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Transaction Cost Analysis
Financial markets are inherently volatile, characterized by shifting values, risks and opportunities. The prices of individual securities are frequently changing for numerous reasons, including shifts in perceived value, localized supply/demand imbalances, and price changes in other sector investments or the market as a whole. Reduced liquidity adds price volatility and market risk to any contemplated transaction, and in the face of this volatility, Transaction Cost Analysis (TCA) has become increasingly important to help firms measure how effectively both perceived and actual portfolio orders are completed.
Conceptually, TCA represents the difference between two amounts, and StreamBase’s Event Processing Platform can play an active role in computing TCA in real-time. The first amount represents the amount if the transaction was instantaneously executed at the price prevailing when the portfolio manager made the decision, without any additional costs. The second amount represents what would have been or actually was realized. This second amount includes direct costs, such as commissions, settlement costs and taxes, as well as indirect costs from timing delays, market impact and missed opportunities. The difference between these two amounts is often referred to as transaction “slippage”.
Increased slippage amounts directly reduce investor returns and hurt relative performance versus the performance of competing investment managers. In an environment of increased regulatory scrutiny, fierce competition, and relatively low returns on equities, TCA has become a staple at buy-side firms to analyze the efficiency of their entire investment processes.
If an entire stock order is sold at once, the resulting sale price generally will be locally depressed relative to the portfolio manager’s decision price. This is due to the trade-off between time and price, even with stocks that have the best market liquidity. Alternatively, if the order is distributed into the market over time, there is an opportunity cost that the market price might decline over time. What’s more, timing delays between the portfolio manager, compliance officials, traders and actual delivery of the order to the market contribute to overall opportunity cost.
Implementation Shortfall (IS) algorithms implemented in StreamBase can measure and balance the risk of moving the security price against the urgency of filling the order. Multiple security IS versions use advanced quantitative techniques to continually calculate the optimal execution, attempting to minimize liquidity impact, opportunity costs, market risk and information dissemination across the entire portfolio.
With technologies such as StreamBase’s Event Processing Platform, the graphical development paradigm enables rapid implementation of trade execution strategies, and easy adjustment of these strategies on the fly to reflect changing market conditions. The high performance server captures more refined data, and the low latency processing platform enables real-time TCA to help pinpoint exactly where and when costs occur in open orders and completed transactions. Process bottlenecks can then be identified more frequently and resolved more efficiently. And the extensive library of pre-built adapters to market data feeds, historical data, and interactive dashboards also provides smoother integration with even the most complex environments. The net result is real-time TCA that enables investment ideas to be more efficiently implemented while minimizing slippage costs.