Smart Investment strategies stand to significantly redu… – Daily Maverick

When investing in the equity market, be it in your personal capacity or via a professional investment manager, the following explicit transaction costs apply:
A practical example helps highlight the impact of these costs on investments. Take a R10,000,000 investment in a hypothetical FTSE/JSE Top40 portfolio. Based on the execution costs above alone, a few elementary sums reveal that it will cost approximately R41,520 (0.42%) to deploy this cash, and another R16,430 (0.16%) to liquidate the same amount held in physical shares. Sure, these do not seem like massive amounts, given the size of the investment, but they can certainly become a significant portion of the investor’s resultant gain or loss, especially in environments where equity markets are stagnant. In fact, in scenarios where the underlying investment grows/declines by less than 20%, these execution costs alone comprise a considerable 2.5% of the resultant gain/loss!
It is precisely these expenses that fund managers, at a minimum, must clear if they want to have any hope of generating positive performance for their clients on a net basis. That is the return client’s will see on their investment statements. Active equity managers attempt to do this – with arguably limited degrees of success – by picking shares based on the outcomes of copious amounts of fundamental research. The cost of these efforts is then passed on to clients in the form of management fees. Passive managers, on the other hand, have little room to mitigate these costs, which undoubtedly makes a pure passive tracker fund less likely to meet its investment objectives on a net basis.
A critical aspect of our Prescient Core Equity Fund strategy is to minimise the execution costs of investing while maintaining full equity exposure. While we cannot escape these explicit execution costs, we manage our equity exposure in a way that minimises these costs and increases the likelihood of meeting  our investment objectives.
Consider the same R10,000,000 investment but using FTSE/JSE Top40 Futures contracts instead of the physical shares. When entering the contracts, the investor gains the same effective exposure as purchasing the underlying shares but, critically, at a fraction of the execution costs. Execution costs applicable in this instance are:
To get the same R10,000,000 exposure using ALSI40 futures contracts at 60,000 index points per contract and a standard multiplier of 10, the investor needs only 16 contracts. These execution costs amount to just under R300, which is a massive 98% saving on execution fees compared to buying and selling the physical shares. 
To illustrate the savings, consider the execution cost difference on the same R10,000,000 portfolio, with an assumed 10% annual turnover per year. The numbers show that over a period of about 20 years, the portfolio will have saved just over R500,000 by simply being prudent in the way investments are executed while enjoying the same market return. Remember this R500,000 is not obvious to the investor. It accumulates in the invested amount, and that higher base then generates an enhanced return. In this example, the value of this saving amounts to 12.5% of the initial investment – an amount that is hard to ignore. This is one of the reasons we prefer – to the greatest extent possible – to utilise such contracts to manage our equity exposure. Without these, the higher expenses, which are borne by the fund, eat into the alpha generated, and ultimately erodes the gains that end up in your back pocket. DM/BM
Author: Ashleigh Allan, Equity Dealer at Prescient Investment Management.

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