Principal Bid vs. Agency Trading

Abstract

In this article we analyze the estimated costs of agency versus principal bid trading. Building on recent academic literature, we analyzed actual program trading costs using data provided to us by a large institutional manager. In general, a principal broker will charge the client a risk premium in return for a guaranteed execution. As both agency and principal brokers have access to similar trading tools and liquidity, the risk premium will usually result in the principal cost being higher than the expected agency cost — a price that may seem worth paying for an individual, zero-risk trade. By analyzing trading costs on an annualized basis (after all, fund returns are measured on an annualized basis), we demonstrate that agency trading can offer significant savings over principal trading.

TOPICS: Equity portfolio management, analysis of individual factors/risk premia, portfolio construction