Though asset managers always talk about "best execution," when it comes to defining best execution, it's often a case of, "I know it when I see it." New tools and clarifications from regulators, however, are emerging to meet the growing demand among institutional investors to identify best execution. But there still is a great variety and scope of utilization of these tools, and in the missions and methods of best-execution and trading-oversight committees at firms, depending on factors such as investment objectives and customer base.

Despite the recent focus on commission-dollar "unbundling" and several waves of mutual-fund scandals in the past few years, there does not seem to be a prevailing definition or explicit rule regarding best execution. The closest regulators have come to identifying it was in late 1999 and early 2000, when then-SEC chairman Arthur Levitt expressed concerns about practices such as paying for order flow and emphasizing speed of executions above all other factors.

Working Definitions
Yet, as the current regulatory environment demands that firms strive for best execution, various definitions of best execution have emerged. According to the Chartered Financial Analyst (CFA) Institute's trade-management guidelines, best execution is defined "as the trading process firms apply that seeks to maximize the value of a client's portfolio within the client's stated investment objectives and constraints." The CFA's guidelines go on to acknowledge that best execution actually is very difficult to quantify, in that it is "intrinsically tied to portfolio-decision value and cannot be evaluated independently ... [and] is interwoven into complicated, repetitive, and continuing practices and relationships."

Typically, head traders say, best execution is evaluated against benchmarks such as implementation shortfall, arrival price and volume-weighted average price (VWAP). According to Bill Stephenson, head of global trading strategy at investment management firm Franklin Templeton Investments, "Our best-execution evaluation is partly based on arrival price and a proprietary benchmark that features a volume-weighted participation target." He stresses, however, that adherence to benchmarks alone does not necessarily result in a great trade. "We don't want traders to be too focused on a benchmark that they execute in a way that is contrary to the goal of the funds," Stephenson says. "You could miss the benchmark and still have a great trade."

As such, best execution may best be thought of as a process, rather than a fixed number or goal. "What we're doing is really just setting up a process to monitor the activity of the traders," says Stephenson, who helps manage 33 traders across 10 locations and attends quarterly trade-oversight meetings with six Franklin Templeton regional trading heads and the head of global trading.