U.S. institutional investors cut the amount of commissions they paid to their brokers last year, even as their assets under management grew, according to a report by Greenwich Associates.

The Connecticut-based market research group takes this finding as a “clear sign” that buy-side firms are still wringing more value out of their brokerage relationships. However, it notes that this success in driving down costs is pushing brokerage firms to focus on their most valuable clients, cutting research and sales services accordingly.

“This reassessment is already altering the way that brokers service their clients, but it will not affect all institutions equally,” says Greenwich consultant Jay Bennett. “As brokers scale back their coverage of institutions that do not consistently generate substantial commissions, there’s a risk that the buy side will increasingly divide into ‘haves’ and ‘have nots’.”

The firm reports that money managers cut their total commission expenditures by 11% during last year’s strong recovery in equity trading volume. “The fact that institutions brought the total commission pot down US$750 million in 2002 while stock markets were falling is not too surprising,” notes consultant John Colon. “But the fact that they drove it down $1.35 billion in 2003 while stock markets rose demonstrates their determination.”

It says that, after dropping more than 10% in 2002, the commission rates on average NYSE agency and NASDAQ transactions stabilized from 2003 to 2004 at 4.4¢ and 4.2¢, respectively. However, institutions are aiming for further reductions in the coming year. “While brokers largely succeeded in holding the line on commission rates over the past year,” says Greenwich consultant John Webster, “they likely will be forced to give ground again in the next 12 months as institutions remain under pressure from the press, from clients, and from regulators to cut costs.”

Commission rates on both electronic and portfolio trades continued to decline last year. On self-directed electronic transactions, Greenwich research shows that the average rate for institutions overall fell from 3.2¢ per share during 2001 to 2.8¢ per share in 2002 and to 2.6¢ per share during the year ended January 2004.

Notwithstanding this downward pressure on commissions, Greenwich says that investors still value Wall Street, reporting that close to 40% of their annual commissions are allocated for broker research and sales coverage. However, it notes that investors are allocating fewer of these research dollars to the traditional sell-side research staples of investment ideas, specific stock recommendations and individual company or industry studies. At the same time, they are spending more for direct access to company management.

“Institutions today are not spending as much on the Street’s EPS estimates, or whether a stock is a buy, a hold or a sell,” says Colon. “But they are generally placing incremental emphasis on the Street’s ability to facilitate access to corporate management. Among the market’s largest institutions, management access now accounts for nearly 25% of the total research allocation — even more than analyst service generally.”

With this shift in the buy-side, sell-side relationship, Greenwich reports that buy-side institutions are also taking it upon themselves to build up their own internal research and portfolio management capabilities. The average number of portfolio managers at U.S. institutions rose from 9.1 at the beginning of 2003 to 11.1 at the beginning of 2004. The average number of equity analysts at institutions overall rose from 8.6 to 10.8.

“Some of these hires can be seen as replenishing the ranks after past cutbacks,” says Webster, “but the strength of this trends suggests that institutions are in the process of a meaningful expansion of their in-house capabilities.”

“The largest institutions apparently plan to augment Street research and services with in-house capabilities,” Bennett says. “Smaller institutions could find themselves without the resources to compensate to changes in the availability of sell-side research and services with large in-house research staffs.”