September 6, 2011

When Investors Buy and Sell

When investors buy and sell shares, what happens?

The logical answer is “stocks go up and down.” Let’s get more specific. Among the 20 largest asset managers at the end of 2009, ten were bank-owned, says consulting firm Towers Watson. The five largest – Blackrock, State Street, Allianz, Fidelity and Vanguard – are independents that pass the preponderance of their buying and selling through the biggest sellside firms on passive equity and ETF trading programs.

The banks behind ten of the twenty largest asset managers include BNP Paribas, Deutsche Bank, JP Morgan, BNY Mellon, Credit Agricole, UBS, Goldman Sachs, HSBC and Bank of America.

The top ten futures brokers for 2009 were Newedge (Societe General/Credit Agricole joint venture), Goldman Sachs, JP Morgan, Deutsche Bank, Citigroup, UBS, BofA, MF Global, Morgan Stanley and Barclays.

The five largest banks behind derivatives contracts, according to the US Treasury are JP Morgan, BofA, Citigroup, Goldman Sachs and HSBC and the top 30 banks control nearly 100% of this business.

The top prime brokers offering value-added trade-execution services to investment managers in 2010, according to Global Custodian, were Credit Suisse, Deutsche Bank, Morgan Stanley, Goldman Sachs, JP Morgan, BofA Merrill, Newedge, UBS, Citi and Barclays.

The twenty-odd primary dealers for the Federal Reserve’s security auctions include most of the banks mentioned here, from BNP Paribas, to MF Global (formerly hedge fund giant Man Financial), to UBS.

Tracking trading, we have observed big gains in equity program volumes for BNP Paribas, Newedge and Credit Agricole. Barclays, Goldman Sachs, Morgan Stanley and Credit Suisse dominate still.

Do you see the pattern? The same banks that manage risk also drive trade executions. The ones that underwrite futures and options also help money shift from equities to futures and options. The ones managing the movement of government money are behind program trading in equities.

And the rules, from how trades match, to order-types, to best execution, to order-routing practices, are uniformly decreed by the SEC. Risk-management requirements are so steep that just big banks qualify to handle massive globally sloshing cash.

Thus, the answer to our opening question is this: When investors buy and sell, their liquidity becomes a tool for trading tactics that may be the exact opposite of what the investors actually think about your shares. Liquidity flows to prime brokers in fragments that congregate into tributaries forming a mighty stream that meets execution requirements and fuels index arbitrage or relieves counterparty risk.

But it’s not fundamental. It’s a device controlled by the few who transfer risk from asset class to asset class.

As you head out this autumn fulfilling the IR tradition of traipsing to sellside conferences, don’t forget the small brokers, the boutiques. Maybe they will buck this monochromatic crowd.

Yet often, boutiques can’t execute trades for investors who buy and sell stock on merits. They may be unable to meet SEC best-execution requirements. So they route to Morgan Stanley, which rolls orders into programs to earn rebates from exchanges, while simultaneously fostering index-arbitrage schemes with algorithms for top clients.

If this bugs you, IR pros, read everything you can about how trading works now. Then tell your management. It’s a place where IR can shine. The rub inescapably rests with the well-intentioned but unfortunate rules that cause all the money to work the same and look the same and flow to the gigantic few.

To borrow the title of a Bob Saget HBO comedy special, “That ain’t right.” And it can change.

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