Introduction (1)

1. Market Impact Costs of Institutional Equity TradesJaap Bikker (DNB), Laura Spierdijk (UT) and Pieter Jelle van der Sluis (ABP)

2. Introduction (1) • Employees pay pension fund premia to pension funds. • Pension funds invest the premia in various assets such as stocks. • With buying and selling stocks, the pension fund incurs trading costs.

3. Introduction (2) • Trading costs costs should be taken into account, as they considerablyaffect the optimal portfolio holdings by the pension fund. Thus, ignoring trading costs may substantially reduce portfolio performance.

4. Contribution (1) • Using a unique data set,this paper investigates the trading costs of the global equity trades executed by the world’s second largest pension fund (ABP) during the first quarter of 2002.

5. Contribution (2) • We focus on the magnitude of the trading costs, as well as the determinants of both expected trading costs and the variance of these costs. Variance of trading costs  risk of facing high trading costs

6. Results • On average, the magnitude of trading costs is substantial. • Trading costs depend on various trade, exchange, and stock-specific characteristics such as momentum, volatility, investment style, trade timing, and trading venue. • There is a mean-variance trade-off related to the duration of a trade.

7. Relevance • Results shed light on the determinants of trading costs and the mean-variance cost relation. • Results contribute to improved trading cost management.

8. Setup • Stylized facts about ABP • Measuring trading costs • Sample statistics • Determinants of trading costs • Mean-variance trade-off • Conclusions

9. Stylized facts (1) • ABP has 2.4 million clients and an invested capital of 180 billion Euro (d.d. December 31, 2005). • At the moment ABP is the 2nd largest pension fund in the world.

10. Stylized facts (2) • The data set contains detailed information on allworldwide equity trades (in Europe, Japan, Canada, and the US) of 10 different funds at ABP during the first quarter of 2002. • The sample consists of 3,728 trades with a total transaction valueof 5.7 billion Euro.

11. Components of trading costs (1) • Trading costs consist of several components: • Fixed costs: commission, taxes; • Variable costs: market impact costs, opportunity costs, delay costs.

12. Components of trading costs (2) • The literature points out that market impact costs dominate the other cost components. • Market impact costs: the difference in price between the moment that the trade was passed to the broker and the moment that the trade was executed.

13. Measuring market impact costs • We correct for market-wide price movements. This means that we correct for “delay costs” (the risk of adverse price movements that may occur when trading is postponed). • Delay costs are approximated by the return on the corresponding sector index during trade execution. • Positive market impact costs represent a loss for the pension fund.

14. Sample statistics buys/sells

15. Preliminary conclusion • On average, the magnitude of the market impact costs is substantial. • Next step: market impact costs are likely to depend on several stock,market, and trade-specific characteristics.

16. Approach (1) • We investigate the relation between market impact costs and relevant determinants by means of a regression approach. • We examine expected market impact costs, as well as the variance of these costs.

17. Approach (2) • The variance of the market impact costs reflects the risk of facing high market impact. • Together, they reflect the mean-variance cost relation. MV-relation  trade-off between cost and risk

18. Possible determinants of MIC (1) • Relative trade size; • Price volatility; • Momentum; • Trading venue; • Industry sector (MSCI Global Industry Classification Standard); • Type of stock: value/growth (based on MSCI Value/Growth Index);

19. Possible determinants of MIC (2) • Small cap or large cap stock? (market capitalization) • Type of broker intermediation (agency, single, or principal); • Trading strategy used by the pension fund (quantitative or fundamental); • Trade timing, including trade duration.

20. Determinants of expected MIC • Most important determinants of expected market impact costs: • Momentum; • Trading venue; • Trade timing.

21. Determinants of variance MIC • Most important determinants of variance of market impact costs: • Momentum and volatility; • Type of broker intermediation; • Trading venue; • Trade timing.

22. Buys versus sells • Literature on “trading cost asymmetry”: (average) trading costs of buys and sells differ substantially. • Often, buys are found to be more expensive than sells. • This study: sells are on average more expensive than buys.

23. Trade duration and MIC • Trade duration plays an important role: • Longer trade duration: lower expected MIC, higher variance; • Shorter trade duration: higher expected MIC, lower variance.Mean-variance cost relation Trade-off between costs and risk

24. Mean-variance cost relation (1)

25. Mean-variance cost relation (2) • In trading cost management, the focus should not only be on expected trading costs, but also on the volatility of these costs.

26. Conclusions (1) • On average, the magnitude of the market impact is substantial. • Expected market impact and the variance of the market impact costs depend on severalstock, market, and trade-specific characteristics.

27. Conclusions (2) • Market impact costs depends strongly on variables such as momentum, volatility, trading venue, and trade timing. • There are significant differences between buys and sells. • There is a mean-variance cost relation.