Cheap trading makes Hong Kong attractive

Japanese brokerage Nomura has produced a new guide to help managers to pick the cheapest stocks by transaction cost.

Hong Kong stocks are the cheapest around the region in terms of transaction costs, making them more attractive to fund managers when rebalancing portfolios, according to brokers Nomura.

In a study measuring the market impact of 749 key stocks that account for more than 70% of the market capitalization in eight Asian countries, Nomura finds Hong Kong stocks historically incurred the lowest cost of trading, followed by Taiwan, Singapore, Korea, the Philippines, Malaysia, Thailand and Indonesia, based on last quarter's figures.

Kenneth Chan, a quantitative analyst with Nomura, says the findings can assist fund managers to account for and improve the transaction costs of their portfolios. They may also help managers decide which stocks to buy based on their transaction costs, with everything else being equal.

"Managers are often ranked according to the performance of their portfolios. The difference between the few managers on the top often could be just around 100bp [basis points]. Given the number of stocks managers buy and sell each year, that 100bp outperformance can be easily achieved if they select stocks in the most efficient way, helping them to improve their performance," says Chan.

Brokerage commissions, bid/ask spreads and market impact make up the total transaction cost of a stock. While the first two are relatively fixed and easily quantified, the market impact of a stock is far less tangible and could be the most expensive.

Market impact refers to the effect on prices when a manager decides to buy or sell a stock, depending on the size of the order and the number of buyers and sellers. If a manager wants to buy one million shares of stock A and the market only has 10 sellers selling 100,000 shares each over a period of time, then each tranche may get progressively dearer simply because of the manager's own action. How high the price will rise - the so-called market impact - has been hard to predict until.

"It's essentially a demand and supply situation. If the two are in balance, a rather low cost of trading is expected and vice versa," says Chan.

Managers typically lump together overall charges for moving in and out of a given market, including commission fees, the spread difference and the market impact of selected stocks. Such guesswork by managers, according to Nomura, is often wide of the mark, particularly when small cap stocks are involved.

The Hong Kong stock market accounts for nine of the 10 stocks with the lowest market impact, according to Nomura. Among the lowest are Cheung Kong, Hongkong Electric, Henderson Land and CITIC. Of the top 100 stocks, Korea accounts for 36, Taiwan 35, Hong Kong 25 and Singapore 4.

According to Chan, quantitative analysis on transaction costs is gaining popularity among managers in the US, given the intensely competitive nature of the industry there. It also has started to attract attention in Asia. In the case of Nomura, more and more managers are presenting the broker with lists of stocks for which they wish to know transaction costs involved.

The total value of stocks traded in Asia in the fourth quarter last year fell by 22.3% on a quarter on quarter basis, and was 37.6% below the year's average. Based on those figures, Nomura expects market impact and overall trading costs will continue to escalate as fund managers try to move in or out of increasingly tight markets in Asia.

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