Transaction Costs and Your Funds Largest Expense.

Transaction Costs and Your Funds Largest Expense

Source: Myners Report 2001; QSG 2005. 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:

4.35

5.98

16.24

-4.78

-7.05

-15.73

-18.71

-25.2

-71.26

-88.75

Broker A

Broker B

Broker C

Broker D

Broker E

Broker F

Broker G

Broker H

Broker I

Broker J

Investment Style: 178%

Small CapEquities:

220%

Large CapEquities:

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 ManagersI. 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 DirectorGTS [email protected]