Byline: Ben Sills
Portfolio managers used to live in a state of blissful ignorance. They had no cause to dirty their hands with the tricky business of actually buying securities. There was another desk to deal with that, on another floor, with dealers - essentially administrators - to whom they never talked.The publication of the Myners Report in 2001 changed that. Paul Myners' investigation into institutional investment pointed out that dealers can add value - and subtract it.
Since the report was published, there has been a great deal of attention focused on the trading costs of fund managers, exposing the fact that many did indeed have shockingly amateurish dealing desks.
Now the buyside has sorted out its house to a considerable extent. In the process, the independent transaction cost analysts have thrived. However, cost analysis is home territory for the broker-dealers and they may be about to reclaim it.
Portfolio trading desks often offer clients a degree of transaction cost analysis as part of their service. The problem is, they can only analyse the costs of business that they execute, so they cannot compare execution between different venues.
Simon Thompson, head of equity trading at Barclays Global Investors, argues that the analysis that portfolio traders offer is useful as a first take on transaction costs, but dealers need to do additional work on top. He says: "Most brokers' portfolio trading desks will provide a measure of the transaction costs on the trades they execute, but if you're going to get any value out of it you need to look at costs across the board. For some people, the reports they get from the brokers may be the only view they have of transaction costs but I would expect most people to require more analysis, either using in-house tools or those from independent providers."
Zachary Tuckwell, European head of portfolio trading at Dresdner Kleinwort Wasserstein (DrKW), argues that measuring the supposed cost of one transaction can be meaningless unless you understand the thought process behind that transaction.
He says: "A little knowledge can be a dangerous thing for consultants. If you're trading a tricky stock it might cost you a lot in market impact, but that might still be cheap when you consider the volatility and potential alpha of that stock."
Transaction cost measurement is a complex business. You start with a price, then you trade, and you want to find out what the price would have been if you had done nothing. Stefan Hartmann, head of quantitative analysis at ABN Amro, says: "You're trying to estimate something that can't actually be measured."
Barry Marshall, chief operating officer of Gartmore's investment division, says it is like house price inflation: everyone can agree that you need to measure it, but finding an acceptable standard for doing so is surprisingly difficult. There are almost as many different methodologies as there are transaction cost measurers. And if you employ the different methodologies together you can get widely differing results.
For ABN Amro's Hartmann, the post-trade reports from the portfolio desk are most useful when taken as a group. He says: "The success of any trade depends to a large extent on what happens on that particular day. Fund managers might often be dealing 10% of the average daily volume in a stock. If someone else wants to make a similar trade then the impact would be much greater. …