Credit Union Investment Execution Costs

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Credit Union Investment Execution Costs

• Sanjay Ramchander
• Colorado State University
• Marc W. Simpson
• University of Texas Pan American

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Investment Execution Costs

• Purpose of the study
• Why is it important?
• Best investment execution
• Definition
• Steps
• Measuring trading costs
• Data requirements and analysis
• Conclusions

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Investment Execution Costs

• Purpose
• To measure investment execution costs of credit
  unions.
• Compare execution costs with a market baseline
  and other peer institutions.
• Draw implications for credit unions investment
  management.

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Investment Execution Costs

• Importance
• U.S. credit unions have experienced a dramatic
  growth in their assets grown by about 10 since
  2001!!
• Over 200 billion of surplus funds are invested
  in various securities.
• It may be easy to ignore the importance of
  transaction costs in trading because of a secular
  decline in unit trading costs.
• However, this decline in unit trading costs is
  more than offset by increases in trading volume.

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Investment Execution Costs

• Importance
• The value of an investment decision is judged by
  subtracting the costs of trading from the net
  benefit of the portfolio.
• Thus, any reduction in transaction costs trickles
  right to the institutions bottom line.

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Investment Execution Costs

• Importance
• The bad news is that most managers are somewhat
  unaware of the full extent of trading costs until
  they are exposed to the idea.
• The good news, however, is that something can be
  done about these costs once they are identified.
• Therefore, an analysis of transaction costs
  (which is the purpose of this study) should help
  credit unions better control their investment
  management process.

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Investment Execution Costs

• Defining Best Execution
• The U.S. SEC defines best execution as those
  transactions that are the most favorable under
  the circumstances.
• It is the process that is most likely to capture
  investment decisions and add maximum value to the
  portfolio.
• Best execution is an exercise of fiduciary
  responsibility i.e., how prudent individuals
  would conduct their own affairs with their own
  money.

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Investment Execution Costs

• Defining Best Execution
• While defining best execution is straightforward,
  measuring whether a client is in fact getting
  best execution is quite difficult.
• Partly because of defining the relevant
  circumstance
• These circumstances include the size of the
  order, trading characteristics, reason for the
  trade (liquidity, immediacy etc.).

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Investment Execution Costs

• Steps involved in getting best execution
• Measurement a process where the full cost of
  trading is measured
• Analysis analyze trading costs against a
  benchmark
• Control evaluate trading process and make
  improvements
• Purpose of the present study is to shed light on
  the measurement and analysis issues

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Investment Execution Costs

• Total trading costs are made up of 2 components
• Commission costs
• Hidden costs.
• Commission costs
• Explicit fees charged by the broker to execute a
  trade.
• Hidden or implicit costs
• Difference in price when the order is executed
  and when the order was originally submitted
  accounts for the delay in fulfilling orders.
• Opportunity costs associated with unfulfilled
  orders.

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Trading Order Time Line
Breakdown of Hidden Costs
29
29.75
30
Trading Desks Receives Order
Manager Submits Order
Broker Receives Order
Order Executed
Trader Timing Costs 0.75
Price Impact Costs 0.25
In addition, there may be opportunity costs
associated with the trade.
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Investment Execution Costs

• Data requirements
• From credit unions
• Trade characteristics
• Security characteristics
• Time stamps
• From brokerage firm
• Benchmarking data

First Case Scenario
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Investment Execution Costs

• Trade/order characteristics
• Trade date
• Buy or sell
• Commissions paid to the broker (including any
  soft dollar arrangements)
• Broker identification
• Size of the order
• Order instruction market order, limit order,
  crossed order etc.
• Trade motive diversification, yield capture,
  market timing, liquidity etc.

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Investment Execution Costs

• Security characteristics
• Type and name
• Coupon
• Maturity
• Yield

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Investment Execution Costs

• Under the best case scenario, credit unions
  should maintain and report accurate time stamps
  of the order flow
• Date, time and price when the order was placed
• Date, time and price when the order was executed
• Unfulfilled orders, if any

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Investment Execution Costs

• Benchmarking for analysis
• End of day prices for the relevant securities
• Measure of daily average price preferably,
  volume-weighted average price (VWAP) data

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Investment Execution Costs

• Data period real time data for about 1 year
• Data analysis
• Estimate average total trading cost
• Provide a peer group and market benchmarks
• Results will provide implications for transaction
  cost control and investment management

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Investment Execution Costs

• Conclusions
• Transaction cost analysis is a tool to evaluate
  the trading process
• Trading costs contributes to the investment
  bottom line

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Investment Execution Costs

• Conclusions
• Trade analysis systems are highly developed in
  the equity sector not so in the fixed income
  sector because of spotty data therefore, there
  is more to be gained from this study
• Study will serve 3 purposes
• Measure the magnitude of transaction costs
• Analyze trading efficiency
• Help credit unions achieve better control in the
  trading process