Transaction Costs and Your Funds Largest Expense.

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Presentation transcript:

Transaction Costs and Your Funds Largest Expense

Source: Myners Report 2001; QSG Source: Myners Report, QSG 72% of Portfolio Management Expenses Are Brokerage Related!

Fiduciaries Required To Monitor Transaction Cost Most Plan Investment Policy Statements explicitly state “Best Execution” Requirements Most Manager Contracts Also Refer to “Best Execution” Managers shall “Effect all transactions for the Portfolio subject to best price and execution.“ (quote from a county pension fund IPS)

“Best Execution” Has No Standard Meaning “ When it comes to defining best execution, it's often a case of, ‘I know it when I see it.’“ What Is 'Best Execution'? By Daniel Safarik, Advanced Trading, Jan 29, 2007

Industry and academic research concludes the average performance differential between the top performing broker and the tenth highest ranked broker: Investment Style: 178% Small Cap Equities: 220% Large Cap Equities: 130% *Source: Vodia Group 2007 What is the Primary Determinant of Cost? Broker Selection Is A Major Factor in Execution Quality

What Are Pension Funds Doing to Address the Issue? Investment Review Process: -Quantitative Manager Selection Process -Ongoing Manager Research and Oversight by Investment Consultant -Quarterly Performance Review by Board Best Execution Review Process: -No Broker Selection Process -No Ongoing Research or Oversight of Brokers -No Board Review of Broker Performance

Impact Of Research in Broker Selection

Fiduciary Process is Required to Fulfill The Mandates of Your IPS Step 1 - Gain Enhanced Transparency Step 2 – Use that Transparency as Actionable Intelligence Step 3 – Communicate issues with Managers Step 4 – Monitor for Improvements

Can Pension Funds Directly Effect Transaction Costs? - Default to the Asset Manager - Existing Relationships With Other Service Providers - Qualitative RFP/ Bench - Competitive Bidding Process Event Based Program/ Portfolio Trading

The Right Way: Just Like You Select Asset Managers I. Performance - Liquidity Charge - VWAP - Execution Differential - Timing Consequence II. Process - Evidence of a repeatable approach to trade execution - Systems resources utilized in support of trading process - Trading analytics and measurement systems III. People - Personnel committed to program trading - Middle office staff committed to support of program traders - Personnel turnover ratios - Experience executing transition program trades - Structure of compensation programs 75% Quantitative 25% Qualitative

Same Process Used in Asset Management Establish A True Fiduciary Process - Quantitatively Based Broker Selection - Conflict Free Event Administration - Real Time Independent Trade Oversight - Independent Pre and Post Trade Reporting - End to End Transparency

Stephen Malinowski Managing Director GTS Advisors