Big increase in portfolio trading, says report

The most active US institutional traders executed half their equity trading volume through portfolio trades last year, according to consultants Greenwich Associates.

Portfolio trading – also known as programme trading – is the execution of many equity deals in an automatic process. Most major broker-dealers now offer a portfolio trading service.

Greenwich surveyed 185 trading desks and found that portfolio trading among institutional investors now accounts for 50% of overall share volume, up from 44% last year.

“Institutions are lowering costs by using portfolio trading for a larger proportion of their volume and by directing a portion of those portfolio trades to self-directed electronic trading systems,” said Jay Bennet, a Greenwich Associates consultant. “In addition, they appear to be saving money by doing more risk trades as opposed to agency business. Combined, these trends represent a big win for the institutions.”

Portfolio trades can be split into two broad categories. The simplest is referred to as an agency trade, where the portfolio trading desk simply acts as a bridge to the market and does not take on any trade risk or commit any of its own capital. With a principal trade, however, the portfolio trade provider steps in between the client and the market and facilitates the customer order by trading on its own account, and committing its own capital.

Greenwich reports that as portfolio trading volumes have grown, commission rates have come under pressure. “While institutions on average reported portfolio trade commissions of 2.2 cents in 2004, one-third of all participants in our research said they are paying less than 1.5 cents per share,” said Greenwich Associates consultant John Webster. “That number is particularly striking in that only 13% of institutions dipped below that threshold in 2003.”