Emerging
Brokerage Firms in
the United States
Presented to
Investment Management Consultants
Architects of Financial Prosperity
The Board of Trustees
Los Angeles City
Employees Retirement System
October 6, 2005
About the Study:

Objectives
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Gain sound understanding of emerging brokerage landscape
Identify emerging brokerage firms
Support the LACERS Board in
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Basis for the Study
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Commissions as Trust Assets
There is ‘alpha’ at the point of trade
Backdrop
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determining constructive and informed policy decisions
Moving ahead to provide access and opportunity to firms in the marketplace
Fiduciary responsibility
The Concept of Best Execution
Content
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In-depth review and analysis of the current landscape
Quality database

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Detailed profiles of each firm
Review of other emerging brokerage programs
2
The Concept of Best Execution
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Brokerage commissions are an asset of the Fund
Trustees can direct managers to employ certain brokerage firms
as long as trustees honor fiduciary responsibility and managers
obtain best execution.
Best execution:
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SEC: “a duty to seek the most favorable execution terms reasonably
available given the specific circumstances.”
AIMR: “the trading process firms apply that seeks to maximize the
value of a client’s portfolio within the client’s stated investment
objectives and constraints.”
Why put a name to the concept?
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SEC: to ensure that brokers and managers trade in the client’s “best
interest”.
Trading costs are not limited to commissions on trades.
Effective trading = cost containment plus value-added.
3
Best Execution
 Components
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Explicit
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Commissions: price change associated with executing a trade:
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Implicit
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Market Impact or Liquidity Charge: caused by a trade entering the
marketplace
Timing: price change due to information leakage or momentum
Opportunity Cost: cost of incomplete orders
Examples of Methodologies for Measurement
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
Cents per share
- Mark up/Mark down
Basis points on total value
Volume weighted Average Price (VWAP)
Implementation Shortfall
Who measures?
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Plexus
ITG
- Quantitative Service Group
- Others
4
Best Execution
 Why measure?
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–
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Can affect performance
Can impair ability to generate “alpha”
Can be one of the largest erosions in investment value and a
barrier to superior performance
A Pro-active Stance…
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Acknowledges and establishes best execution standards
Monitors transaction costs of both managers and brokerage
firms.
5
The Investment Manager’s Perspective

Stated Methods for Brokerage Selection
1. Traders and portfolio managers decide
2. Trading Oversight Committee
3. “Tiers” system
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Tier I: Bulge bracket firms
Tier II: New firms, niche players
- Tier III: Client Mandated
Separate category for sources of “street” research
Getting on the “Approved” List: Some Stated Criteria
4.

Quality & quantity of proprietary research
2. Ability to execute different types of trades, like directed or programmed.
3. Legal & compliance profile
4. Financial Strength
4. Financial strength
5. Credit Risk
6. Regulatory violations
1.
6
In Search of Emerging Brokerage Firms
 Definition:
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“Emerging Brokerage Firm” is typically used to refer to relatively “new”
companies with a newly developing revenue model.
A firm is usually considered “emerging” based on its years of experience
and its volume of business.
Such firms are usually established by seasoned professionals with an
interest in developing certain working teams and strategies, and with a
knack for or interest in executing specific trading strategies.
These firms seek to compete on equal terms with larger, traditional
brokerage firms.
The term “emerging” is also used in reference to firms whose owners are
women, ethnic minorities and/or the physically challenged.
Definition employees:
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51% ownership African American, Hispanic, Asian, Woman and/or Disabled
Veterans
Members of the National Association of Securities Dealers
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
Preparing the list:
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Conversations with LACERS
Conversations with LACERS investment managers (10)
Firms known to Consultiva
National Association of Securities Professionals
New America Alliance
Reaching out
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In-depth, comprehensive RFI based on
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Brokerage criteria and trading qualifications provided by managers
Existing programs across the US
Covers:
1. Organization and Firm Overview
6. General Trading Capabilities
2. Legal & compliance Issues
7. Equity Brokerage
3. Company Personnel
8. Fixed Income Brokerage
4. Research Capabilities
9. Emerging Brokerage Experience
5. Sales
57 firms contacted, 31 responded.
Subsequent tele-conferences with each.
Profiles developed for each.
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The Universe
Observation
Minimum
Maximum
Average
Years since
Founding
3
34
12
Number of
Employees
2
136
26
A Seasoned Group:
1. At least 21 (72%) firms are more than 10 years old.
2. All founders with over 15 years experience.
3. Most have over 20 years experience
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The Universe
Location
Number
New York
8
California
7
Illinois
5
Texas
3
Washington DC
2
Other
4
10
The Universe
African American
Hispanic
Asian
Disabled Veteran
Caucasian
Total
Male
12
6
3
2
0
23
Female
3
1
0
0
2
6
Type of Services
Wealth Management
Institutional Brokerage
Retail Brokerage
Banking/Underwriting
Research
Asset Management
Total
15
7
3
2
2
29
•52% African American
•24% Hispanic
•10% Asian
•7% Disabled Veteran
•7% Woman-owned
Caucasian
# Firms
2
28
8
16
16
4
11
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Stated Trading Capabilities
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Most have average trading experience of over 15 years.
All have electronic trading capability.
Nearly 40% provide either equity or fixed income liquidity.
Nearly 30% have proprietary trading desks, either equity or fixed
income.
75% have Transition Management capability, either through an
alliance, or through their correspondent.
13 firms execute trades for soft-dollar credit.
Commission rates are $0.01-$0.06.
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Existing Emerging and Minority Brokerage Initiatives
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Gathered information on 46 initiatives across 16 states
A three level progression
Programs
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List of “Approved Broker/Dealers”
Goals or percentages of allocations of business
Predefined goals, milestones,
accountability and monitoring
34
1
11
States with most comprehensive programs: Illinois and Ohio
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Findings
1.
2.
3.
4.
5.
Policies without goals, tracking or monitoring are tantamount
to no policy at all.
Active communication between plan sponsors, broker/dealers
and managers is essential.
Strategies should be developed to address the use of small
firms versus larger ones.
Approved brokerage lists rest on will of managers.
“Caps” are counterproductive.
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Recommendations
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Create a formal Emerging Brokerage Program with a clear
Statement of Purpose
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A clear description of Eligibility Criteria
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“Support the development of new and innovative initiatives in
securities brokerage that will enlarge the landscape of providers,
while providing increased opportunities for new firms.”
“Support and promote competition among brokerage firms”
the qualifications, registrations and certifications
Specific Implementation Suggestions: Some Best Practices
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Develop and staff¹ a tracking or trade monitoring system;
Establish standards for scoring or grading, gradually awarding more
business to best performing firms;
Standards for volume of trades by asset class, to be executed by the
firms included in the program ;
¹ “Staff” refers to internal or external human resources
15
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Statement and Process of Intent to Implement
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Staffed mechanism to track:
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Investment managers ongoing reporting on
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volume of business executed with each emerging firm
– verification of the manager’s attempts to trade
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Actions and guidelines for investment managers who do not meet
policy goals or failure to adequately document reporting
requirements.
Incorporate emerging brokerage policy and guidelines into the
investment manager mandates
Support with Governance
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Staff the initiative! Assign accountability for success.
Sponsor communication forums between brokers and managers
Engage managers in developing fair trading structures for
allocations, while mindful of managers regulatory circumstances
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Protect the Integrity of your Intent
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Ensure best execution capabilities: Conduct a study on trading
costs and best execution
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Implicit trading costs contribute more than commissions
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Market Impact
– Timing
– Opportunity costs
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Next Steps
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Review best practices for LACERS program options
Develop program recommendations for Board consideration.
Conduct a study on trading practices and best execution.
Follow up with firms to set up formal communication and
introduction with LACERS Managers.
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
Conclusions
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A more level playing field today: technological advances
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Today, best execution is indifferent to firm size and ownership
structure
LACERS Database of Emerging Brokers encompasses firms
with sound institutional capabilities to service the needs of
investment managers.
Challenges for the emerging firms:
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Concentrated skill: domestic equity
Concentrated source of flow: Directed Brokerage
Access to the business: Not being acknowledged by managers
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Addendum
19
Consultiva Internacional, Inc.
– Independent, employee-owned, investment management and
research firm
– “Boutique”, specialized in financial architecture, serving the
small-middle market.
– Based in San Juan, Puerto Rico and New York, New York
– Over 20 years of experience with pension assets
– Our job:


To determine appropriate asset allocation and investment
strategy,
To advocate on behalf of clients with product designers, vendors
and asset managers.
20
Whom we serve:
Fund-specific methodologies in place, delivered
in a multi-cultural environment...

Pension Funds

Savings Plans

Corporate Reserves

Endowments & Foundations

Taft Hartley Plans

Insurance Companies

Individuals & Families
The only Hispanic
investment consulting firm in the United States.
21
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Asset
Management
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Fiduciary
Education
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Products
22