Transaction Cost Analysis A-Z

Transaction Cost Analysis A-Z — November 2008

V. Trading Performance Measurement

its average execution price. Modelled after the percentile ranking, the RPM attempts to provide a descriptive and meaningful measure of trading performance that is consistent across days and across stocks. Not unlike VWAP-based measures, in that it properly accounts for contemporaneous market conditions and trading activity, the RPM is more robust because it allows multiple comparisons. (a) Calculation and interpretation The RPM is built on a combination of both market volume and number of trades, which makes it possible to account for the potential skew of large block trades at extreme prices. Accordingly, if P* is the average execution price of the order and P i is the price of the i th trade, the RPM is calculated as follows for a buy: 28 RPM = 1 2 RPM trades + RPM volume ⎡⎣ ⎤⎦ , with ∑ Graphically, we present the RPMby plotting the percentage of activity traded at a price less favourable than or equal to the average execution price. For this purpose, activity needs to be sorted from lowest to highest prices for sells and, by contrast, from highest to lowest prices for buys. Figure 12 illustrates the RPM calculation for a sell order with an average execution price of € 31. The figure shows an RMP of 80% for the order, meaning that 80% of all market activity was traded at prices lower than € 31. The interpretation is that RPM trades = trades P i > P * ∑ trades ∑ and RPM volume = volume P i > P * ∑ volume

First, benchmarks provide absolute measures of costs, which are often expressed in basis points. Determining whether the trading performance is bad, normal or good is not straightforward and benchmarks do not make comparison easy because they deliver inconsistent metrics. For example, a measure of 10bp could mean good performance in one security but bad performance for another. Similarly, it could also mean good performance today but bad tomorrow. Next, existing measures are built on benchmark prices that often depend on trade characteristics. Consequently, using only one benchmark price to analyse the execution quality of a universe of trades can be criticised, unless all the trades take place at the same time and are of a similar size and difficulty. The absence of a standardised framework has led to the absence of consensus about a universal indicator and accounts for the availability in the industry of a great many indicators. As a result, investors are often confused. 27 Furthermore, from the absence of consensus emerges the difficulty of comparing trading performance and execution quality across different intermediaries. The heterogeneity of trades and diversity of measures complicate any attempt at comparative analysis of trading performance. (2) Relative performance measure The relative performance measure (RPM) is a metric proposed by Kissell and Glantz (2003). Founded on peer group review, it compares the average execution price of the trade to all market activity over the trading period. For a given trade, the RPM is the percentage of all activity in the market that traded at a price less favourable than

27 - The domination of the sell-side in the TCA services provision is also problematical. TCA tools and services have been at the heart of the development of the sell-side industry over the last five years. With the multiplication of electronic trading capabilities (direct market access or algorithmic trading), brokers have endeavoured to provide substantial tools for their clients to help them measure transaction costs and, to a larger extent, assess trading performance. Created as independent boutiques, most TCA providers were quickly acquired by the major brokerage firms so that they could become a significant and visible element of the sell-side value proposition. That the sell-side has totally taken over the market for TCA confirms the strategic importance of this function for the industry.

28 - The RPM calculation is symmetric for a sell order (P i

61 An EDHEC Risk and Asset Management Research Centre Publication