TRANSACTIONS COST MATTER
Of the main components within an investment process, transaction costs are the most often overlooked. Transaction costs are commonly divided into direct costs such as commissions, fees, and taxes while indirect costs include market impact and opportunity costs. Investment advisers widely accept that execution costs can reduce performance in a meaningful way. All Atlas Capital Advisors equity strategies are optimized to minimize transaction direct costs. Atlas manages in excess of $500 million, a large number in appearance, but modest in overall market scale. As a result, our size allows us to transact with minimal, if any, market impact. Such nimbleness is difficult to attain at larger firms. These execution costs can erode net returns and is one of the many benefits of using Atlas to implement an investment strategy.
ANALYZING THE MARKET IMPACT
The biggest factors when estimating market impact, and ultimately investor execution costs, are transaction size and trading volume for the security in question. The chart below shows the estimated market impact by trade size for the average stock in the S&P 500, a high volume stock, Apple, and a low volume stock, Alcoa. The market impact for a $10 million dollar trade of an average S&P 500 stock is about 35 bps. That implied cost rises to about 130 bps for a $150 million dollar trade. Correspondingly, market impact costs are lower for higher-than-average volume stocks and more expensive for lower-than-average volume stocks. Intuitively, common sense supports the mathematical findings; it’s easier to be a price taker for proportionally smaller amounts of volume. Of course, any experienced trader will not execute substantial quantities of stock merely by executing market orders; they will work to mitigate their market impact by strategically working the amount of volume they want to trade using any variety of trading techniques (algorithm, VWAP, REL limit, etc). This now introduces another level of risk associated with time needed to execute; the market can move away from you thereby adding to the opportunity cost of execution. For those interested in additional data on this subject, please refer to a study in our data base of External Research.