NETHERLANDS – A paper prepared by staff at the Dutch central bank and civil service pension fund ABP has found that a small number of trades causes most market impact.

The study – which used ABP equity trading data from 2002 – found that cutting costs in just a few trades could result in substantial savings.

“When a relatively small group of trades causes the major part of the market impact costs of an investment portfolio, a reduction of the trading costs of comparatively few expensive trades would already result in substantial savings on total trading costs,” the 20-page paper found.

“For the equity trades studied in this paper, executed by the world’s second largest pension fund, we find that only 10% of the trades determines 75% of total market impact costs,” the researchers write.

The comments come in a working paper from De Nederlandsche Bank called ‘Forecasting Market Impact Costs and Identifying Expensive Trades’.

It was prepared by the DNB’s Jacob Bikker, Twente University’s Laura Spierdijk alongside Roy Hoevenaars and Pieter Jelle van der Sluis of ABP. It is stressed that the views expressed are those of the authors and not the DNB.

The paper advocates two methods for forecasting future trading costs.

The first involves using five ‘buckets’ to classify trades. Each trade is assigned to a bucket depending on the probability of the trade incurring high market impact costs.

The second identifies expensive trades by considering the probability that market impact costs will exceed a critical level – whereby it is labelled as potentially expensive.

“Applied to the pension fund data, both methods succeed in filtering out a considerable number of trades with high trading costs and substantially outperform no-skill prediction methods.”

The study has emerged as Dutch pension associations have called for transparency on fees to brokers.

The company pension body OPF and the VB industry-wide association are calling upon their members to insist on transparency regarding the fees paid to brokers in the context of asset management.

They said in a joint statement: “Until now, it has often been the case that in the fees paid by an assets manager to a broker for carrying out securities transactions, no distinction is made between the costs that the broker incurs when carrying out equities transactions and the costs for other services, such as investment research.”

They said the drawback is that the asset manager's client (the pension fund) is unable to check whether services other than carrying out transactions are provided for their asset manager and they are therefore paying for something of which they have no knowledge.

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