Most active U.S. institutional traders executed one half of their equity trading volume through portfolio trades last year, according to a report from Greenwich Associates.

Portfolio trading, or program trading, is a single transaction that involves the simultaneous execution of a number of trades.

Greenwich says that the growth of portfolio trading among these institutional investors to 50% of overall share volume represented an increase from 44% reported in 2003, continuing an upward trend of the past few years. The Greenwich, Ct.-based research group says that investors are taking advantage of falling commissions, which declined to an average of US2.2¢ per share from US2.5¢ in 2003 for portfolio trades, with the most active portfolio trading institutions paying just US2¢.

“For institutional investors, the game is pretty favorable right now,” says Greenwich Associates consultant Jay Bennett. “Institutions are lowering costs by using portfolio trading for a larger proportion of their volume and by directing a portion of those portfolio trades to self-directed electronic trading systems. In addition, they appear to be saving money by doing more risk trades as opposed to agency business. Combined, these trends represent a big win for the institutions.”

Among the 185 most active trading desks participating in Greenwich Associates’ 2004 research, the average portion of equity business directed to portfolio trading increased by 7% last year to approximately US$7 billion.

As portfolio-trading volumes grew, commission rates continued to come under pressure. “While institutions, on average, reported portfolio trade commissions of US2.2¢ in 2004, one-third of all participants in our research say they are paying less than US1.5¢ per share,” says Greenwich Associates consultant John Webster. “That number is particularly striking in that only 13% of institutions dipped below that threshold in 2003.”

Greenwich predicts that the declines in trading commissions suggest that brokers will eventually become less willing to watch volumes migrate to portfolio trading from their traditional agency business, where average per-share commissions can top US4.5¢. Indeed, Greenwich says its research shows that the growth in portfolio trading seems to be leveling off, with institutions predicting that volume will remain at 50% of total equity trading over the next 12 months.

“Brokers are competing for portfolio trading business, but this effort has been primarily defensive,” says Greenwich consultant John Feng. “It now appears that things might be settling out at a mutually acceptable level.”

Self-directed electronic trading systems accounted for 38% of portfolio trade volume last year, up slightly from the 35% reported in 2003. Due to uneven usage among the largest institutions, self-directed volumes could fall back to levels closer to 2003 levels next year.

Greenwich also reports that the bulk of 2004 portfolio trading volume was generated by trades related to cash-flow management, index rebalancing, and manager transition activities. Three-quarters of all U.S. institutional investors say they use portfolio trading for cash-flow management and 57% use it for trades relating to manager transition. Almost half of all institutions use portfolio trading for index rebalancing and 42% use it to achieve cost efficiencies by packaging smaller trade flows.

“If you combine index re-balancing, sector re-balancing and re-balancing related to internal proprietary algorithms, you find that re-balancing in some form or another represents more than 40% of all portfolio trading volume,” says John Webster. “If you also take into account the one-third of the volume generated by cash-flow management, you’ve accounted for about 75% of portfolio trading.”