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ITEM PF15
- ANNEX 2
PENSION
FUND COMMITTEE – 25 FEBRUARY 2005
MONITORING
TRANSACTION COSTS
The
Different Elements of Transaction Costs
Commissions,
Fees and Taxes
Commission
costs are negotiated with the brokers by the investment manager and a
typical range for agency trades in the UK would be from 10 basis points
to 25 basis points. Trades in other countries, which require special attention
charge higher commissions. These may be as high as 50 basis points for
some emerging markets.
Fees
may be levied by a country’s exchange and in some countries there are
additional government mandated charges or taxes (e.g. UK stamp duty of
50 basis points).
Timing
Costs
Timing
costs are the costs that occur as the price moves between the time that
the fund manager generates the order and the time the order is placed
in the market by the dealer.
For
example: A portfolio manager passes a buy trade in mmO2 plc to
his dealing desk at 10am and the market price at 10am is 119p to 119.25p.
By the time the dealer has the trade ready to go to the market, i.e. he
has completed any administrative tasks relevant to the trade and checked
indications of interest etc. the price is 119.50p to 119.75p. At 10am
he could have brought, say, 1 million shares at 119.25p; by the time he
has placed the order he will only be able to buy these shares at 119.75p
so the timing cost is 0.5p per share. The total timing cost on this trade
is £5,000.
Market
Impact
Market
impact is the price movement that occurs in a stock due to an order being
in the market. Market impact can be calculated by comparing the executed
price of the trade in the stock to a benchmark such as volume weighted
average price (VWAP) or average price, for the time the order was in the
market or on the day of the trade.
Using
the mmO2 plc example: From the time the trade was placed with the
broker to the end of the day when the trade was completed the VWAP was
119.65p. The dealer executed the trade at a price of 119.60p. So the market
impact cost was –0.05p per share, i.e. the trade was executed at a price
better than the market average, so saving £500.
Opportunity
Cost
Opportunity
cost is the loss or gain that occurs in the price of a stock as a result
of a delay in completion of, or an inability to complete in full, a trade
after an investment manager’s decision to buy or sell a stock.
Opportunity
costs are incurred as a result of investment decisions and trading decisions.
They are analysed by the investment manager and are part of the investment
style or trading style of the investment manager.
Looking
at the mmO2 plc example: - The fund manager decides to limit the
trade at 119.60p and the trader is only able to buy 500,000 shares on
the first day at this price. On the next day the stock trades above this
level at 119.80p. The opportunity cost over this period is 0.20p per share.
Making for an opportunity cost of £2,000. Opportunity cost is normally
assessed against a longer time period than the following day, say, a week
or more later.
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