Money Manager Dilemma: Revenue Down, Service Expectations Up

Along with the continued decline in asset levels of buy-side institutional portfolios, institutions are also cutting their complement of portfolio managers as much as 30%  to recoup the continued hemorrhaging of revenue.   Additionally, i nstitutional commission spending fell 12% last year alone, according to a sampling of 243 institutions interviewed by Greenwich Associates in both2002 and 2003.

“The cumulative result of these pressures is that the equilibrium pointbetween buy- and sell-sides has shifted,” Greenwich Associatesconsultant Jay Bennett said in a statement. “Nobody now knows where it should be andwhat they can reasonably expect – institutions in terms of what they cancount on in needed Wall Street services, Wall Street in terms of what itcan count on to fund the cost of providing those needed services.”

With the decline in commission spending, the average commission rate dropped in 2003 to 4.6 cents/share on thelisted market, and 4.5 cents/share for NASDAQ from 2002’s rates of 5.1 cents/share and 4.9cents/share, respectively. The decline appears to be ongoing as i nstitutions expect commission rates to fall further in 2004, to 4.5cents/share for listed stock, and 4.3 cents/share for NASDAQstock.

Commission rates are not alone in the cuts.   US equity portfolio managers’ total cash compensation – salary and bonus – was also down, albeit marginally, to $566,000 in 2002 from $572,000 in 2001. While salaries were up on average by 2%, bonuses were down 3%.  US equity traders’ total cash compensation increased by nearly 4% to $262,000 in 2002 on average salary rising 6% to $148,000 in 2002.

Alternative Clearings

Further fueling the commission-rate pressure is the growth in alternativeslike portfolio trading, electronic brokerage systems and the increasing use ofsoft-dollar and commission-recapture programs. Among portfolio trading, the average commission rate went from 3.8 cents/share in 2001to 3.2 cents/share this year, while the proportion of institutions doingat least some portfolio trading rose from 38% to 51%.

Meanwhile, the proportion of institutions of business being done on asoft-dollar basis rose from 10% to 12% this past year, mostly due to theskyrocketing proportion of institutions doing soft-dollar NASDAQ trades,from 13% in 2001 to 62% in 2003. The proportion of institutions makingcommission recapture arrangements has also risen from 33% in 2001 to 59%this year.

However, the real coup de tat was scored in the utilization of electronic brokerage systems for trading on bothlisted and NASDAQ stocks. Among those doing NASDAQ business, 80% ofinstitutions report trading electronically in 2003, up from 74% in 2002, with similar numbers being reflected in listed stocks:   75% of institutions report trading electronically, up from 65% in 2002.

Institutions that are trading from these electronic brokerage platformssay they trade 24% of their NASDAQ business and 13% of their listedbusiness in that manner, and expect to trade higher volumes (28% oftheir NASDAQ business, 19% of listed) in 2004.

Service Plus

The service expectations come from a heavy reliance on Wall Street research.   In fact, the proportion of total commissions allocated to equity research has risenfrom 29% two years ago to 39% in 2003.

This is to a very large extent a reflection of their drastic reductionin commission spending on new issues – commissions for which have fallenfrom 21% of the total in 2001 to just 4% in 2003. “They are hardlyspending anything on new issues because there are hardly any newissues,” Bennett notes.

Greenwich Associates interviewed 257 US equity portfolio managersabout the research and sales services they receive and 305 US equitytraders about the trading services they receive from their brokers inthe United States. Both groups were also asked about current marketpractices, trends, and compensation. Interviews were conducted fromDecember 2002 to February 2003.