Morningstar, the fund tracking firm in Chicago, may soon try to bring market impact costs to the attention of investors, right along with rates of return, fees and its star ratings.
Morningstar is considering contracting with Barra, a research and consulting firm in Berkeley, Calif., to publish data on the market impact costs that lower funds' overall returns.
Barra developed a software program a year ago that can quantify how a fund's performance is affected when a buy or sell order moves a stock's price. The model does this by weighing more than 20 factors, including trading volume and price elasticity, on the 10,000 publicly-traded stocks. Market impact costs are likely to result from large orders or orders in illiquid stocks and can range from 50 basis points to five percent, said Nicolo Torre, Barra's managing director of research.
John Rekenthaler, research director for Morningstar, does not expect mutual fund companies with low market impact costs to use the data for marketing because he does not think investors will immediately understand the concept. Instead, Rekenthaler believes the financial press will eventually expose mutual fund companies with high market impact costs, and that this will educate the public and raise awareness of the costs.
"We are considering publishing this data and, like our other technical measures, popularizing it among sophisticated investors and financial planners in specialty publications," said Rekenthaler. "Eventually, the word will spread to general interest publications, and I can foresee articles about funds that have become too big, too fat, too bloated. I can see the headline now, The Industry's Whales.'"
Market impact costs are too complex for them to become an issue among investors, said Geoffrey Bobroff, a mutual fund consultant with Bobroff Consultants of East Greenwich, R.I. He expects the use of market impact data to be limited to mutual fund portfolio managers trying to improve performance.
"The concept of market impact costs is prevalent in the institutional world, but true total cost has not been an issue in the mutual fund world," Bobroff said. "Instead, they've focused on commissions. As we move to commoditization of funds, however, execution costs will become more of an issue."
It would be premature to expect mutual fund marketers to hone in on the issue when mutual fund portfolio managers are only now beginning to become familiar with market impact costs, he said.
A number of mutual fund companies have expressed interest in the model, not as a marketing tool but as a means of improving performance in a very competitive market, said Torre of Barra.
"They want to deliver better performance than the other guy, even if it's by one percent," Torre said.
American Century of Kansas City, Mo., began using the Barra model earlier this year in an effort to improve performance, said John Schniedwind, senior vice president of American Century's quantitative equity group. The model has improved the performance of American Century funds by 50 basis points to one percent, Schniedwind said.
But, the firm has no plans to promote its efforts to lower its market impact costs in its marketing, he said.
"We talk about this with our board of directors but have not trumpeted it to our shareholders because market impact cost is not something investors typically see or care about," he said.
