DO YOU KNOW WHAT YOU’RE MEASURING (AND WHY)?

It may have taken time for transaction cost analysis (TCA) to become a firm fixture in the equity toolkit, but that does not seem to be the case with foreign exchange and other asset classes, according to a recent report by Aite Group.  It is rapidly gaining acceptance among the buyside community who are looking to improve their execution performance.

Regulation of course is one of the main drivers but today’s intensely competitive environment and the  never ending pressure to generate better returns, is also a key factor. Fund managers need to prove their FX mettle and while a couple of basis points may not sound like much, it can be a key differentiator separating the wheat from the chaff.

The foreign exchange (FX) market, which comprises banking transactions, corporate deals and investments, is difficult to get your hands around. The Bank for International Settlements estimated daily global trading to be $4 trillion. However, the costs of these currency transactions are not typically measured and the failure to do so and manage them properly could diminish capital as well as erode investment results.

This is why it is important to use TCA in a much more holistic way. Like in equities, it has become more than just a tick box compliance and post trade analysis exercise. The Aite report points out that an increasing number of firms are starting to experiment with using both pre-trade and intraday analysis to enhance traditional TCA. This is tied to the adoption of execution management systems (EMSs) across multiple asset classes which enable traders to aggregate fragmented pools of FX liquidity onto a single venue. However, it is also attributed to the need to achieve better executions and leverage both pre-trade and intraday analysis to predict, and then adjust, performance expectations in real-time.

For those that don’t, they should take heed of Howard Tai, senior analyst in Institutional Securities & Investments at Aite. He noted that “TCA should be regarded as an investment process improvement tool, not as an internal trader performance evaluation metric. Some investment management firms are tempted to use TCA data to evaluate the short-term performance of the buyside traders themselves. This may discourage traders from taking full advantage of the real-time analytics available at their disposal to improve long-term investment results time and again.”

Lynn Strongin Dodds,

Editor

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