More frequent trading could
boost returns—at least for the right fund size.
Although research has shown
that high-frequency trading detracts from retail investor performance, some institutional
investors actually outperform as a result of active trading, according to
finance professors Jeffrey Busse (Emory University), Lin Tong (Fordham University), Qing Tong, and Zhe Zhang (Singapore Management University).
“Skillful trade execution can
enhance an investment fund’s return relative to the competition,” they wrote.
“Active trading has the potential to generate alpha if it can take advantage of
opportunities in the securities markets.”
But lack of skill, the authors
warned, could result in “excessive transaction costs and lagging performance. Only traders with skill can
afford to bear the transaction costs associated with active trading.”
For the study, the researchers
examined the performance, transaction costs, and trading frequency of asset
managers and asset owners from 1999 to 2009 using data from trading cost
Frequent trading among institutional
investors, they found, was tied to higher risk-adjusted returns net of
transaction costs: The highest-frequency traders outperformed the most static
group by 0.73%.
However, this gap narrowed as
funds grew larger and generated higher transaction costs.
“Given that larger funds trade
larger orders, they are susceptible to greater price impact from their trades,”
the researchers explained. “Larger funds consequently realize lower net returns
when they attempt to exploit short-term trading opportunities.”
Perhaps due to these higher
costs, Busse, Tong, Tong, and Zhang found that larger funds exhibited lower
trading frequency than their smaller peers.
“While it is difficult to argue
with the idea that expenses should be minimized,” they concluded, “our evidence
suggests that more expensive strategies can sometimes dominate, insofar as the
most active institutional traders persistently produce positive abnormal
Read the full report, “Trading Frequency
and Fund Performance.”
Trading: Winner Takes All?