flow data clearly demonstrates that over a recent nine-year period, stock funds with the lowest expense ratios consistently received the majority of ‘new money’. In Figure 1, we see that between 2000 and 2009 stock funds with expense ratios in the lowest quartile received 79 percent of the net new cash flow, while the remaining 75 percent of funds received only 21 percent of the net new cash. This pattern holds for actively managed funds and is more pronounced for index stock funds. As the fight for fund flows continues, performance matters and managers are actively looking to reduce or contain costs which may impact their bottom line. While portfolio managers are actively engaged in alpha generation, it is the responsibility of the trading desk to preserve alpha. In their attempts to obtain the best price with minimal market impact, traders are employing more electronic tools such as algorithms to deftly source liquidity across the numerous exchanges, electronic communication networks, alternative trading systems, multi-lateral trading facilities, and dark pools. As they utilise algorithms to slice and dice orders into smaller pieces in an effort to reach numerous liquidity sources and obtain best execution, order fragmentation increases. And as order fragmentation increases, fund expenses and ratios tend to increase. Order fragmentation has increased the overall volume of trade tickets that must be processed and with each ticket, settlement costs increase. Furthermore, not only has the rapid rise in ticket volumes increased the cost and complexity of trade settlement, it adversely affects fail management, data warehousing, reconciliation, and performance benchmarking for both fund managers and their institutional customers. In this article we will examine the drivers of order fragmentation, review their impact on fund operating expenses and ratios, and present strategies for cost reduction.
Keywords
clearing and custody, fund expense, fragmentation, ticket aggregation, settlement cost, trade allocation
Scott Kurland, a Director at Investment Technology Group, Inc (ITG), is responsible for global sales and product management of ITG Single Ticket Clearing, the firm’s broker-neutral trade aggregation service. He joined ITG in 2010 as a result of the firm’s purchase of ESP Technologies’ Clearvoyance software and service. In 2002 Scott co-founded ESP and served as Head of Product Development. At ESP he was responsible for developing the industry’s first buy-side, broker-neutral Electronic Algorithmic Routing Network, EARN, and post-trade equity aggregation software (Clearvoyance). Scott is a finance graduate of the Wharton School of Business at the University of Pennsylvania and a regular contributor of editorials and commentary to industry publications.
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