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December 1, 2002

Know Thy Costs

By Editorial Staff

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Bad performance numbers and regulatory pressure are forcing buyside desks to pay more attention to trading costs. Desks that are looking beyond brokers' commissions are building systems or are subscribing to third party offerings. The goal is to measure their implicit - timing and opportunity - costs. Armed with better information, they can then revise their trading strategies.

Among the top providers of transaction cost analysis are Plexus Group, which was acquired by J.P. Morgan Chase this summer, Elkins & McSherry, a unit of State Street, Instinet, ITG, Abel Noser and BECS.

Now a relative newcomer is stirring things up. Quantitative Services Group, a suburban Chicago consultancy, markets a transaction cost measurement system called T-Cost Pro that lets traders evaluate their executions one day after they occur.

The six-person firm was founded in 2000 by former Donaldson, Lufkin & Jenrette quants Tim Sargent and John Wightkin, following their employer's acquisition by CS First Boston.

Both execs have several years of quantitative trading and research under their belts. Sargent began his career at Northern Trust with responsibilities for index funds. He later had stints at Merrill Lynch and Salomon Brothers before establishing a global quantitative research effort at DLJ.

Wightkin also started on the buyside at Ohio Teachers as a quantitative analyst and head of the trading desk. He later moved to Weiss Peck & Greer and a research boutique called Chicago Analytics before joining DLJ.

Both execs discussed the T-Cost Pro service with Traders Magazine technology editor Peter Chapman.

Traders: Why is transaction cost measurement hot right now?

Sargent: There are a few different reasons. First, of course, is the overall low return environment. With returns negative or modest at best, transaction costs play a larger role. The other would be the regulatory climate.

Traders: Why. New rules coming out of Washington?

Wightkin: No. But the Securities and Exchange Commission is stepping up its auditing and trying to develop a best practices document. Also, AIMR [Association for Investment Management and Research] is coming out with trade management guidelines that will provide some structure as to how to measure best execution. One of their recommendations is to quantify and measure trading costs and the quality of trading. AIMR is emphasizing the need to have some transaction cost analysis in place.

Traders: O.K. How does T-Cost Pro help?

Sargent: T-Cost Pro is a forensics device. We developed a new set of measurement techniques to help the decision-making process. Rather than rely on traditional benchmark analysis, we wanted to come up with a methodology that would give us a measure that traders and portfolio managers could use to make better decisions.

Traders: What's unique about T-Cost Pro?

Sargent: Much. We can give you a few examples.

Traders: O.K.