Industry Voice: Exploring transaction costs in fiduciary management

In the first of Schroders ‘Fiduciary Management Insight’ series, Neil Walton, Head of Investment Solutions at Schroders examines why Trustees should be aware of transaction costs and their impact on portfolio returns.

clock • 6 min read
Industry Voice: Exploring transaction costs in fiduciary management

Manager selection and oversight activity for fiduciary managers is continuing to accelerate.  With that acceleration, we have noticed that transaction cost analysis is starting to become a far more regular feature in our interactions with clients and their advisors. 

The very nature of a fiduciary management relationship, with the increased scope for outsourcing of investment decision making and implementation, requires that Trustees have confidence in the capabilities and values of their fiduciary manager.  The area of transaction cost management and reporting is no different.   Given the impact of transaction costs on returns, Trustees should gain the necessary comfort that their fiduciary manager has the appropriate investment implementation resources, governance structures and reporting capability to manage transaction costs and deliver meaningful transparency.

It is important to note that transactions are necessary to manage portfolios and to generate returns for clients. One has to buy or sell assets at some point to create the return generating portfolio. Returns generated are the outcome of those transactions.  As reporting of transaction cost figures becomes more widespread, using transaction costs for investment decision making is becoming more common. 

However, this does not mean that high transaction costs are necessarily bad and they certainly do not mean a ‘more expensive fund', they are a function of the style of portfolio management.  Lowering transaction costs will not necessarily result in higher returns. What we can say with certainty is that a different set of transactions will result in a different portfolio and hence level of return.

The concept of best execution is critical to managing transaction costs and avoiding erosion of returns.  Transaction costs exist because buying and selling securities is not frictionless. Since this friction translates into lost value, at Schroders we transact on behalf of clients to minimise the value that is lost by optimising the way we trade. This is what "best execution" is. In simple terms, it means executing a trade in the best possible way.

Having the right infrastructure and the right governance structure are pre-requisites to successfully managing transaction costs and achieving best execution. 

The right infrastructure
In trying to achieve best execution, your fiduciary manager must take into account many different (sometimes conflicting) factors at the same time, such as:

  • the price of the security that is being traded
  • the liquidity of the security
  • the size of the trade compared to the total volume that is traded
  • the orders that are being filled by other market participants
  • the urgency in completing the trade and
  • all the possibilities to fill that order (through different brokers and using different trading venues, etc.)

 

Figure 1: Best execution : how we define and monitor best execution

Source: Schroders

 

The right governance structure

Even though governance is not explicitly mentioned in the best execution regulations, good governance and oversight by your fiduciary manager within best execution should prevent inefficient trading that results in unnecessarily high transaction costs and lower value for your scheme.

Having separate portfolio management and trading functions is essential. The portfolio manager makes the decision to trade but it is the trader who is responsible for executing each trade subject to any restrictions or conditions imposed by the client.

Our integrated fiduciary management solution means our clients benefit from a joined up platform where we can manage costs effectively. Our clients have growth portfolios with a separate portfolio management and implementation function. We are extremely cost-aware. Before implementing a new investment idea in our clients' fiduciary portfolios, the costs of adding the new position and selling existing holdings are fully considered in the context of their impact on return.  

Transaction cost figures certainly have a purpose. Transaction costs, particularly alongside information on best execution, can indicate how efficiently your fiduciary manager has delivered against the investment objective.

The intention behind requiring their disclosure is that, along with other fund attributes, such as if the fund is actively managed, or what is the net return, they can give a fuller picture of what the solution is trying to achieve and how well it has achieved it.  Having that integrated fiduciary management model outlined above, increases transparency and the ability to understand how costs associated with trading impact your portfolio.  We remove unnecessary layers, making everything more transparent and ensuring connectivity of solution components across growth and matching portfolios.

At Schroders, our focus on having the right infrastructure, the right resource and the right governance structures is essential to successfully managing transaction costs.  Just as important is the right culture; a culture of disclosure and of being close to your clients, of delivering the right information and the right support to facilitate meaningful interpretation of that information.  All of these features become magnified in a fiduciary relationship, where Trustees are outsourcing both day-to-day investment decision making and implementation. Our approach, removing layers between our clients and their investments, allows us to provide unique levels of oversight which delivers the effective investment governance that Trustees entrust us with.

 

We have produced a detailed paper on transaction costs and the considerations for Trustees within fiduciary management which can be accessed here

 

Webinar PP Talks: Fiduciary Management - Wednesday 5th May 10:30am

 

Important Information
Marketing material for professional clients only. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. The views and opinions contained herein are those of the individuals to whom they are attributed and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This information is not an offer, solicitation or recommendation to buy or sell any financial instrument or to adopt any investment strategy. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Nothing in this material should be construed as advice or a recommendation to buy or sell. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions. Insofar as liability under relevant laws cannot be excluded, no Schroders entity accepts any liability for any error or omission in this material or for any resulting loss or damage (whether direct, indirect, consequential or otherwise). Schroders will be a data controller in respect of your personal data. For information on how Schroders might process your personal data, please view our Privacy Policy available at www.schroders.com/en/privacy-policy or on request should you not have access to this webpage. For your security, communications may be recorded or monitored. Issued in February 2021 by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered in England, No. 1893220. Authorised and regulated by the Financial Conduct Authority. UK002166. 600468.

Advertisement

More on Defined Benefit

Industry Voice: SI dilemmas — is 'E' or 'S' more important?

Industry Voice: SI dilemmas — is 'E' or 'S' more important?

Sustainable investing has become mainstream, but it’s not a perfect science, with many challenges that practitioners must face.

Robeco
clock 17 May 2022 • 2 min read
New research highlights consolidation could address key end game challenges for smaller DB schemes

New research highlights consolidation could address key end game challenges for smaller DB schemes

Stoneport
clock 21 February 2022 • 2 min read
Industry Voice: How member options can help schemes reach their endgame

Industry Voice: How member options can help schemes reach their endgame

Bulk exercises and member journey plans are increasingly being used, according to research from Aon and Professional Pensions

Gareth Jones
clock 18 February 2022 • 1 min read
Trustpilot