An expected shift out of fixed-income assets, and into equities, won’t necessarily reverse a long-term decline in U.S. institutional equity trading, suggests a new report from Greenwich Associates.
The firm reports that in the first quarter daily trading volume in U.S. equities was down by about a third from its high in 2009. “Equity brokers suffering from the pronounced slowdown in U.S. equity trading volumes had been hoping that an increase in interest rates might jump start trading activity,” it says. “But recently, brokers have started planning for a new market normal in which trading volumes, commission payments and brokerage revenues hover close to today’s depressed levels.”
Greenwich says that brokers are scaling back their businesses, expecting annual institutional commissions of about $9 billion-$10 billion, as opposed to the $13.9 billion peak reached in 2009. As part of that process, brokers are taking aggressive steps it says, including cutting jobs, internal consolidation, and reducing compensation.
While higher interest rates should drive some flow out of fixed income and into equities, Greenwich suggests that this asset shift is unlikely to lift to trading volumes and brokerage commissions back to prior highs. It reports that 81% of buy-side institutions participating in its research think that U.S. equity market turnover will fail to rebound to pre-crisis levels by 2014.
And, it notes that the longer-term decline in trading activity has taken place amid historically strong equity markets. “Institutional commission payments track with market volatility and, in recent years, have been inversely correlated with rising market valuations. This reflects investors’ confident buy-and-hold behavior on market ups and heavy trading on fear-induced sell-offs,” it says.
“Given these patterns, it’s possible that even with a strong rally sparked by an influx of assets from investors fleeing fixed income, trading activity could be dampened by a continuation of the low volatility and volume that has characterized the recent run-up,” says Greenwich Associates analyst, Kevin Kozlowski.
Greenwich points out that institutional funds have been reducing their U.S. equity allocations for years and are increasingly turning to passive U.S. equity strategies. It reports that average allocations to domestic equities have declined from 45% of total assets in 2001 to just 27% in 2012, for U.S. pension funds, endowments and foundations.
“Any major shift of assets into U.S. equities would seem to go against the long-term plans of most U.S. institutional funds, which as a group have embarked on a multi-year effort to reduce their exposure to domestic stocks,” it says.
The firm also notes that the drop in trade volumes and commission flows has also slowed the rush to electronic trading, with institutions executing trades through higher cost traders, as opposed to lower cost electronic executions, in order to compensate the sell side firms for research and other services.
“The slowdown in the growth of electronic trading can be attributed in part to the fact that institutions are routing trading volumes to high-touch execution in order to generate commissions to compensate brokers for research and other services,” says Greenwich Associates consultant John Colon. “Investors still have plans to significantly increase the share of their business done electronically over the next three years, but it remains to be seen if they will be able to achieve that goal.”