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CONTRACTION COSTS MAY ACT AS A BRAKE

Transaction costs, if not well managed, can act as a brake on investment performance and their effective management should thus be a priority for fund managers, says Kevin Swart, Chief Financial Officer of institutional stockbroking company Noah.  “In an environment where costs, and their impact on performance, are increasingly under the spotlight, quantifying the true cost of trading in a retirement fund portfolio has become vital.”  Traditionally, the focus has been almost exclusively on explicit costs such as trading commission fees as these are clearly visible. But, says Swart, pension fund members need to understand that there are also hidden or implicit costs such as market impact and opportunity costs. “While these may be more difficult to measure, research has shown that they often account for the majority of transaction costs and have a far greater impact on portfolio performance. “Por example, a fund manager decides to sell 1 million of a particular share from his portfolio. Assuming that this is the only share in the portfolio and it is valued at R1O, the entire portfolio is worth R1O million. By the time this trade is released to the in-house trading desk the share is worth R9.95, placing the portfolio value at R9.95 million. Once the trade finally reaches the brokers, the share has slipped to R9.90. By this stage, the portfolio is worth R9.9 million and has lost R100000 or 1 percent of its initial value. “Depending on the timing, the entire trading process can take place over one or more days. Because price movement can never be guaranteed, it could go either way for a fund manager. Instead of relying on luck, a better approach is to put measures in place that will manage the entire trading process and its costs, hence minimising the risk of losing money” Swart explains, “That the first step in successfully managing transaction costs is to dearly understand the entire trading process and then to evaluate its effectiveness at each step in the process. The current and most common practice of evaluation is to look at a brokers’ performance in terms of the total amount of money traded divided by the total number of shares traded.  “What needs to be considered is that the effectiveness or ineffectiveness of the trading process begins at the asset management house where the initial decision to trade in a particular share is taken. The decision is then communicated to the in-house trading desk where delays can, and often do, occur,” Swart concludes.

Source: The Star – Retirement Fund Review