TCA Drives Investment Management

Terry Flanagan

Asset management firms are adopting transaction cost analysis (TCA) to guide short- and long-term portfolio management decisions and measure the performance of traders.

“TCA is very important, especially in light of how difficult and misleading the analytical process when comparing algorithms from different brokers,” said Effi Zakry, head trader at Paz Investments, at last week’s TradeTech conference in New York. “One algorithm can affect others, which causes knock-on or correlation effects.”

Effi Zakry, head trader, Paz Investments

Effi Zakry, head trader, Paz Investments

TCA Drives Investment Management
Prior to joining Paz, a firm that specializes in emerging markets derivatives and arbitrage strategies, Zakry was director of execution at WorldQuant and an algorithmic strategist at PFTC Trading, a high-frequency shop and options market maker. He also spent several years developing trading strategies at Tykhe Capital, where he served as head trader of statistical arbitrage.

“Often, performance results can be misleading,” said Zakry. “For example, if you give an order to two different brokers, the more aggressive broker can appear to outperform because they’re front-running the order, when in reality the less aggressive broker had performed better.”

Even though Paz develops its own algorithms, Zakry advises most firms to use broker-supplied algorithms, albeit with caution. “Developing your own algos costs a lot of money,” he said. “Unless you’re ultra-high-frequency, it’s much more cost-effective to use a broker.”

Institutional investors are applying TCA to asset classes beyond equity investments, where its successes have been tested.

Among the world’s largest institutions—those managing more than $20 billion in assets—41% of institutions that employ TCA use it in their FX investment process, according to research firm Greenwich Associates.

Reflecting that depth of the marketplace, 72% of study participants using TCA employ a third-party vendor in cash equities.

“Despite some very real shortcomings in vendor platforms, there are few compelling reasons as to why an institution would take on the burden of building a proprietary TCA system for cash equities,” said Greenwich Associates analyst Kevin Kozlowski.

Among the largest responding institutions, that share approaches 80%. Approximately 40% of institutions say they employ a proprietary, in-house TCA tool for cash equities, and roughly the same share use TCA products provided by brokers.

In contrast, 62% of institutions using TCA in fixed income rely on proprietary in-house systems, with only 38% reporting the use of a third-party platform and 10% using a broker-provided system.

The lack of proven third-party systems is even more apparent in FX, in which only about 30% of TCA users employ a third-party vendor and around 70% use in-house systems. In futures, meanwhile, more than 85% use a proprietary system for TCA.

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