Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 256

5 red flags on active manager trading costs

Many active managers turnover shares in their portfolios regularly as they seek to outperform. This activity might be to lock in a gain, reduce or prevent a loss, manage portfolio risks, reinvest dividends or manage liquidity. Trading is a ‘bread and butter’ activity in any active equity portfolio which must keep churning to keep its insights current.

It is surprising, then, that the science – or perhaps art – of trading efficiency is something of a ‘black box’ inside equity portfolios. There are explicit costs of trading equities – brokerage and commissions (and transaction taxes in some countries) – as well as implicit costs of buy-sell spreads and price impacts (also called moving the market, meaning pushing the market price higher as a fund buys into it or lower as the fund sells out of it). Institutional investors with large equity portfolios should care about this ‘black box’ because whether a manager trades efficiently or inefficiently can materially affect net returns. Retail investors also feel the impact via a decision to choose active.

The baseline costs of ‘patient’ trading

To test how returns are affected by such costs, we simulated a range of institutional-size portfolios across Australian and international equity markets. We used as a baseline trading efficiency measure passive (market cap weighted) portfolios in S&P/ASX200 and MSCI World ex-Australia equities which used an execution-only (agency execution) arrangement and adopted a patient trading style. The baseline portfolio trades were a $100 million slice in Australian equities, representing 2.4% of the market’s liquidity (median daily volume) and a $500 million slice in international equities, representing 0.2% of the market’s liquidity.

A fund trading this kind of baseline portfolio could expect to pay about 0.21% of the total value of the Australian equity trades in trading costs, being 0.05% in explicit costs and 0.16% in implicit costs. For international equity trades, it could expect to pay 0.11% of total trade value in transaction costs, being 0.05% in explicit costs and 0.06% in implicit costs. These baseline results are encouraging and, for most funds, probably don’t create much of a hurdle for the trades to add value to the portfolio post-trading costs.

In considering different kinds of portfolios and trading approaches, here are five ‘red flags’ to watch for:

1. Trading on a principal, rather than agency, basis increases trading costs

Most equity trading, especially in Australia, is not agency based. In principal-based trading, the fund investor or manager is legally transacting with a broker who takes the equities onto the broker’s own books and requires additional compensation for assuming this risk. The broker often bundles additional non-execution services into the commissions charged, which in Australia can easily be three times as much as an execution-only commission rate. Are these additional costs worth paying? Perhaps, but because the costs are embedded in brokerage charges on trades inside portfolios, the fund investor rarely considers this question.

2. As portfolio trade sizes get larger, trading becomes costlier

Our baseline cost of trading Australian equities, 0.21%, almost doubles to 0.38% for a $500 million passive portfolio trade and reaches 0.48% for a $1 billion passive trade slice. Our baseline passive international equity trading cost, 0.11%, rises to 0.13%-0.26% when the trade size increases to $1 billion - $5 billion. These trade sizes are not unrealistic when you consider that the capital managed by superannuation funds collectively has now reached $2.6 trillion and APRA-regulated funds, whose portfolios are being rationalised, invest an average 51.5% of their capital (close to $900 billion in total) in Australian and international equities.

3. Active portfolios are costlier to trade than passive portfolios

Active portfolio trades typically demand more liquidity than passive portfolios. We modelled two types of active Australian equity portfolios which, compared to our baseline passive trade, demanded between 12.7%-62.9% of market liquidity for the same-sized trade. This pushed the total cost of the trade up from 0.21% to 0.37%-0.66%. Our hypothetical active international equity portfolios demanded 1.2%-3.4% of market liquidity, which pushed trade costs up from our 0.11% baseline to 0.19%-0.25%.

4. Australian equities are costlier to trade than global equities

Explicit costs to trade in Australia are relatively high by global developed-market standards, and it is not clear why. Implicit costs are also higher because the Australian equity market is roughly one-fortieth of the size of global developed equity markets, so it is easier to adversely move the market.

Superannuation funds and other large investors tend to show a ‘home bias’ towards Australian equities and support active rather than passive management. They are favouring an asset class and investment style that is more expensive to trade. Further, the redundant trading that occurs in multi-manager equity structures (absent centralised implementation) is particularly a problem in Australian equities where there is potential for different managers to trade against each other, to no net benefit in the overall portfolio.

5. Aggressive trading styles significantly increase trading costs

Finally, an equity manager’s view on how quickly, or urgently, to ‘work the trade’ in the market significantly affects trading costs. In our best-case scenario (international equities, passive, smaller trade size), a very aggressive trading style increased trading costs to 0.16% by almost doubling the implicit cost of passively trading the same order. In our worst-case scenario (Australian equities, active, large), a very aggressive trade pushed up transaction costs from an already concerning 0.66% (patient trading style) to 1.24%.

Considerations for investors

Large investors who recognise their own ‘red flags’ in these scenarios should also remember that most trades are ‘round trip’ – selling one stock, buying another – which doubles the trading cost impacts we have identified. The cumulative impact of these higher transaction costs, with the higher taxes and higher fees that come with active management, creates a hurdle that for some equity managers may be just too high to clear.


Raewyn Williams is Managing Director of Research at Parametric Australia, a US-based investment advisor. This information is intended for wholesale use only and does not consider the circumstances of any investor. Additional information is available at


Most viewed in recent weeks

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

“Trust your instinct” Hamish Douglass in conversation with Sir Frank Lowy AC

Sir Frank shares his story, including his journey from war-torn Europe, identifying opportunities, key character traits necessary for business success, and the importance of remaining paranoid yet optimistic.

Latest Updates

Investment strategies

Charlie Munger and stock picks at the Sohn Conference

The Sohn Australia Conference brings together leading fund managers to chose their highest conviction stock in a 10-minute pitch. Here are their 2021 selections with Charlie Munger's wisdom as the star feature.


John Woods on diversification using asset allocation

All fund managers now claim to take ESG factors into account, but a multi-asset ethical fund will look quite different from a mainstream fund. Faced with low fixed income returns, alternatives have a bigger role.

SMSF strategies

Don't believe the SMSF statistics on investment allocation

The ATO's data on SMSF asset allocation is as much as 27 months out-of-date and categories such as cash and global investments are reported incorrectly. We should question the motives of some who quote the numbers.

Investment strategies

Highlights of reader tips for young investors

In this second part on the reader responses with advice to younger people, we have selected a dozen highlights, but there are so many quality contributions that a full list of comments is also attached.

Investment strategies

Four climate themes offer investors the next big thing

Climate-related companies will experience exponential growth driven by consumer demand and government action. Investors who identify the right companies will benefit from four themes which will last decades.

Investment strategies

Inflation remains transitory due to strong long-term trends

There is momentum to stop calling inflation 'transitory' but this overlooks deep-seated trends. A longer-term view will see companies like ARB, Reece, Macquarie Telecom and CSL more valuable in a decade.


Infrastructure and the road to recovery

Infrastructure assets experienced varying fortunes during the pandemic, from less travel at airports to strong activity in communications. On the road to recovery, what role does infrastructure play in a portfolio?


The three prices that everyone should worry about

Among the myriad of numbers that bombard us every day, three prices matter greatly to the world economy. Recent changes in these prices help to understand the potential for a global recovery and interest rates.



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.