The Buy Side chronicles the hedonistic days of Turney Duff, a highly successful hedge fund trade picker. He recounts the days in which Wall Street traders who pitched him would have to take him to Las Vegas or Florida with sex parties and alcohol galore just to get his advice. The reason that these financial types were so eager to provide him with these perks was that the cost of the trips ultimately did not come out of their pocket – it came out of yours.
What traders understand that most people do not about financial world is that value comes from transactional costs, not from actually making the correct decision about business affairs. When it comes to the fees and costs that leak out of the portfolios of investors, transactional costs may comprise up to 30% of these.
A study by Lane, Clark & Peacock, experts in the world of hedge fund pensions in the United Kingdom, found that hedge fund managers would much rather keep their clientele in the dark about transactional fees. Most of the people they studied were actually completely unwilling to disclose these costs. Could it be because this is the only true value that is being generated in these huge financial holding houses?
What exactly are transaction costs?
Even the term “transaction costs” is mired in squirmy half definitions and legal talk. What experts have finally been able to define transactional costs as it comes in two main categories: implicit costs and explicit costs.
Explicit costs are costs such as charges for custody are defined by the general market and accepted as standard for the industry. They can also include stamp duty, brokerage commissions and exchange fees. Even though these fees are defined by the market, the amount of fees that are given to brokerage traders are not. Brokerage fees are especially dipped in mire when it comes to this type of definition: The fees that fueled the partying of Turney Duff were made by him for dubious services such as research or preferential treatment in access to certain people.
Implicit costs are fees that are not very easily defined nor spoken about by the members of the financial community who receive them. Brokers can also generate these fees for themselves by unnecessary trading or preferential treatment for new companies who are trying to enter the stock market. As the gatekeepers to the world of public holdings, they have a great deal of power that is completely unregulated by any entity outside of themselves. New companies who are trying to enter this world must go through them, and as such, they pay quite a hefty toll that eventually comes out of the pockets of the average consumer and the small investor.
What is the price of research?
Many fund managers create their value added to consumers by playing up the value of their research. This claim may or may not be accurate, as much of the gains that a fund gets in past years may be due to many aspects of trading other than “picking the right stocks.”
Brokerage trading funds spend an enormous amount of money on what they called research. Very few of these dollars and euros spent have any line item to them or are defined in any more succinct way than the singular term. As a matter of fact, there were studies conducted separately in November 2013 and December 2013 that showed fund managers do not even read the research that is given to them. These studies called for a crackdown in defining the term and limiting the fees that could be generated from it.