(UX Wealth) The financial services industry has experienced growth in managed accounts, custodial platforms, separately managed accounts (SMAs), and unified managed accounts (UMAs). This growth has presented challenges related to best execution in trading assets for these accounts. This noteworthy development is to the tune of $10 trillion in assets across these various management styles and products. While this achievement indicates the success of managed accounts, it also highlights a long-standing issue – best execution challenges associated with these assets.
The trend is noticeable; RIAs have begun to ramp up their usage of outsourced managers for some time. However, the increase in assets and endless model marketplaces hosting the same managers and their respective strategies translate to a significant issue regarding best execution. One of the critical pieces to this puzzle is the notion of “who’s pressing the buttons,” meaning who is in control of physically executing the orders.
Control matters, and for more than one reason. For example, if an investment manager has many clients (executing and non-executing) across various custodial platforms, releasing an update to the strategy, or a trade signal, becomes quite cumbersome. So how does the investment manager treat their participants fairly, and what if the manager updates their strategy much more frequently? Well, the issue continues to compound. Trade rotation is an attempt to solve this problem, primarily what our industry currently uses.
Trade Rotation refers to the process in which sponsors and institutional orders are placed in a predetermined sequence, whether ordered numerically or through a randomized method. The underlying rationale is to ensure fairness among sponsors, believing that any short-term performance disparities will balance out eventually. Although the concept of trade rotation is well-intentioned, it essentially signifies the recognition of inherent flaws within the system. In virtually all other aspects of the business, relying on a random selection process is hardly a desirable approach. Individuals prefer securing a prime position, obtaining the finest accommodations, and procuring stocks at the lowest possible price. Therefore, trade rotation serves merely as a temporary fix rather than a comprehensive solution, as it fails to address the fundamental issue of best execution.
To be clear, rates for agency trading range from a couple of pennies per share at most to amounts lower depending on the relationship and order flow. Clients and advisors would happily pay that rate if their execution was significantly better (think 5-15 cents/share). This is not only available for investment managers but easily doable! But if we look at this problem from the position of the custodian, we see why many cannot achieve this.
From a custodian’s perspective, they want to retain as much order flow as possible on their platform. Instead of acting like an agency desk and earning the order flow, they gate-keep it. They charge exorbitant fees for this feature, making it so cost-disadvantageous for managers that many avoid the discussion or the opportunity altogether. On top of that, the various venues that custodians make available to their clients are not always the best sources of liquidity. Certain custodians only participate with specific platforms. What happens when a large block of a security that needs to be traded has liquidity in a venue not part of the custodian’s “approved” venues? The gatekeeping prevents the best execution from being achieved and leads to a disadvantageous execution in client accounts. However, they cannot turn a blind eye to the compliance issue due to all of this.
From a compliance perspective, advisors, RIA’s, and anyone executing a trade on behalf of a client has a duty and care to seek best execution on every transaction placed. This is achievable and efficient through the trade-away process with the right partner. The hurdle is getting the custodian to play ball; they are even forced to see and align with the benefits at the end of the day. With the proper disclosures and a bite-sized amount of education, the conversation of best execution becomes quite simple and doable. However, operationally speaking, considering multiple execution venues, various custodians, and orders passing between each can be daunting for the end advisor or RIA. That is where UX Wealth comes in.
UX Wealth has built a platform to drive best execution for its clients. We have an award-winning model marketplace that is full of quantitative, artificial intelligence, and machine learning solutions exclusive to our clients. Not only do we offer our strategists, but we help in executing our client’s models as well. We take an agnostic approach to custodians and facilitate the execution of hundreds of thousands of shares across multiple custodians daily. We assume the operational burden of trading and strive daily to push towards a reality where trading away, sourcing liquidity, and achieving best execution is the norm because you and your clients deserve better.
