Slow Path to Cost Analysis
Byline: Lynn Strongin Dodds
Transaction cost analysis (TCA) has been the talk of the investment community for two years. While many agree that reducing trading costs should be top of the agenda, recent studies suggest that, surprisingly, most fund managers are only paying lip service to the concept.They will have to change their ways, though. The deadline is looming for the Myners recommendations, the UK report on institutional investment, to be implemented and the prolonged bear market has put institutions across Europe under more pressure to enhance performance.
One industry participant says: "The pressure and the recognition for transaction cost analysis has been there for some time, but fund managers understanding how to measure and reduce trading costs is a process. It is not an easy issue. There are many complexities."
This perhaps explains the results of several studies published in the past six months.
Consultants Hewitt Bacon & Woodrow, which polled 88 of its largest institutional clients, found that 48% had not improved their awareness of transaction costs, while a William Mercer study showed that 13 out of the 29 fund managers it questioned, with a total of pound sterling800bn ([euro]1.2 trillion) under management, did not measure or closely monitor transaction costs.
The Mercer research also showed that fund managers ranking in the top quartile for their ability to monitor charges incurred a 19.1 basis points charge on each transaction, compared with those in the bottom quartile, which suffered a hefty 56.4 basis point hit. This makes a difference of [euro]500,000 ($540,000) for a E100m pension fund.
More telling perhaps was a study conducted by ClientKnowledge, a UK global market research company, on behalf of ITG Europe, an agency-only broker. It showed that one in five fund managers used transaction cost management systems as a reporting tool, but only 16% actually used the systems as a way to cut trading costs. The survey questioned UK, French and German institutional investors with more than pound sterling2.5 trillion of funds under management - of which about 50% were in equities.
The code of practice published after the Myners report stipulated that trustees should have a full understanding of transaction related costs, including the direct costs such as commissions as well as indirect expenses including market impact and implementation shortfall. However, this has meant that fund managers are claiming they are measuring them without employing the tools to cut the costs and improve their returns.
Part of the motive for the slow uptake is the expense of implementing the information technology systems to support transaction cost analysis. The market downturn has meant that fund managers, especially small- to medium-sized players, do not have spare cash to plough into new systems. They can measure the costs by turning to third-party providers such as Elkin/ McSherry or Plexus to compare and contrast brokers' performances and measure their transaction costs. However, it could be two months before they get the results, which is too late for them to change their trading processes.
Another reason for fund managers' apparent reluctance to employ transaction cost analysis to cut trading costs is cultural. As Richard Hughes, managing director for Europe, Middle East and Africa, at Omgeo, a US-based global trade management service firm, says: "Historically, fund managers have not focused on trading costs, especially during the bull market when they were getting 20% returns. Now they are struggling to get positive returns and there is a greater requirement from regulators, actuaries and trustees to show transparency on their cost base. …