Concern Over Trading Cost Oversight

Buy-side equity traders fear rapid adoption of technology that grades execution could distort performance incentives by overlooking material elements of the execution process.

Fund managers use transaction cost analysis (TCA) systems to review their traders' performance and determine if the fund got the best possible prices when buying or selling stocks, notes Toronto's Globe and Mail. Laws and regulations require fiduciaries such as fund managers to obtain "best execution" for the commissions they pay.

"But traders remain deeply skeptical of transaction cost analysis as a way to determine their compensation," the story says, citing a Greenwich Associates survey.

Traders see the new TCA regime as helpful when it comes to monitoring trading desk performance and ensuring regulatory compliance, according to Greenwich. But the consulting firm found using TCA tools to set a pay can have unintended consequences: Traders are tempted to "game the system to produce results that maximize compensation."

Money management executives told Greenwich automated cost monitoring falls short when models fail to account for constraints and other aspects of the investment process that influence a trade. The consulting firm advises TCA users to make sure they consider all aspects of the investment process, "from idea generation and post-trade analytics to the specific limits or conditions placed on traders by individual brokers or portfolio managers."