The average annual portfolio trading volume among all institutional equity investors increased 35% over the past year, but it jumped some 60% at the largest institutions, according to a new report from consulting firm Greenwich Associates.

The research finds that the typical large U.S. self-managed pension fund executed nearly two-thirds of its total equity trading volume as portfolio trades between mid-2004 to 2005.

“Our research shows that half of all equity trading volume in the U.S. is being conducted as portfolio or program trades, and institutional investors say they expect that share to increase to nearly 55% in the very near future,” says Greenwich Associates consultant Jay Bennett.

For all types of U.S. institutions, international equities are making up a growing portion of portfolio trading volumes. In particular, trades of European and Asian equities are making up a far greater portion of the portfolio trading volume. European stocks made up 10% of portfolio trading volume in 2004 and 16% in 2005. Asia-Pacific stock trades (including Japan) made up 6% of total portfolio trading volume in 2004. That number increased to 10% this year.

“Trades of international stocks made up just 13% of the portfolio trading volume of large U.S. institutions as recently as 2003,” says Greenwich Associates consultant John Feng. “Today, international equities account for about a quarter of the portfolio trading volume of these active institutional trading desks — an increase in dollar terms from less than US$75 billion to about US$280 billion.”

Greenwich also reports that the average commission rate on agency portfolio trades has been falling sharply and steadily, from US2.5¢ per share in 2003 to US2.2¢ per share in 2004, and to US1.9¢ per share this year. “A significant amount of business is being done at commission rates well below these averages,” says Feng. “Almost a third of all normal agency portfolio trades are being done at less than US1.5¢ per share.”

Hedge funds, many of which are now counted as brokers’ most prized clients, appear especially aggressive on portfolio trading commissions. The typical hedge fund pays an average commission rate of US1.7¢ per share on “normal” portfolio trades, and US1.2¢ per share on guaranteed VWAP trades. “In these circumstances, brokers are really facing a Hobson’s Choice,” says Greenwich’s John Webster. “Whichever way they slice the portfolio business, it is not particularly attractive — but they have to do it one way or another to accommodate their valued clients in the cash equity business.”

Almost 80% of portfolio trading volume is sent to sales traders at full-service brokerage firms. One reason that the full-service firms are capturing such a large share of this business is that many institutions have begun using portfolio trading flows as currency with which to compensate brokers for the provision of fundamental equity research, Greenwich reports. More than 60% of large U.S. institutions now use portfolio trading business to compensate brokers for equity research. “Our research reveals that, among institutions that do use portfolio trades as compensation for broker research, the practice accounts for as much as 62% of their total portfolio trading volume,” says Feng.

Greenwich research also suggests that the very “full-service” nature of the full-service brokers contributes to their success in winning portfolio trading business. “Although portfolio trading is generally considered a ‘low-touch’ alternative, many institutions want brokers to do some hand-holding on portfolio transactions, particularly on the larger ones,” says Bennett. “Good sales traders provide advice on implementation strategies such as the appropriate use of agency and risk and the most appropriate type of algorithm. With our research revealing that the cost advantage of self-directed algorithmic trades versus normal agency trades has fallen to about a half-cent per share, institutions feel that the value they are receiving from the full-service brokers is well worth the price.”