You’ve got an investment strategy that works, so the old ‘if it ain’t broke, don’t fix it” adage fits. Right?
Well how much have you considered the cost of executing that strategy? Perhaps institutionally, strategy implementation is separate from portfolio management.
Regardless, understanding the costs of implementing a strategy can lead to greater alpha capture. The folks at Pragma Trading can attest to that. They recently issued a case study examining a statistical arbitrage strategy and execution performance and found some telling results.
First of all, the authors point out that the separation of portfolio management and execution can lead to unnecessary costs and suboptimal performance, particularly for high turnover strategies.
The case study applies various tools for analyzing a stat arb strategy, which, the authors call a “relatively high-turnover, middle-frequency trading strategy.” Indeed, they point out that transaction costs of initiating and liquidating positions can cause “significant degradation” in performance and, in some cases, make an apparently profitable strategy unprofitable.
For its case study, Pragma analyzed trading history from April through June of this year and pulled data including date, ticker, side, quantity and average execution price for each trade executed during that period. A total of 839 names were traded over 16,727 executions.
The investment manager's basket was generated at 2 p.m. each day. The basket was traded on the close using market-on-close orders.