Learn how investment advisors and their clients can realize cost savings, operational efficiencies and increased flexibility through block trading.
Block trading allows portfolio managers to purchase or sell a large quantity of securities executed as a single trade and then allocate those securities to multiple clients. This tool can create cost savings and operational efficiencies. In this article, we’ll explore how block trading works, look at some of its benefits and obstacles, and provide perspective on whether it might be a good option for you and your clients.
What is a block trade?
Put simply, a block trade is an order for the sale or purchase of a large number of securities that is subsequently allocated to multiple accounts. If a certain security is selling at an attractive price, an advisory firm can purchase a “block” of its shares and distribute them among its clients, rather than having to make multiple purchases of smaller quantities. For example, a 10,000-share block could be purchased instead of 100 separate 100-share purchases.
Sell side benefit
If an advisory firm holds a large position and wants to liquidate it, they run the risk of driving down the market price as multiple buyers are found and multiple trades are executed.
Instead, the advisory firm could arrange a block trade through a wholesaler. The wholesaler would contact investors – hedge funds, institutions and/or investment managers representing several smaller portfolios – and attempt to execute the trade at a price that is discounted relative to the current market price (but still better than the anticipated aggregate price they would realize if multiple trades were executed). If successful, the seller will pay a slightly higher commission but will realize significant principal savings due to better pricing.
Buy side benefit
In the above example, the buyer and seller both receive better prices because of their willingness to take on a large trade. Along with the pricing benefit, the buyer can gain the following additional benefits:
- Economies of scale:In the scenario above, smaller underlying investors of the investment manager are able to realize the same price benefits that a large institutional trader would by pooling their assets together. In our example, had the seller been looking to sell $5 million worth of an investment, and an advisor had 100 clients with $5,000 each, the clients can collectively make the purchase, whereas individually they could not.
- Fee savings:When you purchase a large number of shares in a block trade, you pay for a one-trade execution with a single fee instead of paying a fee per-purchase, per-client. In the example above, the 100 clients would’ve paid one commission to the broker-dealer versus 100 commissions if traded individually.
- Intraday trading flexibility:The advantage of intraday trading with block trades increases flexibility. For instance, if an advisory firm purchases a block of securities early in the day and the price improves, it can add to its earlier position throughout the day and all its clients, combined as one group, will receive the same average price.
- Back-office simplicity:Especially for investment advisor firms with smaller staff, block trading can be invaluable. The ability to allocate one trade to 100 clients, instead of executing 100 separate trades, is far less cumbersome.
While block trading has numerous advantages for sell side and buy side firms, there are limitations. First, an investor needs to establish a relationship with a wholesale brokerage firm that specializes in block trading. Additionally, there are a couple situations where an advisor may choose to trade individually rather than in a block.
For example, if an advisory firm has a client base with unique or alternative assets, it may not have enough assets to pool together to meet block trade minimum thresholds. Also, if an advisory firm is running drastically different investment strategies for clients, it may not be able to bundle enough clients together for an advantageous block.
A strategy for success
Block trading is a strategy that could yield significant benefits for many advisors and their clients, yet it isn’t as widely used in today’s market as one might expect. Depending on a firm’s client base, holdings list and asset allocation strategy, it could be worth a second look.
At U.S. Bank, we continuously expand and align our offerings to meet your needs and support your success. Learn more about our services for registeredinvestment advisors.
