Hidden Cost of Trading and Portfolio Performance: A Short Note on Implementation Shortfall

Abstract

Chasing performance is a constant battle among fund managers and other investors. Stock picking ability is not the only means to perform that chase well. Trading wisely by managing transaction costs, which comprise all visible, invisible, and implied or hidden costs, is also a significant factor. In his seminal paper, Perold (1988) was the first to point out that fixed charges are not the only costs of trading. Instead, they are rather a small portion of the total transaction costs that include other costs known as “implementation shortfall.” In this short article, the authors extend the existing literature by highlighting various aspects of the execution and opportunity costs that can give traders a much clearer understanding of implementation shortfall and help them to use this guidance in trading wisely.

TOPICS: Performance measurement, portfolio management/multi-asset allocation, security analysis and valuation