In an effort to improve that performance, institutions are adopting Transaction Cost Analysis (TCA) as a core part of their equity investment and trading operations. However, even as more institutions integrate these performance measurement tools into their investment processes, questions about TCA's limitations persist and many traders remain ambivalent about TCA's ultimate impact. These doubts could grow as institutions start using TCA results to help determine the compensation of buy-side traders. In fact, 60% of buy-side traders say they would change the way the trade if TCA results became a significant determinant of their compensation.



Recognizing the growing importance of trading performance to buy-side institutions, Greenwich Associates surveyed institutions in the U.S., Canada and Europe about their use of TCA tools, the effectiveness of these tools and shortcomings that limit TCA's utility. Based on this Greenwich Market Pulse, the firm has compiled a list of steps that buy-side institutions, broker-dealers and third-party vendors can take to improve the effectiveness of TCA.



"Ultimately, institutions will judge the value of TCA on one factor: Does it improve investment returns?" says Greenwich Associates consultant John Colon. "Right now, there is no clear consensus on that count, but our research has identified specific improvements that would help make TCA a more effective tool for measuring and improving the performance of buy-side trading desks."



Wanted: More Comprehensive Analysis

The survey results show that buy-side traders and other decision makers are generally satisfied with their TCA providers and a clear majority sees TCA as an important contributor to such key business functions as managing internal trading desk performance and regulatory compliance. Traders are much less enthusiastic about TCA's ability to add value to the process of allocating trading business to broker dealers, and only a relatively modest proportion thinks TCA can have a strong impact on investment returns.



Many institutions that are less-than-satisfied with the effectiveness of their TCA systems share some common complaints with institutions that have decided to forgo TCA entirely: They say TCA systems' main shortcomings are the fact that they are inflexible and fail to take into account constraints and other aspects of the investment process that influence a trade. "It is important for TCA results to reflect — and for everyone at the institutions to understand — that implementation of investment decisions is a process, not an instantaneous event," says Greenwich Associates Director of Institutional Marketing Jennifer Litwin.



TCA and Trader Compensation

Buy-side traders are also in general agreement about how large a role TCA should play in determining their compensation. Their answer: not much. Approximately 20% of respondents say TCA should play a large or extremely large role in determining compensation for buy-side traders. At the opposite extreme, 23% say TCA should not play any role at all in determining compensation for buy-side traders, with the remainder falling somewhere in the middle. Critics of using TCA as a primary determinant of buy-side trader compensation caution that traders will alter their strategies and practices when TCA is integrated into the compensation process. In particular, some traders would be tempted to game the system to produce results that maximize compensation. "There are always ways to game TCA," says a trader for a U.S. hedge fund.



In one of the study's most striking findings, 57% of buy-side traders say they would change their trading practices if TCA played a larger role in determining their compensation.