I sat in on a media briefing that ITG conducted this morning looking at whether trading in dark pools adds value in terms of transaction costs. In a study, ITG analyzed the trading performance of one-time matching compared to continuous crossing versus liquidity aggregation.

The study was conducted over the first three quarters of 2007 using ITG’s extensive database of 12.6 million orders entered during 2007. I will write more about this later, but for now, here are a few key points that I found to be most interesting:

There is increased risk of slippage by using a liquidity aggregation algorithm relative to using direct access to a crossing system. A buy-side firm using Posit Match, ITG’s one-time crossing system, was able to add four basis points over the benchmark. “Crossing networks have lower risk of slippage than liquidity aggregation,” explains Ian Domowitz, managing director of ITG's analytical products and research group. But it can cost as much as 18 basis points to get an order done with liquidity aggregation if someone is bouncing around different dark pools searching for liquidity in a high volatility environment.

Using the analogy of driving a car into a Cul de Sac and then leaving to go onto the highway to search for more liquidity, at different exits, ITG shows the orders are more exposed to information leakage with liquidity aggregation.

Perhaps most interesting was a slide showing the performance of orders across 10 different dark pools. (ITG has access to all this data because its own dark liquidity algorithm accesses these particular dark pools.) For instance, an order that stayed for more than two hours in a liquidity aggregator and wound up in the UBS Price Improvement Network cost the trader 31 basis points.