Global Equity Trading Cost Analysis

August 1, 2015

Robert A. Gillam, CFA Chief Investment Officer McKinley Capital Management, LLC
Joseph J. Dobrzynski, MBA Head Trader McKinley Capital Management, LLC 
Gregory S. Samorajski, CFA Director of Investments McKinley Capital Management, LLC

Executive Summary

McKinley Capital Management, LLC (“McKinley Capital”), is a buy-side investment manager trading approximately $12 billion per year in global equities in developed, emerging and frontier markets.  McKinley Capital has significantly enhanced its trading implementation as illustrated in the charts shown here.  It is important to note that McKinley Capital utilizes sophisticated transaction cost analysis, and has compared its transactions costs against those estimated that McKinley Capital utilizes sophisticated transaction cost analysis, and has compared its transactions costs against those estimated by ITG to measure execution quality. Notable McKinley Capital’s trading costs have been the same or lower than ITG cost model assumptions since 2013.

Best Execution, Dark Pools and HFTs

The buy-side trader’s ultimate goal is and has always been best execution.  However, the means to achieve best execution and even the definition of best execution have evolved over time.  In the past, best execution was often thought of as minimizing transaction costs.  Transaction costs are the combination of explicit commissions and implicit market impact caused by the order itself and other simultaneously occurring market factors.1  A better definition of best execution is the process of maximizing the expected return of the investment signal.  This standard requires the trader to balance the increased transaction cost of fast execution with the opportunity cost which can result from a more patient execution style.  In measuring execution impact it is important not only to consider the impact while the order is exposed, but also the relative price change of the security in the days immediately prior to and following the execution interval.

At McKinley Capital, the trading decision is fully integrated with the investment decision.2 Utilizing a 360 degree feedback loop ensures that trading costs are factored into the portfolio construction system, and that the relevant investment signals are fully utilized by the firm’s traders.  This process has led to continued improvement in the timing of investment selection and trade placement, leading to increased alpha.

Some of the important changes in global market structure include an increased number of exchanges, the growth of off-exchange trading venues, such as dark pools, and the increasing sophistication of electronic trading.  Historically, three stock exchanges dominated U.S. equity trading; the NYSE, AMEX, and NASDAQ.  Today there are eleven registered U.S. securities exchanges owned by three different groups and many off-exchange trading venues.

A significant amount of global equity trading now occurs in dark pools.3  It is estimated the percentage of dark pool trading is: 5-10% in developed Asia, 10% in the European Union, 15% in the U.S. and 5% in Canada.  Some of these off-exchange venues allow institutional investors to match trades with other institutional investors.  Other dark pools are accessed by executing brokers through their smart order routers.  While providing limited pre-trade transparency, it can require more time to execute through a dark pool.  Some pools allow the participation of other markets participants according to a variety of rules and procedures; some transparent, and some less so.  The availability of dark pools is more prevalent in developed markets.

McKinley Capital’s traders are connected to multiple execution options globally.  The firm trades with global, regional, and local brokers; either with the cash desk, the portfolio trading desk, or using the broker’s electronic trading platform.  Size and order difficulty dictate the selection of the broker and execution strategy.  In 2014, McKinley Capital executed 21.5% of trades through algorithmic trading, and 5.0% through agency-only crossing networks.

Recently, there has been significant media discussion about high frequency trading (“HFT”).  However, not all HFT is bad.  High frequency traders utilize algorithmic trading systems to transact very quickly across multiple trading platforms.  These are the modern day “market-makers”, effectively replacing onfloor specialists or pit traders of the past.  In gaining small information advantages and lighting quick electronic execution speed, high frequency traders are often able to earn small profits on multiple trades.   Some of the positive results of technology include: faster trading, cheaper trading, and bid-ask spread compression.

HFT is probably here to stay.  As part of the trading process the firm continually analyzes the trading venues available and excludes those identified as toxic – where it appears high frequency traders are behaving in a predatory fashion and where the potential transaction costs imposed greatly exceed the benefits of liquidity provided.

Trading and Transaction Cost Analysis

One of the significant developments in trading and transaction cost analysis (“TCA”) is increased access to detailed trade data.  New data allows investment managers to analyze not only the transaction costs of trading, but also the opportunity cost of alternative timing strategies.  This kind of analysis can help a manager identify and correct inefficiencies in the implementation of the underlying investment process.

McKinley Capital uses TCA data to help optimize security weight, time intervals between signal identification, qualitative security analysis, and actual entry of a trade into the trading system. 

The firm’s traders use TCA data to help decide when and how to actually begin and implement trade execution. Since the McKinley Capital process incorporates momentum and earnings acceleration into its model, efficient execution can be an important source of alpha.4  The following charts demonstrate the types of analyses McKinley Capital conducts using TCA data as provided by Investment Technology Group, Inc (“ITG”).

1507 Global-01 Chart1a

Chart 1A shows typical equity bid-offer spreads by country for 2013 and 2014 as defined and calculated by ITG. Most developed market stocks have tighter spreads than the emerging market stocks. Also, most spreads declined from 2013 to 2014.

Of particular note are tighter spreads in Japan, New Zealand, Singapore, and Indonesia as some of these countries have implemented reduced tick size. The firm trades in most developed and emerging markets. This type of analysis is useful in indicating where the need exists to select more customized venues, and where to rely on quicker and more standardized execution. Chart 1B shows how McKinley Capital’s trading is distributed across countries.

1507 Global-02 Chart2

Chart 2 relates volatility by developed region and emerging markets overall in 2013 and 2014 to McKinley Capital’s implementation shortfall.  Implementation shortfall is the difference between average execution price and the market price at or near the time that the order arrives at the trading desk.  It is no surprise that it costs more to execute trades in more volatile markets.  Understanding how trading costs relate to volatility allows the firm to fine tune the stock selection and trade execution process.5  Volatilities were generally lower in 2014 than in 2013.

1507 Global-03 Chart3

Chart 3 shows how trade size (as a percentage of median daily trading volume) relates to McKinley Capital’s implementation shortfall. As expected, less liquid securities cost more to trade than more liquid securities. Nonetheless, the firm does not avoid trading in smaller, less liquid securities. In fact, it is often advantageous to do so. However, the differential in execution cost of less liquid securities is a factor used in McKinley Capital’s model to determine security weights. It also explains why McKinley Capital owns more securities in less liquid market mandates (like U.S. small cap, non-U.S. small cap and emerging markets). While not illustrated by Charts 2 or 3, McKinley Capital uses data that shows how volatility and liquidity vary within a typical trading day, and by the day of the week. For example, while there is often more liquidity at the close, there can be more information based trading early in the day. The firm uses day of the week trading volume data to assist in optimizing the timing of trade placement.

1507 Global-04 Chart4

Chart 4 shows McKinley Capital’s implementation shortfall compared to ITG’s PTA ACE Cost Model. ITG’s model is meant to incorporate a pre-trade cost component which includes consideration of order size, market conditions during the time of execution, and investment style. This Chart shows how McKinley Capital has used new trading cost data to steadily reduce market impact over the last five years both absolutely and relative to the ITG model.

1507 Global-05 Chart5

Chart 5 shows total slippage, not only during the execution timespan, but also before and after execution. The difference between price at order start and the McKinley Capital average corresponds to the implementation shortfall. Since the firm employs an intermediate-term price momentum factor, it is to be expected that a security selected for purchase will have gone up in price on a relative basis prior to model selection (that is what momentum means). However, once a security is identified through the process as a purchase, it is advantageous to consider very short-term momentum as a timing signal both in the process itself, and in the trading system. This consideration is an input in the decision of how quickly to trade. Incorporating very short-term momentum signals as a reversal indicator has improved the pre-trade slippage. From 2013 to 2014, the slippage from T-3 to the trade date declined from 166 basis points to 65 basis points.


These charts illustrate the type of work McKinley Capital is currently doing to utilize TCA data, and to continue to enhance both the stock selection and implementation processes. The firm will continue to search for these kinds of opportunities. As always, your McKinley Capital account representative is available to discuss the firm’s processes and to answer your questions.


McKinley Capital Management, LLC (“McKinley Capital”) is a registered investment adviser under the U.S. Investment Advisers Act of 1940. McKinley Capital is not registered with, approved by, regulated by, or associated with the Financial Conduct Authority (“FCA”) or the Prudential Regulation Authority (“PRA”). Neither the FCA nor the PRA have commented on the firm, the content of any marketing material or any individual suitability assessments.

All information contained herein is believed to be acquired from reliable sources but accuracy cannot be guaranteed. This presentation is for informational purposes only, and was prepared for academic, financially sophisticated, and institutional investors. It is not intended to represent specific financial services or recommendations for any targeted investment purposes. This material may contain confidential and/or proprietary information and may only be relied upon for this report. The data is unaudited and may not correspond to calculated performance for any specific client or investor in referenced disciplines. McKinley Capital, nor its employees, makes any representations or warranties as to the appropriateness or merit of this analysis for individual use. Investors must seek individualized professional financial advice before investing.

Investments and commentary were based on information available at the time and are subject to change without notice. Any references to specific indexes or securities are for informational purposes only, may or may not have been owned by McKinley Capital in the past, may or may not be owned by McKinley Capital in the future and may or may not be profitable. No single security, discipline, or process is profitable all of the time and there is always the potential for loss.

Global market investing, including developed, emerging and frontier markets, also carries additional risks and/or costs including but not limited to: political, economic, financial market, currency exchange, liquidity, accounting, and trading capability risks. Derivatives trading and short selling may materially increase investment risk and potential returns. These risks may include, but are not limited to, margin/mark-to-market cash calls, currency exchange, liquidity, unlimited asset exposure, and counter-party risk. Future investments may be made under different economic conditions, in different securities and using different investment strategies. McKinley Capital’s proprietary investment process considers factors such as additional guidelines, restrictions, weightings, allocations, market conditions and other investment characteristics. Thus returns may at times materially differ from the stated benchmark and/or other disciplines and funds provided for comparison.

Charts, graphs and other visual presentations and text information were requested by the client and derived from internal, proprietary, and/or service vendor technology sources and/or may have been extracted from other firm data bases. As a result, the tabulation of certain reports may not precisely match other published data. Data may have originated from various sources including but not limited to Bloomberg, MSCI, Axioma, Russell Indices, FTSE, APT, ClariFI, Zephyr, and/or other systems and programs. With regards to any material accredited to FTSE International Limited (“FTSE”)©FTSE [2015]: FTSE™ is a trade mark of London Stock Exchange Plc and The Financial Times Limited and is used by FTSE International Limited under license. All rights in the FTSE Indices vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE Indices or underlying data. With regards to any materials accredited to MSCI: Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent. Please refer to the specific service provider’s web site for complete details on all indices. McKinley Capital makes no representation or endorsement concerning the accuracy or propriety of information received from any other third party.

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