Transaction costs lower returns, so managers should minimize those fees.
So says Adrian Banner, CEO of INTECH Investment Management and manager of the Renaissance U.S. Equity Fund.
He suggests the following two strategies help reduce transaction costs when he rebalances portfolios.
1. Screening for liquidity. “Smaller-cap stocks tend to have lower liquidity,” and they’re more expensive to trade as a result, says Banner. To help clients cut down on fees, “keep statistics on how much it costs to trade those securities,” and minimize costly transactions accordingly. Fortunately, “in developed countries, liquidity, even for smaller stocks, tends to be fairly plentiful.”
2. Rebalancing sparingly. “Don’t rebalance every position when you come up to trade,” he notes. Instead, “set some thresholds around each of your targets and only trade if [the prices have strayed] far enough to make it worthwhile from a trading cost perspective.” For instance, if a stock has a target of 5%, you wouldn’t trade if it hit 5.1%. However, you might if it hit 6%.
Banner finds that “in both the U.S. and in other developed markets, we incur transaction costs in rebalancing trades that average 30 bps.” A portfolio trading at 100% annual turnover would therefore cost 0.60% (200% multiplied by 30 bps), including taxes and currency effects.
But it’s worth the expense, he says, since “that level of turnover could, if correctly designed, generate 300 to 400 bps of excess return over time. That makes it highly worthwhile to go after that rebalancing premium.”