SMA Managers Lean on Step-Out Trading for Fixed Income

SMA Managers are relying heavily on step-out trades to support investments in fixed income securities, according to the results of a survey done by Financial Research Corporation (FRC).

The survey, which is titled “SMA Step-Out Trading Trends in 2009”, had responses from 23 managers and most (86%) managed 20,000 accounts or less. However, the managers represented a wide variety of investment styles and the results could be an indication of some larger industry trends.

Use of Step-Out Trades Increasing

Managers appear to be increasing their use of step-out trading, according to the survey results. Several reasons motivate them, such as a renewed focus on best execution, the expansion of sophisticated investment strategies within separately managed account programs, and the need to enhance growth in the managed account industry.

Specialized Security Types Driving Use of Step-Outs

The increase in the complexity of investments used by SMA managers has forced the need to source liquidity from specialized brokers that either provide the necessary trading platforms or specialize in specific security types.

This is evident from the results of the survey, which showed that 100% of the managers used trade-aways for fixed income securities (see chart below).

Step-out trading continues to be very pervasive among SMA managers. Nearly 90% of the managers in the FRC survey population responded that they conduct step-out trades. 43% indicated that step-outs were dependent upon the security type being traded.

Manual Processes Still Prevalent

Almost half of the managers surveyed reported they still use manual processes (phone, fax, e-mail) to create and communicate step-outs. This greatly increases the chance of trade booking errors and reduces the efficiency of step- out trades.

Rise in Trading Volume Expected

Account opening and maintenance volume is typically traded with the sponsor — 70% of managers step out less than 10% of this volume — based on the relative size of the trades. However, model change/across-the-board volume is traded away much more frequently. Almost 25% of managers traded away almost all of their model change volume, with over 50% trading away more than half of their model change/across-the- board volume.

Many managers expect that the future volume of step-out trades will be going higher. When asked to provide their expectations for future step-out trading, every manager indicated that SMA step-out trading would either remain at the current level or increase.