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Implicit transaction costs (ITCs) are not directly visible but may be a material drag on investors’ return. This note aims to measure and identify ITC drivers, which can have implications for trading strategies. For agency trades, we calculate a volume-weighted average effective spread (VWAES) as a proxy for ITCs.
Based on reported transactions involving 62 European-listed ETFs between Jan 2015 and Dec 2016, we show that VWAES primarily depend on market conditions and intraday trading times – they may be wider if trades are executed at market open or during volatile trading sessions - but also vary by ETF, driven by the commercial and marketing strategies of ETF providers. For non-agency trades, ITCs are difficult to estimate due to lack of public data.
However, we explain that ITCs may be low if the requested ETF positions are held in market makers’ inventories. If not, ITCs can be broken down into hedging costs and creation & redemption fees and ultimately depend on ETFs’ underlying exposures and market conditions.
