Transaction Costs And Equity Portfolio Capacity Analysis

Yossi Brandes, Ian Domowitz and Vitaly Serbin

in The Oxford Handbook of Quantitative Asset Management

Published in print December 2011 | ISBN: 9780199553433
Published online November 2012 | | DOI:

Series: Oxford Handbooks in Finance

 Transaction Costs And Equity Portfolio Capacity Analysis

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  • Economics
  • Financial Markets
  • Econometric and Statistical Methods and Methodology: General


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The article gives an overview of the current state of equity portfolio capacity analysis. The investment performance exhibits two factors that include the underlying investment strategy of the portfolio manager and the execution costs incurred in realizing those objectives. Liquidity, measured in terms of implementation costs, can be affected by changing the breadth of the portfolio or by changing the investable universe. The liquidity effects differ depending on the investment strategy, implying that capacity is a strategy-specific phenomenon. The cost-aware portfolio performs much better, yielding a modest but positive Sharpe ratio of 0.07. The average costs of implementing the cost-aware rebalancing strategy are two to four times lower than the costs of implementing the non-cost-aware strategy. Portfolio net returns are used as the yardstick by which the alternative combinations of turnover levels and fund sizes are compared. Expected costs are derived from ITG's Agency Cost Estimator. The generation of these costs relies on a transparent methodology, and permits stock-specific estimates, which can be matched against expected returns. The covariance estimates are provided by the monthly US model from the suite of ITG risk models. The model is estimated using time-series on a per-stock basis. The factor covariance matrix is scaled using an option-implied adjustment coefficient to provide forward-looking risk forecasts.

Keywords: equity portfolio capacity; transaction costs; ITG's Agency Cost Estimator; time-series; portfolio net returns

Article.  7314 words. 

Subjects: Economics ; Financial Markets ; Econometric and Statistical Methods and Methodology: General

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