Saving as little as 1.3% on trading costs can result in 21% more capital at retirement.

The institutional investment value chain finds itself operating in an environment with an ever-increasing focus on costs: from administration fees to performance and management fees. As illustrated in National Treasury’s paper on costs, seemingly insignificant incremental increases have the potential to significantly erode asset value and, on a more tangible level, substantially reduce the capital available to members at retirement.

An often overlooked source of this erosion in asset value are the costs that result from trading. Trading, especially for equity managers, is an integral part of institutional investing. A certain level of cost is inescapable, however the true cost of trading is seldom measured and, as a result, trading costs are not accurately controlled.

When looking at institutional trading activity, we see that the simple task of selecting brokers who are able to provide best execution can lead to a reduction in costs of between 0.8% and 1.3% of the value traded.
When looking at returns over time these savings are substantial and, more importantly, they have a dramatic long-term impact on the asset size of institutional investors, and ultimately their members’ retirement savings.

Using the methodology put forward by National Treasury, and applying a relatively conservative annual trading rate of 65%, the 1.3% saving per trade mentioned above translates to a member being able to retire on 21% more capital after 40 years. On a starting annual salary of R120,000, for example, this amounts to retiring with an asset base of just under a million rand as opposed to R755,000. The total saving would be in excess of R161,000, which equates to nearly a year and a half’s worth of the member’s starting salary. When framed in this way, members would be justified in feeling short-changed should they realise that poor broker selection could cost them over an entire year’s earnings.

Of course the selection of brokers is not directly under the control of the retirement fund trustees, but falls within the remit of the individual asset managers responsible for managing and growing the asset pool. These managers typically employ a blend of brokers to execute their instructed trades. As illustrated above, the selection of these brokers has a crucial impact on the trading costs borne by the investor. From our experience, asset managers’ aggregate trading costs can differ by as much as 0.9% (difference between the highest and lowest aggregate costs) over a one year period. Consequently a manager’s ability to monitor these costs, and allocate trades accordingly, is of crucial importance to the investor.

This need has led to the development of Transaction Cost Analysis (TCA) tools that have been implemented in markets around the globe and have been included in many regulatory architectures and best practice guidelines, though not yet entrenched in South African regulation. These tools allow asset owners, asset managers and brokers to monitor and thus manage these costs. TCA can involve a variety of metrics and analytical methodologies designed to analyse and attribute all of the costs associated with trading, thereby providing a quantitative measure to base decisions on.

Given the magnitude of the impact these increases in costs can have, it is imperative that retirement funds closely monitor and manage transaction costs as a key way in which to protect their members’ savings.

– Mark Lucani, Product Specialist, RisCura Analytics

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This article appeared on BizNews.com, and Today’s Trustee.

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