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Hedge Funds Slow to Use Cost Research

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NEW YORK (–In investing, there’s no such thing as a free trade. Trading commissions are way down in price, but looking at commissions alone can be misleading.

There are implicit costs, such as the loss to a trader because the price moves before the trade is completed. To gauge these and to get a net measure of all trading costs, investment managers use a process known as transaction cost research.

The vast majority of medium-to-large money managers, defined as having more than US$10 billion in assets, use this tool, according to a new report from the consulting firm Tabb Group. But many hedge funds and small traditional investment managers do not–only 35% of firms with less than US$10 billion in assets use the approach.

A key determinant is whether the firm trades a lot, said Adam Sussman, author of the Tabb study. High-frequency traders–in particular, quantitative funds–tend to use it. Quant shops typically develop their own proprietary tools to gauge transaction costs, Mr. Sussman said.

There is one group of hedge funds in which transaction cost research is common: firms that manage pension money. Department of Labor regulations require pension plans to make sure their money managers get best trade execution.

Pensions want objective reports on trade execution, said Mr. Sussman. In addition to using internal tools, managers in charge of pension assets are more likely to employ third-party providers of transaction cost analysis.

Vendors include Plexus, which was recently acquired by ITG Inc., another player in this area. Mr. Sussman points out that the buy side’s needs are so diverse, no single provider can satisfy all of them.

The bottom line: He expects transaction cost research will become more prevalent among hedge funds when prime brokers start providing the service for free.

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