Best execution sometimes suffers when investors require managers to trade stocks and bonds through specific brokerage firms. One employee-benefit sponsor is willing to accept the higher cost to its fund as what it believes is a necessary expense to promote the objective of boosting business for certain types of firms.
"We found we don't always get best execution," said Robert G. Cowman, chief investment officer at the Ohio Bureau of Compensation, Columbus, speaking of the $17.5 billion fund's policy that recommends its managers trade 60% with in-state firms and 10% with minority-owned firms.
No law in Ohio mandates the use of minority- or women-owned or in-state firms, for brokerage or asset management, he noted. Ohio law follows the prudent-person standard for all of the state's employee benefits funds. But the bureau has a policy that recommends - but doesn't mandate - the use of minority-owned and in-state firms, although not women-owned firms.
But woe to the firm that fails to comply with that recommendation. Over a two- or three-year period, Mr. Cowman said, the board will terminate a manager for failing to follow the guidelines. None of its 82 managers of publicly traded domestic equity and fixed income has failed yet. The policy casts a wide sweep in one respect. An "in-state firm" includes any firm with a presence the state, including, say, a Merrill Lynch & Co.
Judith Ann Calder, managing director and co-owner of Abacus Financial Group Inc., Chicago, a manager for the bureau, grumbled about targeted trading at a meeting of another employee-benefit sponsor, the Illinois Teachers' Retirement System, although she wasn't objecting to targeted brokerage.
"Sometimes we don't get the best execution in a trade," Ms. Calder volunteered to a subcommittee of trustees of the $24 billion Illinois fund, referring to her firm's management of a $10 million active core fixed-income portfolio for the Ohio bureau. The subcommittee was formed to examine whether the Illinois fund needs to improve opportunities for minority-owned firms.
John E. Glennon, chairman of the board's minority-manager subcommittee, questioned Ms. Calder about Abacus' execution. But she reassured him if the Illinois board were to adopt targeted brokerage, no added trade-execution costs would occur, because of the superiority of brokerage firms in Chicago compared to those in Cleveland. One wonders how the Ohio bureau's board would take such a comparison. Mr. Cowman said he doesn't recall anyone from Abacus ever raising the trading issue with him.
He said the bureau found it doesn't always get best execution, particularly in specialized circumstances involving mortgage-backed and convertible securities. Is he concerned about less-than best execution? "It's not a concern, because the board wants to involve minority and state firms," he said. The board believes the impact of the tradeoff will be minimal.
Does the board give Abacus and the other managers leeway in evaluating their performance? "No, not against a benchmark," he said. "The board doesn't take into account that execution could be affected because of the recommendation."
The bureau uses Birinyi Associates, Westport, Conn., to evaluate trading. But Mr. Cowman said he doesn't have the Birinyi report in a fashion he can make available. He said it shows "overall the execution is good; some is very good and some is not so good."
But there is no recommendation to change the bureau's policy. There should be, "recommending" best execution always, even by targeted brokerage firms.