FX fees costing institutional investors too much

FX fees costing institutional investors too much

New analysis of NZ$28bn of foreign exchange transactions finds average implementation costs can be up to nine times higher than average market price

AUCKLAND – June 17, 2010: The average costs of foreign exchange (FX) transactions conducted on behalf of institutional investors are far higher than what can be achieved by efficient execution according to research from Russell Investments.

Higher transaction costs can potentially cost institutional investors as much as two per cent of a portfolio’s total value over a 40-year period (see note 1 below).

These conclusions come out of analysis by Russell of 40,000 FX trades executed by investment managers with custodians and other foreign exchange counterparties between January 2008 and December 2009 on institutional assets totaling approximately NZ$28 billion.

According to the research findings, the average cost of each FX transaction, defined as the shortfall from the midpoint between the bid and offer prices, came to approximately nine basis points, which is considerably higher than the range of one to three basis points, which is the average cost in the FX market for the most traded developed market currencies.

These findings were nearly identical to similar research Russell conducted in 2004 on approximately 36,000 trades.

Sally Corbett, Russell Investments’ Manager of Investment Services in Australia and New Zealand says the costs of FX trading have been below the radar for far too long.

“The results of our analysis suggest that investors can’t assume that FX trades are being executed efficiently,” she says. “It should be unacceptable to investors and managers when far more foreign exchange transactions are executed close to the worst price of the day rather than the best.”

The new Russell research identifies four main features of the FX market which could potentially lead to unnecessarily high costs. The costs are:
- Specialist competency: Since most investment managers view FX trading as an administrative function they will often let the custodian bank execute FX transactions on a default basis and pay little attention to execution costs.
- Bundled service mix: As part of the custody arrangement, the investor may gain nominally lower fees for a range of services, but may end up with all FX transactions going through the custodian bank leading to sub-optimal FX execution.
- Lack of market structure: Many FX transactions take place away from centralised exchanges therefore investors lack transparent and accurate information about their FX trades.
- Potential conflict of interest: This can happen when the party conducting the FX transaction is also a principal of the transaction. The conflict of interest gives the potential for the execution of FX transactions at uncompetitive prices.

"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 trades are receiving the right level of attention," Ms Corbett says. “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 two per cent 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.

“New Zealand investors keep a watchful eye on both domestic and foreign transactions in equities and fixed income assets, why ignore the cost of foreign exchange and leave basis points on the table?" Ms Corbett added.

In December 2009, Russell Investments announced that its Agency Foreign Currency (FX) Trading program had surpassed NZ$74 million in total savings on behalf of Russell global equities funds as well as other institutional clients. Russell was one of the first firms to offer an agency model, which is designed to cut foreign currency transaction costs through a process that is a cost-effective alternative to traditional FX execution services.

ENDS

© Scoop Media