Excessively high foreign exchange trading fees could be costing investors up to 2% of their total portfolio over a 40-year period, new research by Russell Investments shows.
Russell analysed 40,000 foreign exchange trades executed by investment managers with custodians and other foreign exchange counterparties between January 2008 and December 2009.
The investment firm found the midpoint between bid and offer prices of each FX transaction was about 9 basis points – considerably higher than the average cost for the most traded developed market currencies of 1-3 basis points. These findings were nearly identical to similar research Russell conducted in 2004 on approximately 36,000 trades.
The increase in transaction costs acts as a drag on the long-term return of the portfolio and can end up costing the investor as much as 2% of the portfolio’s total value over a 40-year period, the company says. This figure is based on the difference in end value over the period between an investor earning a 7.00% rate of return versus the same investor receiving a rate of return of 7.06%.
“The costs of FX trading have been below the radar for far too long. The results of our analysis suggest that investors cannot simply assume that FX trades are being executed efficiently,” says Ian Toner, head of commission management and currency implementation at Russell Investments. “It should be unacceptable to investors and managers when far more foreign exchange transactions are executed at prices close to the worst price of the day than at prices close to the best.”
The research identifies four main features of the FX market which could potentially lead to unnecessarily high costs as well as three key areas that investors should focus on when attempting to understand the costs associated with FX execution.
“Some managers are very good at ensuring efficient FX execution, but investors need to analyse the actual trades conducted on their behalf to be sure that their FX trades are receiving the right level of attention,” says Toner. “One course of action for investors to ensure efficient FX execution is to publicly state that the associated costs will be reviewed and measured. Losing 2% of your total fund value at the end of a 40-year period simply because of poor quality FX execution isn’t just a rounding error.”
Currency trade execution came into the spotlight recently when State Street was accused of allegedly marking up the price of interbank foreign currency trades that it made for the California Public Employees’ Retirement System and the California State Teachers’ Retirement System (Squawkbox, 26 October 2009).