Subtitle Koscom Seminar

Transaction Cost Analysis March 2013

2013 Investment Technology Group, Inc. All rights reserved . Not to be reproduced or retransmitted without permission.

Subtitle

Agenda
Introduction to Transaction Cost Analysis (TCA) What is TCA? Why use TCA? Why Measure? TCA and Post Trade TCA in practice Timing cost Impact Cost Reversion Momentum Tools of the Trade(r) Pre trade analysis Post trade TCA Peer analysis
2

Subtitle Introduction to TCA

Subtitle What is TCA?

Transaction Cost Analysis (TCA) Measuring and analyzing the factors which affect the price an order is executed at

Usually involves taking time-stamped data at various points through the investment and trading process, and comparing it to the price of the equity in the market at the time, as well as an overall benchmark for the trade
The goal of analysing and understanding trading costs is to define where unnecessary or disproportionate costs arise

TCA is an important part of the ongoing feedback loop to measure trading costs, so that they can be reduced

Subtitle Why is TCA important?

Best Execution Trading in the most efficient way possible in order to preserve alpha, reduce costs & improve fund performance

A process rather than a price

Has a significant impact on fund performance Absolute terms (dollars under management) eg US$24mm saving in 1 year for a $2bn fund Relative terms (funds performance against peers) a move of a decile in rankings by improving trading efficiency Focus area for industry practitioners and regulators globally MiFID regulations (Europe) & RegNMS (US) mandate Best Execution Many global pension funds & plan sponsors now require proof of trade cost management policies before investing with a chosen fund manager

Subtitle You cant manage what you dont measure

What are trading costs? The difference between the price when the decision to trade was made, and the average price of executing the order
(a) Explicit / Visible costs such as brokerage/commission fees and taxes only 20% (b) Implicit / Hidden costs including market impact and delay (timing costs) costs around 80%

TAXES COMMISSION SPREAD MARKET IMPACT DELAY

Commission costs 14bps (22%)

Implicit (Hidden) Costs 50bps (78%)

Market Impact

Delay Cost Timing Gain/Loss Opportunity Cost

Asia Ex-Japan Trading Costs

Source: ITGs global trading cost review available at www.itg.com

Subtitle How to save your fund money

ITG Peer Analysis of trading costs in Q2 2010 shows:
average cost = 50bps standard deviation = 40bps

For the same fund with US$2bn AUM and 75% annual turnover:

Cost saving of $24million per annum or 1.2% of fund value

between a well executing and a poorly executing fund

With poor execution: average cost = 90bps per trade (50 + 40) Total cost of execution = 90bps x 2 (buy & sell) x 1.5bn = $27million of cost or 1.35% of overall fund value

With average execution: average cost = 50bps per trade

Total cost of execution = 50bps x 2 x 1.5bn = $15million of cost or 0.75% of overall fund value
With good execution: average cost = 10bps per trade (55 40)

Total cost of execution = 10 x 2 x 1.5bn = $3million of cost or 0.15% of overall fund value

Subtitle How to improve your performance versus competitors

Annualised cost savings can make a big difference in peer group ranking Analysing Australian funds over 3 year period - reducing trading costs from the 70-80bps range to the 30-40bps) range can move a fund over a decile up in fund rankings with no change to investment strategy
Fund Rankings
45.00% 40.00% 35.00%

Total Return 3 Years (%)

30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th Performance Deciles
Highes t Return Lowes t Return Median

Source: Intech

Subtitle TCA and Post Trade reports

Objective View Post Trade Reports Monitor daily execution Identify outliers Provide reasoning behind a particular trading strategy Provide details on the days executions Usually a single day Orders given to a single broker TCA Reports Identify longer term trends Optimize decision making process Promote discussion between portfolio manager, trading desk and broker Holistic, can identify overall performance on decision size by PM, as well performance on slices provided to the desk or broker Usually Quarterly Sometimes (semi)-annually Between 1 and 4 quarters The investment process from PM decision thru trading desk and broker execution Portfolio Managers, Trading desk, compliance

Frequency Timeframe Focus

Daily Sometimes intraday Between 1 and several days Trader/Algo/Broker execution on the day Trading desk, sometimes compliance

Audience

Subtitle TCA in Practice

10

Subtitle The trading continuum: Definition of terms

Execution Cost:

Manager Timing Cost (1) + Trading Timing Cost (2) + Broker Execution Cost (3)

11

Subtitle Traders balance impact and timing

Question for the trader

Illustration of Cost Tradeoff

0

Do I participate or not?
If I do how much? Low participation High participation

-10 -40

-20 -40 -100 -60 -80 -100 -120 -140 -160 -180 Case A Timing -5

-32

If I dont what is the cost?

Not trading carries timing costs

-150

Case B Impact

Case C

12

Subtitle A delicate balancing act case study 1

Sell Korea Exchange Bank (004940 KS) Order Size 800% MDV Start Date: Sept 17, 2012 pre Open End Date: Nov 27, 2012 (51 Days to completion) Delay Cost: -700 bps (US$ -2.0 mm) Total Cost: -730 bps (US$ -2.1 mm) Avg. Participation Rate: 12%

PWP 20%: KRW 8,175 or -450 bps 33 days horizon (Nov 2)

13

Subtitle A delicate Balancing Act - Case Study 1 (Cont.)

14

Subtitle Measuring participation

Distribution of Value Traded by MDV & DTC Group
100% 1% 1% 3% 90% 1% 2% 3% 4% 1% 2%
7% 10% 2% 3% 5%

4%
5%

8%
10%

12% 28%

80%

70% 23%
% Value Traded

30%

60%

20% 50%
95%

90% 80% 20% 25%

40%

30% 55%
20% 23%

10%

10%

17%

0% A) 0 - 5%
A) 1 Day

B) 5 - 10%
B) 2 Days

C) 10 - 25%
C) 3 - 5 Days

D) 25 - 50%
D) 1 - 2 Weeks

E) 50 - 100%
E) 2 - 4 Weeks F) 1 - 2 Months

F) >100%

15

Subtitle A delicate balancing act - case study 2

Reversion

Reversion Period

Order Duration

Sell order 700% MDV

Reversion Cost: -618 bps (US$ 8mm) Avg. Participation Rate: 45.4%
16

Subtitle Measuring participation

Distribution of Value Traded by MDV & DTC Group
100%

0% 1% 2% 1% 5%

0% 3% 1% 11%

0% 2% 4%
14%

0% 3%
8%

0% 1%

0%
10%

90%

19%

80%

7% 30%
11%

70% 25%
% Value Traded

38%

60%

50% 91% 40%

30% 78%

47%

24%

30%
54%

20% 28% 10% 9% 0% A) 0 - 5%

A) 1 Day

16% 13%
5% 6%

B) 5 - 10%
B) 2 Days C) 3 - 5 Days

C) 10 - 25% % MDV Group

D) 1 - 2 Weeks

D) 25 - 50%
E) 2 - 4 Weeks F) 1 - 2 Months

E) 50 - 100%
G) 2 - 3 Months

F) >100%
H) >3 Months

17

Subtitle Intraday Alpha Profile (T-5 to T+5)

Intraday Alpha Chart
150

100

50

bps

-50

-100

-150

-200

-250

TZero

T-5

T-4

T-3

T-2

T-1

T+4

Buys

Sells

Net

T+5

T+1

T+2

T+3

18

Subtitle Tools of the Trade(r)

19

Subtitle Pre Trade Analysis

20

Subtitle Pre Trade Analysis

21

Subtitle

22

Subtitle ITG TCA performance by quarter

23

Subtitle ITG TCA liquidity management

24

Subtitle ITG TCA broker commission review

25

Subtitle ITG Peer Analysis - example

26

Subtitle ITG Peer Analysis - example

27

Subtitle Peer Report Example

28

Subtitle Appendix

29

Subtitle Whats in a benchmark?

BENCHMARKS

DISCRETE I.S

AVERAGE PRICE VWAP PWP

Open
Last

Arrival
Next Mid

PDC
+XMid mins

Bid/Ask

I-VWAP

Full Day VWAP

X% Participation

EoT+ X mins

Start to EOD

30

30

Subtitle Comparing apples to apples

Problem: when comparing using Implementation Shortfall not all trades are created equal
Demand for liquidity may be different Market conditions may be different Spreads may be different

Solution: Create a handicap (much like golf) in an effort to equalise the field
1. Modelled approach ACE/Post Trade ACE

Advantage: takes all relevant parameters into consideration Disadvantage: Model. Struggles at high ADV trades

2. Peer approach

Advantage: real life trades comparison Disadvantage: complex, requires a large dataset

3. Average pricing for participate (PWP) approach

31

Advantage: looks at the market over the life of the PWP horizon Disadvantage: ignores own trade impact
31

Subtitle Disclaimers
Broker-dealer products and services are offered by: in the U.S., ITG Inc., member FINRA, SIPC; in Canada, ITG Canada Corp., member Canadian Investor Protection Fund (CIPF) and Investment Industry Regulatory Organization of Canada (IIROC); in Europe, In vestment Technology Group Limited, registered in Ireland No. 283940 (ITGL) and/or Investment Technology Group Europe Limited, regist ered in Ireland No. 283939 (ITGEL) (the registered office of ITGL and ITGEL is First Floor, Block A Georges Quay, Dublin 2, Ireland and ITG L is a member of the London Stock Exchange, Euronext and Deutsche Brse). ITGL and ITGEL are authorised and regulated by the Central Bank of Ireland; in Asia, ITG Hong Kong Limited (SFC License No. AHD810), ITG Singapore Pte Limited (CMS Licence No. 100138-1), and ITG Australia Limited (AFS License No. 219582). All of the above entities are subsidiaries of Investment Technology Group, Inc. MATCH NowSM is a product offering of TriAct Canada Marketplace LP (TriAct), member CIPF and IIROC. TriAct is a wholly owned subsidiary of ITG Canada Corp. These materials are for informational purposes only, and are not intended to be used for trading or investment purposes or as an offer to sell or the solicitation of an offer to buy any security or financial product. The information contained herein has been taken from trade and statistical services and other sources we deem reliable but we do not represent that such information is accurate or complete and it should not be relied upon as such. No guarantee or warranty is made as to the reasonableness of the assumptions or the accuracy of the models or market data used by ITG or the actual results that may be achieved. These materials do not provide any form of advice (investment, tax or legal). ITG Inc. is not a registered investment adviser and does not provide investment advice or recommendations to buy or sell securities, to hire any investment adviser or to pursue any investment or trading strategy. All information, terms, and pricing set forth herein is indicative and based on, inter alia, market conditions at the time of this writing and are subject to change without notice. All trademarks, service marks, and trade names not owned by ITG are the property of their respective owners. Any opinions expressed in this document solely reflect the judgment of the author(s) on this date and are subject to change. The screen shots provided herein contain sample data and represent hypothetical examples of certain products available from ITG. All functionality described herein is subject to change without notice.

32