Matt Samelson of Woodbine Associates has a new report out titled “US Equity Performance” Read summary of Woodbine report here. In this report, Woodbine dives into the data from the SEC Rule 605 reports. Rule 605 requires market centres to make available standardized, monthly reports of statistical information concerning their order executions. The headline that grabbed our attention was this:
“As much as $4.5 billion in opportunity cost or “alpha-at-risk” is wasted market-wide on sub-optimal order routing decisions.”
As many of you know, we have long warned about the routing decisions that are programmed into your broker-sponsored algorithms. We wrote a paper last year titled “What’s In Your Router?” where we talked about routing practices and detailed a few questions that institutions should be asking their brokers. Read article here. While we have suspected potential egregious behaviour with these routing decisions (based on trading patterns that we see daily), Woodbine can now prove it based on the Rule 605 reports. This information has been out there for a long time but it took an independent, unconflicted research firm like Woodbine to actually parse the data. You didn’t actually expect your friendly neighbourhood algo salesman to tell you that their router is conflicted?
Matt Samelson had this to say:
“Contrary to what some might believe, there are measurable differences among the exchanges in terms of price improvement and information bias,” said Matt Samelson, Principal, equity market analyst, and author of the study. “If the services provided by these venues are not a commodity, how and where orders are routed can be extremely meaningful from a best execution perspective. It’s about more than just take fees and rebates.“
Let’s think about the $4.5 billion number that Woodbine has calculated. This is $4.5 billion per year that is being siphoned away from retail and institutional investors and being handed over to the high frequency traders and broker-dealer internalizers due to poor routing decisions. Routers are sending orders to destinations that are in their best economic interest and not necessarily in your best economic interest. So, next time your algo salesman comes knocking with his new anti-gaming, anti-pingy, dark sweepy router and tells you that it only cost $0.002/share to execute, think about what is happening to your order once it goes through the algo sausage grinder.