In Search of the Optimal Trading Frontier

Abstract

What matters more during portfolio transitions: opportunity costs or transaction costs? This article demystifies the investment risks and costs associated with restructuring portfolios, and shows how it is possible to achieve low-risk and low-cost transitions. There will always be some trade-off between performance and costs in a transition, and where an investor sits on that balance is defined as the optimal trading frontier. The lower an investor's risk tolerance, the higher the cost the investor must be willing to pay for a transition. An efficient transition manager should be able to provide both in a strategy that has access to low-cost trading sources and includes risk-managing trade executions. This article also addresses how the transition should be measured, and describes one method for evaluating it.