Transaction cost analysis can have a large impact of portfolio performance.
Our proprietary software incorporates all three levels of the transactional cost pyramid when making our trading decisions.
Most people tend to focus on commissions when they think about transaction cost, but commissions turn out to have a small impact relative to other costs.
1) Tax Impact
In order to offset capital gains and/or up to $3000 of ordinary income, Atlas Capital will overlay a tax loss harvesting strategy on each account depending on client circumstance. This is the unique benefit of utilizing separately managed accounts over commingled investment structures (ETFs or mutual funds). Separately managed accounts allow us to sell an individual security once it falls below a certain threshold and replace it with a similar security with a new cost basis. While the loss is realized for tax purposes, the performance of the portfolio is not dramatically affected.
Transaction cost analysis strategy is most effective in the first few years of a portfolio’s existence. As the portfolio ages, the potential for tax loss harvesting is decreased as the cost basis for the existing positions becomes lower and lower as compared to market prices.
2) Market Impact
This is merely a function of how wide the ‘bid/offer’ is on a particular security and how large of a position one needs to trade relative the volume offered at the bid or offer. Our relatively small asset size combined with the utilization of algorithmic trading techniques can significantly reduce the overall amount of market impact costs. Nonetheless, market impact cost are incorporated in every trading decision.
Atlas will utilize a variety of custodians and brokers on behalf of our clients. For clients who invest in strategies with higher turnover, we can 1) utilize discount brokers who are the cutting edge of reduced commissions or 2) enter into asset-based pricing agreements with popular custodians like Schwab and Fidelity in which clients are charged an annual fee for unlimited transactions instead of per trade commissions.
Atlas operates as a registered investment advisor and fees are charged on invested assets without the return-sharing typical of hedge funds or the layering of costs typical of fund of funds, investment brokerage firms and insurance companies.
There have been numerous academic studies quantifying how the layering of fees adversely affects client returns. Two of our favorites were produced by MIT professor Mark Kritzman and Vanguard Funds research group. Kritzman compared the hypothetical returns over a 20-year period of index equity funds, actively managed equity funds, and hedge funds – adjusting for fees, other costs, and taxes. He found that in order to break even with an index fund after expenses, actively managed funds would need to produce an annualized alpha of 4.3%, while a typical hedge fund would need to produce an annualized alpha of 10%.
A 15-year study conducted by Vanguard Funds revealed the silent, but costly, impact of fees and expenses. Bogle concluded that the average equity fund investor only kept 47% of their cumulative returns while an index fund investor retained 87% of their cumulative returns.
At Atlas Capital Advisors, we’ve formulated our equity investment thinking over a number of years, drawing heavily from personal experience and leading academic research. Successful investing requires a long term perspective. Too frequently the investing community can focus on near term results or the latest fad, neither of which has repetitively proven fruitful. The asset allocation decision is the most important component of out-performance; we identify geographic region and industry sector weightings before individual stocks. We diversify risk and do not believe in concentrated exposures to any one stock or asset class. Favor value over growth, small over large, and high momentum over low momentum. There exists a lot of academic research showing how value stocks have outperformed growth stocks over long periods of time. The same can be said about the academically supported merits of small capitalization stocks over large capitalization stocks or how stocks exhibiting positive momentum stocks have outperformed negative momentum stocks.
Consistently trying to pick winning stocks is very difficult. Choosing managers that repeatedly outperform is equally difficult. Most active managers may outperform their benchmark for a year, but very few can do so for successive years. We believe a more passive approach is a better approach than complete active management. However, being totally passive means portfolio performance is completely subject to market risk. We believe using a multi-factor quantitative process that tilts benchmark portfolio exposures towards favorable attributes like value, size, and momentum is a more successful way to identify the best expected return opportunities.
We do not market time a company’s stock investment entry and exit. Substantial research exists supporting the premise that market timing just doesn’t work; there is no provable method to implement such an investing strategy. One of the biggest robbers of portfolio performance are transaction costs; transactions should be limited, efficient, and low cost.