Edition: Mar - May 2014

Watch trading costs and help guard retirement savings

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

Mark Lucani, Product Specialist, RisCura Analytics

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 NationaiTreasury'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 R 120,000, 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 R I   61 ,000, which equates to nearly a year and a halfs 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, an asset manager's 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.

RisCura Analytics  is Africa's leading independent provider of innovative, analytical investment services for the financial and investment industry. The company offers an array of services, including 3rd party Transaction Cost Analysis (TCA). Since 2002, RisCuraAnalytics  has been supported by a competent staff contingent, solid processes and robust technology that leave clients confident that they are getting the best service the industry has to offer.

Visit riscura.com/analytics for information.