Transaction Costs

Entering transaction costs on the Constraints Worksheet allows you to consider the effect of trading costs and fees. (To access the Transaction Cost columns, activate transaction costs in the Constraints Menu.)  The Optimizer applies transaction costs to trades away from the initial portfolio, so you must enter an initial portfolio in order to utilize this function.  If you do not enter an initial portfolio, the Optimizer loads an empty portfolio, and transaction costs are applied as if you were trading from cash.

Linear transaction costs penalize the optimization as follows:  (Initial Portfolio Weight – Optimal Portfolio Weight) x Linear Transaction Cost Value = Penalty

For example, changing an asset’s allocation from an initial weight of 0% to an optimal weight of 15%, with a 2% linear transaction cost assumption, results in a 0.3% transaction cost penalty [(0.00 – 0.15) x 0.02 = -0.003 or -0.3%].  To continue this example, 0.3% of the expected return is subtracted from the expected return during the optimization process.  The Optimizer includes trading costs when calculating which trades improve the overall value of the portfolio.  A buy transaction cost is applied to the difference in portfolio weights of the asset being purchased.  A sell transaction cost is applied to the difference in portfolio weights of the asset being sold.

Default transaction costs work as the other defaults on the Constraints Worksheet. Entering a default (in the cells below the Transaction Costs header) populates all unchanged cells in the column below with the default value. Defaults are indicated by a light blue background. Entering a different value for a specific asset in a particular row overrides the default and appears with a white background. Return the cell to the default by entering a letter.

Transaction costs can be saved and loaded in an NFA format (*.nftc).  

• Make sure to label the transaction costs in order to identify the investment universe.
• Transaction cost files include quadratic transaction costs.  
• Transaction costs are not included in constraint set files.
• Transaction cost models do not currently account for options.  They can still be used, but must be interpreted carefully.  Transaction costs for the options themselves are included in their prices.

Do not confuse transaction costs with expense ratios.  These transaction costs are also distinct from the Relative Transaction Costs of the Filter.