The impact of trading on pension fund portfolios

Published on 4 February 2021

Transaction cost reports can mislead pension fund trustees, so how can they measure the impact of trading on their investments? Under MiFID II, since 1 January 2018, trading costs and execution quality have been reported by European asset managers, yet these numbers are widely considered to be a shallow reflection of trading quality, or even misleading.

For pension fund trustees, who are likely to manage multi-asset portfolios, the complexity of reports for trading across different instruments can be substantial. Rachit Sharma, investment director of RPMI Railpen and Carsten Just, head of fixed income trading at Nordea Asset Management discuss the role of trading in the investment process, outline how execution quality can be measured both quantitatively and qualitatively, and consider how trustees can use this information to make better decisions.

Dan Barnes Welcome to TRADER TV, I’m Dan Barnes. Since 2013, pension fund trustees have much greater visibility over trading and execution costs over all the funds they oversee. However, execution is not always a simple affair. Today, we’re speaking with Rachit Sharma, investment director of RPMI Railpen, and Carsten Just, head of fixed income trading at Nordea Asset Management. We’re going to be discussing why execution is important to the trustee, how execution and investment work within the process, and then how a trustee can understand best execution.

Carsten, Rachit, welcome to the show.

Carsten Just Hi Dan, thanks for having me.

Rachit Sharma Hi Dan, and thanks for having me.

Dan Barnes We’ve seen research from Mercer, investment consultancy suggest that anywhere between 15-59% of day-to-day investment decisions can fall within a trustee’s remit. Rachit, what sort of interactions do you typically have with trustees, and how much of that is around execution as well as investment?

Rachit Sharma So I think that split probably has a lot to do with the way the governance of my work for a particular scheme. In our setup the investment team makes a lot of the D2D, if not all of the D2D investment decisions, and the dealing desk and the full implementation being they work closely with the individual portfolio managers to figure out what’s the best way to execute transactions for those portfolios.

Carsten Just We deal with them through our reporting and compliance.

Dan Barnes So that emphasizes the importance of getting the right data and both qualitative and quantitative information from the trading desk to the investment function to the trustee, I suppose.

Carsten Just Absolutely.

Dan Barnes When managing trading as part of the investment process, what measures are useful for you to assess execution quality?

Rachit Sharma There’s a multitude of reporting that we feed back into how we think about the trading process. For instance, we started trading stock in China A-shares, typically we bias our trading towards the close in other markets, because that’s a good liquidity point. But actually that’s not a great thing to do in Chinese A-shares, because it’s a retail-driven market and the close is not such a big part of the trading day and its volumes can be very volatile, so we trade very differently in that market than we do elsewhere. The way we came about that is through regular review of our execution data, execution quality, participation levels, slippage versus relevant benchmarks. And when there are outliers, what might be driving that? We have investigated that and thought about where in the process we need to make a change.

Carsten Just I totally agree, it’s much more about the process and the numbers. Do we follow strictly a well-defined and optimized process? Rather than having a look at certain numbers? I think we use numbers very much to tune our processes, to learn from it and obviously for outlier reporting, but the statistics themselves are so littered with issuers.

Dan Barnes I think that’s a good point. At what level of data do you think it’s actually useful for a trustee compared to a head of trading, fx?

Carsten Just I think if you take it to that level, figure out data that will prove your process. So how do you figure out that there’s a process and it’s followed by all traders, and that actually fits with the mission management style and approach that the firm has? That way you can gain confirmation that you are doing best execution, basically. The thing is whether your trade with little fear of little more counterparties, whether you trade at certain times, you can always do pure comparisons. But there are so many factors affecting these numbers, particularly in the slightly shorter run, that the comparison risks being more noise than information, basically.

Rachit Sharma I agree completely, actually. Any DCA or execution quality numbers need to be taken in the context of that particular transaction or the market environment at the time. And so it’s much more beneficial for trustees to think about best execution in the same way they think about the overall asset management process in that you don’t just rely on faster terms, you think about the investment process, the culture of the organization, people and their stability of being, etc., and whether that extends to the execution of the investment process as well.

Dan Barnes So you would see pension fund trustees assessing best execution using both qualitative and quantitative measures?

Rachit Sharma Yes, absolutely.

Dan Barnes Where execution analytics are complicated, Carsten, what can a trustee consider to assess them?

Carsten Just I think there’s a couple of values. One thing is to take some of the complexity out and look at more overarching numbers and check for consistency over time. So not the lever or all the change in numbers. For trustees it’s all about being not only compliant, but also have a very high faith in your investment managers and the people you work with. So it’s basically trying to get the data that will support that trust, and would meet your demand for reporting. It’s not an easy task. I will say one thing you can get is peer reporting and that will use the same basis for a meaningful subset, at least of your trading.

Dan Barnes Ratchit, that point about peer reporting, is that something you’re aware of and something that you use?

Rachit Sharma We look at peer transaction costs, yes, but I think the context around the transaction is so important and a lot of that context is lost in high level peer reporting. For a large asset manager over a 12 month period, looking at that number is not really informative. There are other explicit costs where peer reporting can help benchmark our levels, the rest of the industry, and we do that. But I think for trustees that have extended that qualitative, quantitative aspect, I think the sort of confidence in the process and the best execution process needs to come from the qualitative work.

I think it is entirely acceptable to think about large transactions or a big transition, etc. and look at the actual numbers, realize numbers on execution quality for those, because what you can do there is you can build in all of the context that transaction required, whether the urgency or illiquidity, the duration of the trade and what the appropriate benchmark is. So you can kind of build all of that into it and then look at it. So I would suggest for trustees to think about the process and then on a one-off basis, for important transactions, look at the execution of all the numbers, but then look at those with all of the context that those numbers involve.

Dan Barnes What advice would you give a pension fund trustee who wants to understand how execution is impacting their investments?

Rachit Sharma Look for attribution on overall execution costs as a percentage of the portfolio. So for low level strategies, obviously, execution should be much less important to portfolio outcomes than it is for high level strategies. And then if it’s high turnover in what sort of instruments that are trading the future strategy, so for instance, execution costs in themselves are not massive, or a high turnover equity portfolio can really suck out all of the alpha in the portfolio.

Dan Barnes Guys, that’s been great. Thank you so much.

Rachit Sharma Thanks Dan, great talking to you.

Carsten Just Thank you Dan, its been a pleasure.