Trade Cost Analysis Maximizing Performance by Preserving Alpha

Transcription

1 Trade Cost Analysis Maximizing Performance by Preserving Alpha Educational Workshop for: Fresno County Employees Retirement Association April 5 th, 2017

2 What are Trading Costs? 1

3 The easiest route to the top quartile of performance is to be in the bottom quartile of expense. Jack Bogle Founder, Vanguard Group Agenda I. What Are Trading Costs? II. Why Should You Care? III. What Can Plan Sponsors Do About It? 2

4 Transaction Cost Pop Quiz What is the average impact from trading on a Pension Fund? [A] [B] [C] [D] 1-3 per share bp bp About 10% of the Fund total equity return Hint: the answer illustrates both the importance and confusion regarding trading costs. 3

5 Transaction Costs: A Common Sense Definition The loss of asset value associated with buying and selling securities in your portfolio. How to Measure Transaction Costs Value before the transaction $X Value after the transaction - $Y Cost to complete the trade $X - $Y Nothing tricky here. Simple arithmetic. 4

6 When measured correctly, equity trading costs average about -60bp each way (-120bp round trip)! Commission (10 bps) Impact (14 bps) Delay (36 bps) Zeno Trade Cost Universe for four quarters ending 3Q13 5

7 What Are Transaction Costs: EquityWhat Should Asset Owners BondsBe Concerned About? Spread and/or Commissions (Agency Trades) Commissions Market Impact/Brokerage Costs Delay/Opportunity Costs Commission Recapture/Directed Brokerage Program Capacity issues/aum HFT Soft Dollars Turnover Other Risks in the Trading Process Competitive Bidding Use of Brokers Execution Venues Trade Size Implied research payments FX Spread Timing Costs Competitive Bidding Use of Counterparties/ Venues

8 Warning: different definitions of cost can lead to dramatically different conclusions! For example: Are trading costs just Commissions? Are trading costs calculated by comparing the execution price of a trade to the average price of that security on the day of the trade (i.e. VWAP)? Are trading costs calculated by comparing the execution price of a trade to the price of that security when the manager first decided to trade it (i.e. Implementation Shortfall)? The answer you choose matters! 7

9 Zeno Peer Group Universe Small Cap Growth Universe Median Trading Costs Trading Costs Total Cost Commission VWAP (bp) ( ) (bp) Total Costs Commissions VWAP Potential Savings Difference between 4 th Quartile vs. Median Trading Costs Total Cost Commission VWAP bp ($*) ($*) bp ($*) ($689K) 0.5 ($64K) 15 ($153K) ($831K) 0.6 ($84K) 7 ($72K) ($1,423K) 0.6 ($88K) 11 ($112K) ($1,373K) 0.5 ($137K) 20 ($203K) ($776K) 0.5 ($61K) 15 ($147K) ($678K) 0.3 ($57K) 7 ($72K) ($500K) 0.4 ($40K) 9 ($89K) ($244K) 0.4 ($18K) 5 ($32K) ($200K) 0.4 ($18K) 5 ($33K) Total Costs Commissions VWAP * $ costs based on $100 mm in AUM and avg. turnover rate 8

10 Why plan sponsors use Trade Cost Analysis Satisfy legal obligations, as fiduciaries, to monitor your managers (and their brokers ) trading processes for Best Execution. Provide critical transparency, substantive due diligence, and insight into how your managers are handling Fund assets ( What you don t know, can hurt you! ) Help control excessive trade costs (often the single largest expense of the Fund). 9

11 Great, but if you re a plan sponsor What can we do about it? 10

12 An Inconvenient Truth: Some equity managers trade costs are dramatically worse than their peers. Why is that? Zeno Total Trading Costs (one way) Small Cap Growth Small Cap Value Large Cap Growth Large Cap Value 25th Percentile (Least Expensive) -59 bps +26 bps -18 bps -4 bps 50th (Median) Percentile -93 bps -20 bps -61 bps -26 bps 75th Percentile (Most Expensive) Difference Between 25th and 75th Percentile Round Trip Trading Costs -136 bps -57 bps -84 bps -59 bps 154 bps 166 bps 132 bps 110 bps * Zeno Consulting Group Total Cost Ranking Universes as of 3Q13 11

13 Three reasons why managers don t trade equally well: Reason 1: Reason 2: Reason 3: Process Inattention Trading interests are not always aligned» Asset Managers have multiple clients, which can create competing pressures (e.g. directed brokerage, soft dollars, wrap fees, etc.)» Asset Managers may compensate trading personnel in ways that incentivize practices adverse to a particular client.» Asset Managers are in the business of gathering assets, as well as picking good stocks - which may lead to AUM issues.» Some managers devote more resources to trading than others. Reasons 2 and 3 represent TCA opportunities for concerned Plan Sponsors to become the squeaky wheel 12

14 A practical TCA application for plan sponsors Three-step oversight process: Step One: Quantitative review of report analytics (utilize top-down approach to maximize staff time and resources). Step Two: Identify specific issues that may be driving manager s costs. Step Three: Communication and follow-up with managers (engage managers in focused meaningful discussions intended to ensure manager s awareness of issues, and gain comfort in their process). Result: Satisfy fiduciary obligations to monitor, achieve deeper understanding of (and comfort with) manager trade processes, better manage and control excessive costs, and custom due-diligence/research on an as needed basis. 13

15 Zeno s Sponsor Monitor Equity Oversight Process Step One: Quantitative review of report analytics I. Review aggregate fund costs, ranking, commissions, brokers, traded returns. II. III. IV. Identify which managers are driving costs, commission rates, and broker usage. Review individual managers costs, ranking, commissions, brokers, traded returns. Review other items of specific interest to your Fund.

16 Zeno s Sponsor Monitor Equity Oversight Process Step Two: Identify specific issues that may have driven managers costs For Example: I. Is the manager s trading process consistent with their investment mandate? II. III. IV. What are managers policies and procedures for trading the portfolio? Is Assets Under Management an issue? Are client specific instructions, affecting execution quality?

17 Zeno s Sponsor Monitor Equity Oversight Process Step Three: Manager specific due diligence and follow-up recommendations. For Example: I. Use specific results from reports to identify appropriate Significant Issues that warrant follow-up. II. III. Given manager s specific mandate and trading style, determine appropriate questions for follow-up with the manager. In partnership with client, schedule three-way calls with highlighted managers to discuss the Significant Issues.

18 Conclusion The CFA Institute defines Best Execution as: The Trading Process Most Likely to maximize the Value of Client Portfolios As prudent fiduciaries, more than ever before, plan sponsors should understand their managers : Trading process What they pay to execute trades Whether they obtained best execution, and Its impact on performance. Bottom-line: Meaningful trade cost analysis helps fiduciaries better safeguard the assets of their Funds. 17

19 For further information please contact: Vinod Pakianathan Brian J. Greene The information contained herein has been taken from trade and statistical services and other sources we deem reliable but we do not represent that such information is accurate or complete and it should not be relied upon as such. No guarantee or warranty is made as to the reasonableness of the assumptions or the accuracy of the models or market data used by Zeno Consulting Group, LLC (Zeno) or the actual results that may be achieved. The screen shots provided in this presentation represent hypothetical examples of certain products available from Zeno. They contain sample data and are provided for informational purposes only. None of these materials is intended to be used for trading or investment purposes or as an offer to sell or the solicitation of an offer to buy any security or financial product. These materials do not provide any form of advice (investment, tax or legal). All trademarks, service marks, and trade names not owned by Zeno are owned by their respective owners. All functionality described herein is subject to change without notice. These materials are not to be copied, displayed or transmitted in any form without the prior written permission of Zeno.