STUDY SHOWS COMMON PRACTICE COSTS 0.23% MORE THAN CASH: SOFT-DOLLAR TRADES HARDER ON POCKETBOOK

A soft-dollar trade costs institutions 23 basis points more than a cash trade, a new analysis shows.

That figure may sound low but to mutual funds, which trade in large blocks, it sure adds up.

What’s more, the study, one of the first ever, shows soft-dollar costs can vary widely, depending on the type of investor making the trade and the type of broker executing the trade.

Those findings are based on a recent analysis of the trades of 33 institutional investors. The findings have important implications for investors and regulators concerned about the costs and benefits of soft dollars, the authors contend.

Soft-dollar trades are controversial because a portion of a broker’s commission is earmarked to pay for services not related to the trade, ranging from research to computers. The potential for abuses exists since few details about soft dollar trades are disclosed to investors.

just the costs

The study, “Institutional Trading and Soft Dollars,” was a joint effort of Sunil Wahal, assistant professor of finance at Emory University’s business school in Atlanta; Jennifer S. Conrad, a finance professor at the business school of the University of North Carolina at Chapel Hill; and Kevin Johnson, partner and director of research for Aronson + Partners, a Philadelphia money manager.

But the study addresses only one side of the soft-dollar equation — costs. More information is needed on the benefits of soft dollars to properly evaluate them, Mr. Wahal says.”We’re not saying soft dollars are good or bad because we don’t know what the benefits are.”

The value of services received from soft dollars will vary widely from investor to investor, so it’s tougher to generalize about the benefits, he says. “You can get lots of things for soft-dollar payments. You need to tally all that up. Nobody has a stock-by-stock analysis . . . that tells you how much soft-dollar trades cost,” Mr. Wahal says.

The study’s authors note the 0.23% difference in cost between a soft-dolla
r trade and a cash trade varies by the type of investment trading situation. For momentum-style investors, the difference is 0.28%, while for index fund traders, the difference is only 0.06%.

Mr. Johnson says the study shows investors using soft dollars “don’t get something for nothing.”

Some investors believe paying for research with soft dollars muddies the waters, regardless of whether the benefits are worth the cost.

“There’s a philosophical and/or accounting issue: Is this good business practice?” says Garth Dickey, executive director for the Indiana Public Employees’ Retirement Fund in Indianapolis.

Payments for research services should be directly linked, and money managers should pay for research with their own money, he says. The study itself points out there is “a paucity of data” regarding soft-dollar costs, he adds.

William Quinn, president of AMR Investment Services Inc., oversees a group of mainly outside-managed mutual funds, along with the pension fund of American Airlines, from the firm’s base just outside Dallas. He says investment managers are “already getting paid” for the services they provide.

There’s no reason to chip in — through soft-dollar expenditures — to cover more of a money manager’s expenses, Mr. Quinn says, particularly if trades cost more. He says AMR tries to limit its soft-dollar payments as much as possible.

supplying the grease

Still, in situations such as block trades, not using soft dollars could result in getting a worse price, he notes. At times, he says, AMR essentially is forced into trading through directed brokerage, such as when an external manager is making a block trade on behalf of multiple clients.

Not everyone agrees on the cost of soft dollars.

R. Charles Tschampion, managing director for General Motors Investment Management Corp. in New York, recently chaired a panel that created soft-dollar standards for the Association for Investment Management & Research in Charlottesville, Va. He says putting a
value on Wall Street research can be difficult.

Eliminating soft-dollar execution, Tschampion says, would “basically grind the system to a halt.”

Crain News Service