In our Market Notebook, we often share information when we make policy changes and adjust portfolio allocations. In these summaries, we typically explain the What (the allocation change), the When and the Why (the reasons behind the rebalance), but we have never explained the How: the behind the scenes mechanics that go into an allocation change. Though Balentine is not a Broker Dealer, each time a policy change is enacted, implementation considerations play a central role. Implementation is one of the key components of investment management, and though often overlooked or misunderstood, implementation has important implications for our clients’ portfolios. In today’s low return environment, effective implementation can add precious value to an investment portfolio, while poor implementation can cost portfolios dearly. Like the level of risk taken in a portfolio, implementation costs are one of the things we are able to control, and our only incentive is to drive these as low as possible for our clients.
Our investment and implementation process follows a very regimented path. Before any action is ever taken, every potential investment idea is vetted for its potential for return and risk. Additionally, to ensure best implementation, the Investment Strategy Team also considers a number of other variables including the internal risks associated with each investment, liquidity capacity, exchange utilized, its legal structure, turnover, fees, timing and tax policy. This due diligence process takes place over the course of several phone calls, meetings, and on site visits before the Investment Strategy Team votes to approve an investment vehicle. Once the analytical and operational due diligence processes are complete, investment execution finally begins.
Execution is particularly important because, if done correctly, can defray the inherent frictional costs associated with buying and selling. In its most basic form, execution involves the purchase or sale of a security (e.g. stock, bond, mutual fund, exchange traded fund). However, purchasing or selling a security carries with it certain challenges, and Balentine takes the appropriate behind-the-scenes steps to manage a transaction toward a better and more equitable execution. By considering price discovery, liquidity, settlement and the time of day to trade, the cost of execution can be greatly reduced.
The first step in the execution process is a price discovery and liquidity analysis and involves multiple partners (authorized participants, capital markets groups, independent trading desks, custodian banks) to determine the approximate impact a trade may have on the market price of the security. Once the liquidity picture is determined, we coordinate with our trading partner and custodian to ensure settlement periods are synchronized. This is important because concurrent settlement eliminates being out of the market and bearing unnecessary risks. Not all securities are required to settle with the same frequency; for example, stocks settle three days after the trade date while most mutual funds settle one day after the trade date. The final step is the actual trade, which establishes an appropriate limit price in conjunction with the available liquidity and determines when to trade.
There has been significant research with respect to the “best” time of day to trade, and findings show there are certain periods within the trading day that afford better liquidity and better opportunities to minimize market impact. With this in mind, Balentine attempts to execute every trade during these optimal windows, reducing the slippage between the time of decision to execution as much possible. In addition to our focus on the best time of day to trade, we also ensure every Balentine client receives the same price for each purchase and sale. While best execution will always remain subjective, equitable execution is attainable and achievable regardless of portfolio size.
With every purchase or sale, there are inherent explicit and implicit costs. At each juncture during execution, Balentine attempts to manage and minimize the implicit costs to buy or sell securities. However, we also work to minimize the explicit costs of transaction: commissions. Even though commissions have steadily declined over the past 30 years, Balentine has negotiated commission charges that are at least 20% lower than industry averages.
Each step of the process described above works to ensure that we implement our investment strategies in the most cost-effective and efficient way. That process even continues once a trade is complete. In an attempt to constantly improve our processes, every transaction undergoes a post-trade analysis that includes evaluation against a minimum of four benchmarks to determine the efficiency of the execution. Despite all our efforts to manage this process, it is difficult to quantify the exact amount of value added through effective implementation. However, by following a well documented and controlled process, Balentine has lowered the implicit and explicit costs to transactions by paying close attention to security selection, operational efficiencies and execution. The combined effect of better execution and lower commission charges equates to improved portfolio returns through lower costs for our clients.