Are investors paying too much for FX trading? Streamlining trading practices for price enhancement

As the economic recovery from the coronavirus pandemic picks up steam and the U.S. dollar weakens, we anticipate that institutional investors will seek to capitalize more on global opportunities this year, particularly in the cheaper and more cyclical areas of the equity market. In addition, with U.S. equities at all-time highs, we expect an uptick in portfolio rebalancing, underscoring the need for strong equity and currency trading strategies.

When managing international exposures, a challenge for many pension plans is determining exactly how much they are paying for foreign exchange transactions. The cost to trade foreign exchange is affected by the way the investor chooses to execute their orders. Independent analysis¹ has confirmed that direct negotiation with an agency provider typically will reduce the implicit costs.

Many of Russell Investments' large pension plan clients have outsourced the management of their international equity exposure to a variety of asset managers (in some cases over 20 different asset managers). Asset managers vary in their approach for trading foreign exchange (FX). Some managers are still manually executing orders and sending instructions to custodians via SWIFT for automated execution by the custodian with little oversight. In this scenario, plan sponsors have no clear insight into the quality or true costs of the FX trades being performed.

To overcome the variation in costs and processes and coordinate a sophisticated execution approach across all managers in a defined-benefit plan, we have worked with clients to provide detailed analysis of their FX trades using independent data sources. From this analysis, we have identified significant potential cost savings. Through more efficient execution and centralization of FX trades on a single trading platform, investors can simultaneously reduce turnover and improve overall execution quality.

The Russell Investments' FX trading platform strongly features agency trading, netting and crossing, which ultimately improves the cost of execution, by reducing the cost of actual trades needing to be executed in the market. Implicitly, open market trading costs are higher and can expose the orders to information leakage and lack of price discovery if only traded with a single counterparty. A centralized trading platform that accesses multiple banks dealers, and streaming liquidity sources allows costs to be minimized via netting, crossing and high-quality execution. The benefit of this approach is that it allows managers' trades to be aggregated to offset trades in opposite directions, then crossed against client orders, leaving the remaining trades to be executed competitively in the market. This reduces the impact of the market transaction.

We have highlighted several direct examples where pension and superannuation funds have experienced significant savings by consolidating their FX trading through a centralized trading platform.

CASE 1. Best execution – Asset manager coordination and streamlined processing

A multi-billion-dollar defined-benefit pension fund outsourced asset management to 23 asset managers for their international exposure. The panel of asset managers varied in their ability to trade FX. Russell Investments managed the FX trading program and received FX orders from each manager using a variety of protocols to send orders including SWIFT, FTP and FIX, therefore not changing the asset managers processes. Through a combination of cutting-edge execution strategies and crossing and netting flows, Russell Investments reduced execution costs by 6.305 basis points, delivering a cost savings to the pension fund totaling $7.72 million in 2020².

CASE 2. Best execution – Independent multi-venue trading platform

An Australian superannuation fund had outsourced their FX trading through a single currency provider and their custodian via a local bank. The 16 underlying asset managers were using the same custodian to execute their FX trading. Through the independent TCA analysis, we identified over $1 million in hidden transaction costs resulting from trading and charging in the spreads. Russell Investments established a trading program for the client in October 2020, which includes a netting program for their 16 managers, crossing with the other FX order flow and smart execution in the market. Currently the client has had a 20% savings from the new FX trading platform.³

CASE 3.  Best execution – Global FX multi-asset trading desk

A large superannuation fund was managing currency exposure across both global equities and alternatives assets (both developed and emerging markets). The fund was using a related party and custodian to provide a currency overlay and currency execution. The custodian was trading with a single counterparty during Australian hours when the local currency market was closed. Arguably, the timing is when many of the markets were the most inefficient, spreads were the widest and the least amount of liquidity was in the system—all elements that lead to higher trading costs. Russell Investments took carriage of the currency overlay, including Agency FX trading, and daily infrastructure valuations for alternatives, expanding the counterparties from one to over 10. As a result, the client achieved over 25% in savings.⁴

The bottom line

Since 2004, Russell Investments' Agency Foreign Exchange (FX) service has provided institutional investors with a strong alternative to currency execution than the traditional banking (or principal) model. Our Agency FX service is designed to help clients manage costs, improve transparency and diversify counterparty risk, all within a single platform.

¹ Independent TCA analysis of FX Trading conducted by FX Transparency from Jan-Dec of 2020

² Source: Russell Investments (RI). For the period of 1 Jan 2020 – 31 Dec 2020. Savings based on the difference between costs incurred by previous trading program with managers and Russell Investment has been calculated at a savings of 6.305 bps.

³ Source: Russell Investments. Savings based on the difference between costs incurred by previous trading program with managers and Russell Investments.

⁴ Source: Russell Investments. Savings based on the difference between costs incurred by previous trading program with managers and Russell Investments.