As the use of commission recapture programs grows, their effectiveness in saving plan sponsors money remains a point of disagreement among pension industry participants.
While plan sponsors are taken with the idea of getting a rebate of up to half of the brokerage commission on trades placed on their behalf, money managers often would rather be free to place trades with whomever they see fit. Opinions among brokerage firm executives vary widely.
Fiduciary concerns on the part of plan sponsors in commission recapture programs also exist.
In a commission recapture program, a sponsor will require investment managers to place a set percentage of trades with commission recapture brokers. Those brokers will then rebate a portion of the commission, say half, to pay the sponsor's bills or directly to the fund. Often, industry participants said, commission recapture rebates are used to pay consulting fees.
Brokers that emphasize their commission recapture programs say the programs are a way to reduce brokerage commission costs incurred by money managers on behalf of plan sponsors and get back some of the fees that might otherwise go toward soft-dollar commissions. (Soft-dollar commissions sometimes are used by investment managers to pay for services or research it receives either from the broker or a third party).
At the same time, money managers and some brokers say any commissions recaptured by the plan sponsor might be lost through higher bid/ask spreads. In other words, a pension plan sponsor might save as much as 5 cents per share through a commission recapture program, but could end up incurring a price differential of 12.5 cents or higher through poorer trade execution.
No one has determined which course is valid, although at least one investment consultant, the Plexus Group, Santa Monica, Calif., is trying to do just that. Mark Edwards, a director for Plexus, said examining the effectiveness of commission recapture programs is something they'll do for their clients for inferential use. But at this point, Plexus doesn't have enough information to make statistically sound conclusions, he said. He noted trade data alone will not reveal any cost to performance of directed brokerage.
That is because money managers typically won't call on a directed brokerage firm unless the purchase is for a relatively easy trade, such as a large-capitalization stock, Mr. Edwards said. "You have to go all the way back to the initial decision to trade."
Because of that fuzziness, some money managers are strongly against the use of commission recapture. As Theodore R. Aronson, partner with Aronson + Fogler, Philadelphia, said, "Nobody knows exactly how much it costs to trade."
"Commission recapture is a classic area where people think they're going to get something for nothing," Mr. Aronson said. Aronson + Fogler, a quantitative-based manager, doesn't participate in commission recapture programs, and doesn't use soft-dollar services. He said Aronson + Fogler saves commission costs by using matching networks and electronic exchanges, bringing per-share costs to 1 cent to 5 cents a share.
Even if a commission recapture program costs more than it saves, generally a plan sponsor will be able to measure the savings side of the equation more easily. Hence, firms like Plan Sponsor Services, a division of Lynch, Jones & Ryan Inc., New York, have seen commission recapture revenue grow 40% a year since 1986, gaining more than 600 clients in the process.
Public pension plans, which are often strapped for cash to run operations, are big users of commission recapture programs.
Greenwich Associates, Greenwich, Conn., which annually surveys plans sponsors on various issues, shows the use of directed brokerage, which includes commission recapture programs, as being used by 34.9% of public funds, while 25.3% of corporate funds uses it.
Rex Privett, executive director of the Oklahoma Public Employees' Retirement System, Oklahoma City, said the system has had a commission recapture program in place for at least four years. He said commission costs have gone down since the program started. The system's money managers, who manage a total of $1.1 billion in equities, are presented with a list of 12 to 13 brokers that rebate commissions.
Mr. Privett said the system asks that managers put 50% of their equity trades through commission recapture brokers, although "the first obligation I have is to get best execution."
Whether that is possible for Oklahoma, or any other sponsor, may depend on the style of investment management being performed. Generally, large-capitalization, actively traded stocks are the best candidates for those programs, said an investment consultant who agreed to talk on the condition he not be identified. He said in some cases it might make sense, although it's not something his firm would "widely endorse." He said he has seen a jump in interest in such programs, although the savings have been falling because commissions in general are falling.
As commissions continue to fall, brokerage firms have adopted widely varying approaches to commission recapture. Some brokers don't offer commission recapture and some actively promote it to plan sponsors, while others fall somewhere in between.
Victor Fontana, president and chief executive of the brokerage firm Autranet Inc., Jersey City, N.J., said his firm's executives made a conscious decision to stay out of the commission recapture business.
He said a commission recapture program, which is marketed to plan sponsors, would conflict with the firm's soft-dollar business, which is marketed to money management firms.
"We want our customer, the money manager, to be free to choose the broker to do business with," Mr. Fontana said.
Some brokers say commission recapture programs can still allow a degree of freedom to exist. R. William Lee III, executive vice president for brokerage firm Donaldson & Co. Inc., Atlanta, said the percentage of trades directed to commission recapture will vary by plan sponsor, and should be a point of discussion between the sponsor and the manager.
Glenn Firestone, managing director of global sales for Lynch, Jones & Ryan, agreed that its important to "talk to your managers," and "keep them in the loop."
Similarly, Paul Hennessey, senior vice president for Boston Co. Asset Management Group, Boston, said "money managers have to have an open dialogue with the clients" regarding the degree to which commission recapture can be used. He said the Boston Co. doesn't feel uncomfortable directing up to 25% of its trades to commission recapture.
Instinet, a New York-based electronic brokerage firm owned by Reuters Holdings PLC, London, offers commission recapture but doesn't actively promote it. Davis Gaynes, senior vice president of sales and marketing for the firm, said getting better execution and limiting the market impact of trades is a more effective way of limiting trading costs.
A plan sponsor might save a few cents per share on a trade done through commission recapture, but see the share price rise from $6 to $8 while effecting the trade, he said.
It is more important to ask "what is the cost, bottom-line, to implement an investment idea," Mr. Gaynes said.
Many have noted that plan sponsors directing brokerage for a money manager may end up waiting behind other firm clients who don't, getting a less favorable price. That is because depending on the type of trade, a manager may want to trade with brokers it is most comfortable with. They fear commission recapture brokers could tip the trade to the market, affecting prices.
Mr. Firestone of Lynch, Jones & Ryan agreed commission recapture won't work in all situations. Appropriate situations should be decided between the plan sponsor and its money managers.
And other soft-dollar brokers say money managers are still free to choose a broker within the broad guidelines of a soft-dollar program. A money manager can be asked to direct from 10% to 50% of trades to commission recapture brokers.
Some trades are "very, very capturable - if that's a word," Mr. Lee of Donaldson said, while others aren't. "Nobody wants to sacrifice eighths or quarters (of a point), all in the name of 3 or 4 cents," Mr. Lee said. Donaldson offers both commission recapture and soft-dollar services.
From the plan sponsor's view, the use of commission recapture is legally troublesome, said D. Bruce Johnsen, director of the Law and Economics Center at George Mason University, Arlington, Va. As interpreted by the Labor Department's Pensions & Welfare Benefits Administration, commission recapture programs do not fall into a section 28(e) soft-dollar safe harbor exemption from fiduciary duty to monitor performance of the manager.
Although contractual ways to set up the program can get around that lack of exemption, sponsors should be aware of it, he said. He noted this would be an issue only if a defined benefit plan became insolvent.