Researchers are proposing a new way to measure the impact of trading costs: "position-adjusted turnover."

In "Shedding Light on 'Invisible' Costs: Trading Costs and Mutual Fund Performance" published in the January/February issue of Financial Analysts Journal, UC Davis associate professor Roger Edelen, UVA assistant professor Richard Evans and Virginia Tech professor Gregory Kadlec detail the size and variation of mutual fund trading costs. The Central Valley Business Times and UC Davis both reported on the research.

Taking a cue from infamous active mutual fund critic Jack Bogle, the trio "estimated funds' annual expenditures on trading costs and examined the impact of those costs on fund return performance" by examining data from 1995-2006 on 1,758 domestic equity mutual funds. They found average trading costs of 1.44 percent, compared to an average expense ratio of 1.19 percent, and they detailed differences in both expense ratios and trading costs for different styles of equity funds.

The trio also noted that "direct estimates of fund trading costs are difficult to come by for reasons of both availability and computational complexity." And they found that simple turnover rates are not good enough for predicting trading costs, as a small cap fund may still have much higher trading costs than large cap fund with substantially higher turnover. To help better predict trading costs, they proposed a new metric, "position-adjusted turnover," calculated "by multiplying each fund's turnover by its relative position size." For more on the research, read the abstract and summary. 

Edited by: Neil Anderson, Managing Editor


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