Soft-dollar spending dips as investors await SEC review

GREENWICH, Conn. — Soft-dollar spending by U.S. institutional investors fell 10% during 2004, but institutions are waiting to learn the outcome of a Securities and Exchange Commission review before cutting deeper into those expenditures, according to a Greenwich Associates report.

Institutional investors interviewed by Greenwich between Nov. 29 and Feb. 18 decreased their use of soft-dollar commissions to purchase third-party research and services to a combined $1.13 billion in the 12 months preceding the interviews from roughly $1.25 billion a year earlier. Greenwich interviewed equity portfolio managers and traders at nearly 400 institutions that invest in domestic equities.

Greenwich found that 73% of the institutions reported using soft dollars over the past 12 months, compared with 82% in the prior year and 86% a year earlier.

The Greenwich report said the SEC has indicated it will issue soft-dollar recommendations in 2005. John Nester, an SEC spokesman, said the agency's soft-dollar task force "is still in the process of developing recommendations" and has no timeline for issuing them.

Melissa De Vries, associate director-institutional research and marketing at Greenwich, wouldn't speculate on upcoming SEC recommendations but noted it seems that regulators have "softened their stance" on soft dollars. It's a matter of "determining what's appropriate" for soft-dollar spending, she said.

Many pension funds and endowments are dropping soft dollars altogether, according to the Greenwich data — 44% of the pension funds and endowments surveyed used soft dollars for third-party products or services in the year preceding the institutions' Nov. 29 to Feb. 18 reporting date, compared with 75% the preceding year. While the decline among pensions and endowments was steep, most institutional investors appear to be waiting for a clearer picture of future soft-dollar regulations, the report said.

Mid-size and smaller institutions are now the more prevalent users of soft dollars, the report said. Between 70% and 80% of institutions with total annual commissions ranging from $5 million to $20 million used soft dollars during the preceding 12 months whereas 65% of institutions that paid more than $50 million in annual commissions used soft dollars during the year.

"Clearly, the smaller institutions are going to leverage soft dollars a lot more" because they don't always have the revenue stream or assets under management to pay for services with hard dollars, Ms. De Vries said. So the elimination of soft dollars would be "far more detrimental" to smaller institutions, she added.

Soft-dollar use is lower among hedge funds and mutual funds than among investment managers and banks. Greenwich found that 55% of hedge funds and 75% of mutual funds used soft dollars in the preceding 12 months, compared with nearly 80% of investment managers and more than 90% of banks during that time.

Hedge funds have traditionally been more "cash rich," Ms. De Vries said, which makes it easier for them to pay for services with hard dollars. She also acknowledged that mutual funds could be decreasing soft-dollar spending in line with increased regulatory scrutiny because of market-timing scandals.

Soft dollars comprise a shrinking portion of the overall U.S. equity commission pool, the report said. During the preceding 12 months, soft dollars accounted for 10% of the respondents' overall U.S. equity commissions, down from 11% a year earlier and 12% two years before.

The report said the "typical U.S. institutional investor" expects to earmark 10% of total U.S. equity commissions to soft dollars and commission recapture in the 12 months following the interviews, after projecting they would allocate 11% in the most recent 12 months. Ms. De Vries said institutions didn't reduce soft-dollar spending as aggressively as they forecasted in last year's survey, however; according to the report, they allocated 17% to soft dollars and commission recapture during the most recent 12-month period. Only time will tell if institutions are closer to the projected mark in the next report.

"It looks like soft dollars are here to stay," Ms. De Vries said.