The Cost of Poor Foreign Exchange Execution

Considerable steps are being made in cost transparency. It is however apparent that where foreign exchange (FX) is concerned, there is still a need to explain the drag on returns that comes from poor FX execution and to underline how simple it is to reduce costs.

Many asset owners have yet to address their currency costs and are therefore routinely over-paying for their everyday currency transactions. These costs simply reduce money in investment portfolios – there is no benefit to over-paying. Once equipped with information about costs, investors can easily reduce costs by simply asking to pay less. This cost saving does not require changes to the dealing infrastructure or credit relationships, it simply requires independent information.

New Change FX (NCFX) have been assessing FX costs for over 5 years now, and our rule of thumb is that where a client has not assessed their FX costs, and all execution is going through their custodian, then they pay around USD 600 per million dollars traded or 6 basis points per deal. Foreign exchange volumes in hedged share classes are a multiple of the NAV due to monthly roll-overs and portfolio adjustments, so the FX costs can often dwarf all the other portfolio administration costs.

Ignoring FX costs, as many investors do has a negative effect on portfolio returns. If we take a commonly invested dollar ETF and look at the effect of 6bps of drag on returns each month, we can see that almost a quarter of the ETF’s return is lost each year and the annualised rate of return is significantly affected.

Reducing FX costs is simple. The investor must assess their FX costs using independent data, and then ask for them to be reduced. This sounds simple, and it is. We have yet to come across a foreign exchange supplier who was willing to lose a relationship rather than reduce the FX costs to their client. It is possible to decrease costs still further by using different execution techniques, but simply asking for a better deal will make a big difference.