Goldman Sachs' guns fastest on the draw

The near darkness behind the bulletproof doors of a windowless New Jersey warehouse is humming with tens of thousands of computers, as US exchanges open on a December Friday.

Brokerages and trading firms, battling for the fastest access to capital markets, lease space at this Equinix centre and others to place their machines as close as possible to stock exchange computers.

The practice, known as co-location, is one way firms are vying to win fractions of a second - the difference between getting a trade and missing it.

Speed is shaking up the brokerage industry - and drawing scrutiny from the US Securities and Exchange Commission.

On January 13, the SEC took a first step toward reviewing the effect of trading strategies in which computers may buy or sell shares as many as 1000 times a second.

The commission asked traders, exchanges and the public to weigh in on high-speed trading, which has soared since 2005 to account for as much as 61 per cent of US stock market activity and 70 per cent of individual trades, financial services consultant Tabb Group says.

Against this frenetic backdrop, brokerages are adding technology and services to help them execute large orders for customers.

"What you needed this past year versus 2007 and early 2008 was lots of tools, technology and the use of gray matter," says Peter Weiler, executive vice-president of global sales at Abel/Noser, a New York-based broker that also analyses trading costs. "Brokers needed to bring their A game."

Goldman Sachs ousted JPMorgan Chase as the firm that got the best prices for its institutional clients during Bloomberg's 12-month ranking period from July 1, 2008 to June 30, 2009, according to Ancerno data.

During that time, stock volatility quadrupled from its 20-year average and the Dow Jones Industrial Average swung by more than 40 per cent.

Goldman was the worldwide winner among brokers that handled at least US$25 billion ($35 billion) in trades in getting an average price closest to the stock level when the order was received, Ancerno reported.

JPMorgan, the top broker during the 12-month ranking period that ended on March 31, 2008, fell to No 4 worldwide in the ranking.

New York-based Goldman also swept the competition in the three regional categories: Asia, Europe and North America. Last time, Goldman placed sixth worldwide and second in Europe; it was a no-show in the top five in North America.

"They have the most developed and advanced electronic systems," says Roger Freeman, an analyst who covers brokerages and exchanges at Barclays in New York.

"They can get some of the fastest execution times on trades, thereby minimising some potential costs."

Goldman, led by chief executive Lloyd Blankfein, is also able to match buy-and-sell interest under its own roof because it receives orders from a mix of mutual funds, asset managers and other institutional clients.

That makes it less likely that hints about trading intentions will leak into the market, says Paul Russo, Goldman's head of US equities trading and co-head of global equity derivatives.

"Any time a client trades with us, we try to match them off against our natural internal flows," he says. "That way we can minimise the trading footprint we leave in the marketplace."

Goldman's technology and its access to a large pool of potential buyers and sellers help it to search for - and find - liquidity at the best price for customers.

Bank of America, which acquired Merrill Lynch for US$29 billion in January 2009, shot to second place from fifth in the global ranking. Merrill, the world's biggest brokerage at the time of the purchase, had placed seventh previously.

"We stayed incredibly focused on clients and the quality of our trading products that came out of the merger," said Mike Stewart, co-head of global equities at Bank of America.

Morgan Stanley finished third, and Barclays tied for fourth with JPMorgan.

"The liquidity we're able to find leads to significant opportunities to match customers' orders against each other," says Jason Crosby, Morgan Stanley's head of Americas portfolio distribution in New York.

In a year of tumult on Wall Street, investors didn't avoid brokers that took money from the US Treasury's troubled asset relief programme.

The top three - Goldman, Bank of America and Morgan Stanley - along with JPMorgan all received Tart funds from the Government, which allocated US$700 billion to purchase assets from financial institutions.

"The stock prices of many brokers were cratering and many received Government bailouts," Weiler says.

"But the perception was that they were OK, rather than teetering, because institutions continued to do business with them."

Some traders bucked the big-broker dominance and sent their orders to specialised block trading firms. Such shops seek to buy or sell thousands or millions of shares at a time without substantially swaying the price.

Clarence Woods, chief equity trader at Baltimore-based MTB Investment Advisors, routes most of his stock orders to Westlake Village, California-based JonesTrading Institutional Services.

JonesTrading relies on discreet phone calls - rather than massive computers - to find people to take the other side of a trade, as is also done on block trading desks at many brokers that serve institutions.

Sanford C Bernstein & Co, the brokerage unit of AllianceBernstein Holding, was the sole "execution-only" shop among the North American top five. Such firms handle customer orders and do not use their own money to facilitate customers' trades.

Trading and investments, along with a cut in its bonus pool, helped spark Goldman's fourth-quarter 2009 earnings to a record. Net income soared to US$4.95 billion, or US$8.20 a share, from a loss of US$2.12 billion, or US$4.97 a share, a year earlier.

Goldman's US$13.4 billion in annual profit exceeded its 2007 record of the highest earnings ever by a Wall Street firm - US$11.6 billion.

"Equities is a technology business now," Tabb Group's senior analyst Kevin McPartland says.

What the humans need to make sure is that their firms have the best equipment, trading know-how and programmers.

BEHIND THE RANKINGS

To rank stockbrokers, Bloomberg Markets worked with Ancerno, which collects information on more than US$7.5 trillion ($10.6 trillion) in trades a year from about 500 money managers.

All of the trades in this ranking were reported during the four quarters ending on June 30, 2009.

In the world ranking, only brokers that trade in more than one region were included. And the rankings were limited to brokerages that handled at least US$25 billion of stock trades reported to Ancerno from its clients during the four quarters.

For North America, the same cutoff of US$25 billion for brokers was used. A cutoff of US$6 billion in Europe and US$5 billion in Asia was used.

The ranking measures the prices that brokers get for clients.

Ancerno calculated the difference between the price of a stock from the time a client placed a buy or sell order to the time the broker executed the trade.

Brokers were rated by the average percentage differences between those two figures, weighted by principal. In the rankings, firms' scores are given in basis points. (A basis point is 0.01 percentage point.)

The brokers were also ranked on their execution of difficult buy and sell orders. These are typically buys in a sharply upward trending market or sells in a sharply downward market.

- BLOOMBERG