07 March 2016
Superannuation funds need to throw a bright spotlight on the cost of trading their portfolios, says Raewyn Williams, head of research of the Australian arm of the U.S. fund manager Parametric.
Williams says there is “significant savings” potential based on how a portfolio is traded, but most funds have very little information about how much equity trading costs, and how efficiently they make their trades.
“Trading Australian and international equities, which, on average, comprise 44% of their total funds invested, is the funds’ ‘bread and butter’ investment activity, and it’s imperative they give the issue more attention as this is another area of implementation efficiency where there could be considerable savings to be made.”
Williams and fellow researcher, Dr Mahesh Pritamani, have just finalised a research paper, “Under the Spotlight: How Much Does it Cost to Trade Equities”, which aims to empower super funds to identify “implementation leakage and inefficiency” so they can improve how their portfolios trade.
Williams says the trading costs measured should include both explicit and implicit trading costs – the latter, including spreads and price impacts, is highly variable and skill-dependent.
“What our research shows is that a great deal of skill is required to trade well and a great range of outcomes are possible.
“To trade a passive Australian equity portfolio patiently, full costs begin at 21 bps per $1 traded and can rise to as much as 66 bps per $1 traded. To trade a passive international equity portfolio patiently, costs begin at 11 bps per $1 traded and can rise to 26 bps per $1 traded. This is the most conservative scenario.
“Other scenarios can see trading costs rise as high as 119 bps per $1 traded for an Australian equity portfolio and 32 bps per $1 traded for an international equity portfolio. Quite clearly the cost of trading equities can be a material drag on performance.”
She says the main driver of explicit trading costs is whether research is included in the service, or if it is execution only and the amount of ‘order flow’ directed to the broker.
The main drivers of implicit trading costs are the asset class traded (e.g. Australian equities cost more than international equities), the size of the trades, how ‘active’ the portfolio is (relative to index weighted investments) and how aggressive the trading style is.
“The need to confirm that trading is done efficiently, therefore, is greater the larger the fund is, the more the fund allocates to Australian equities instead of international equities and/or the more urgent or aggressive the fund’s or managers’ trading styles are.
Funds should demand transparency from their managers and/or internal teams so they can measure trading costs and assess the efficiency of their underlying trades.
Trading should not be a ‘black box’ and the ability to scrutinise all aspects of a fund’s investment portfolio is a valuable element of good fiduciary practice,” Williams says.
Parametric Australia is a division of Parametric, based in Seattle, USA. Parametric is a global asset management firm that offers investors a variety of portfolio solutions, including after-tax equity (performance measurement and indexed portfolio management), centralised portfolio management and structured active strategies. Parametric is a majority-owned subsidiary of Eaton Vance Corp., one of the world’s most dynamic global asset management companies.
Parametric Portfolio Associates LLC (“Parametric”), headquartered in Seattle, Wash., is registered with the U.S. Securities and Exchange Commission (“SEC”) as an investment adviser under the Investment Advisers Act of 1940. Parametric is exempt from the requirement to hold an Australian financial services license under the Australian Corporations Act 2001 (Cth) (Corporations Act) in respect of the provision of financial services to wholesale clients as defined in the Corporations Act and the Australian Securities and Investments Commission’s (“ASIC”) Class Order 03/1100. SEC rules and regulations may differ from Australian law. Parametric is not a licensed tax agent or advisor in Australia and this does not represent tax advice. This material is intended for wholesale use only and is not intended for distribution to, nor should it be relied upon, by retail clients. Additional information is available at www.parametricportfolio.com/au
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