Active Fund Trading Costs Remain High By Will McClatchy January 22, 2002

Many individual investors believe that professionally managed funds have a trading cost advantage over them, but this is not the case. A recent study suggests that smaller volume traders have gained the most from recently shrinking commissions and smaller bid-ask spreads from regulatory changes.

If large volume traders are penalized for their size, it would further explain perennial underperformance by large actively managed funds, since they concentrate their actitivity to fewer stocks than the typical index fund.

Commissions are just the tip of the cost iceberg for large volume traders, according to the Plexus Group, a consulting firm dedicated to improving institutional trading efficiency. First, large volume traders "impact" a stock, forcing its price to move higher (or lower if the investor is selling). Likewise, there are costs associated with the delay as their typically large orders are broken up into smaller blocks for sale. Lastly, large volume traders often miss trades because the stock moves beyond what they might be willing to accept. Below is the extra cost for US stocks of various styles from recent data:

Costs in 1/100th of % (basis points) For Institutional Traders

Type of Stock	Commissions	Impact	Delay
All US Stocks	-9	-34	-58
Core	-9	-70	-40
Growth	-9	-49	-103
Value	-12	-22	-34
Large Cap	-9	-30	-53
Large Cap Core	-10	-22	-17
Large Cap Growth	-8	-21	-40
Large Cap Value	-8	-42	-88
Medium Cap	-9	-36	-50
Medium Cap Core	-7	-31	-8
Medium Cap Growth	-6	-69	-135
Medium Cap Value	-16	-24	-70
Small Cap	-12	-41	-69
Small Cap Core	-11	-70	-8
Small Cap Growth	-10	-65	-112
Small Cap Value	-13	-17	-34

Courtesy of Plexus Group

Curiously, large cap value suffers more than large cap growth, while in the mid cap and small cap arenas value is more efficient to trade than growth.

Presumably index funds are less affected by impact, delay and missed trades because they hold a greater number of stocks in their portfolios on average and trade smaller amounts of each stock. At the same time, they probably pay slightly higher commissions because of the additional trades, but the above data suggests the net effect is in their favor. According to Plexus, there are strategies that large volume traders such as active funds can take to mitigate some of these hidden costs, but so far the trend of actual costs has not been in their favor.