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Investors Urged to Look Beyond Typical Measurements
The report urges
investors to break down the components of the implementation shortfall cost and
focus on the implicit costs of their transitions. It notes that the
implementation shortfall includes both the implicit costs and explicit costs.
The explicit costs include spreads, commissions, taxes and fees incurred in
selling the securities in the old portfolio and buying the securities in the
new one.
Implicit costs include the market impact of the trades and the price movements
of the securities during the transition period. The price gap between the
end of one trading day and the start of the next also could be a factor in the
cost of a transition that extends over more than one day, the report said.
A successful transition minimizes the impact of the implicit costs, which
often are not as well understood by plan sponsors as well as the explicit
costs, the MTM report notes.
“How the attribution of these implicit costs are calculated and presented can
have a major impact on how the success of a transition is perceived,” said
Graham C. Cook, vice president at MTM and the report’s author. “Implicit
costs are difficult to separate out, but a careful analysis can reveal
additional insights into the skills of the transition manager.”
The report outlines several trading benchmarks and discusses their usefulness
to institutions in both gauging execution performance and attributing between
the implicit costs. These benchmarks can be based on the previous day’s
closing price of the securities, the prices of the securities at the close of
the transition, or the trading period average prices of the securities.
An important component in determining the success of the transition is how much
of a trade off is made between rapidly trading the portfolio components versus
making smaller trades over a longer period of time. Trading a significant
portion of the portfolio over a compressed time period can quickly reposition
the portfolio to take advantage of market opportunities, while making smaller
trades over a longer period of time could minimize the impact of the trades on
the prices of the securities being traded, the report says.
“Analyzing the implicit costs and using the right benchmark can help to reveal
whether the transition manager has made the most of the liquidity available
during the transition, whilst managing risk,” Cook added. “Achieving the
optimal balance between the impact of the trades on the markets and the risk of
prices drifting adversely is the key to a successful transition.”