What does it mean if Implementation Shortfall is negative ?

Gain IS is a cost & -ve IS is a gain … for buy order

How do you achieve it?

IMO, IS : +ve => Higher cost relative to “paper portfolio”, i.e., Implementation Cost of actual portfolio is higher than the Implementation Cost of paper portfolio. IS : - ve => Lower cost relative to “paper portfolio”, i.e., Implementation Cost of actual portfolio is lower than the Implementation Cost of paper portfolio. If you say it is gain in case that IS : - ve , where is the source of the gain ? This is my confusion. Any further comment is welcome !

Implement shortfall is the measure of costs. So, we look at costs as positive here as a matter of convenience. If IS is -Ve it means -ve costs which is a gain. You have to take into account the market movement as well and remove that effect from your cost.

For instance opportunity cost is negative. You put in buy order you are not filled and the price falls.

-Ve IS is a gain for both Buy and Sell order If a manager wants to buy 100 Stocks … he placed the order in a crrosing netwrok at $11 (Day1) cl price of yesterday (day 0) $10 … benchmark price Order didn’t find the matching order on day 1 causing delay costs … close price day 1 $12 Delay price/cost (12-10)100 … 200 Day 2 manager expectes the price to go down and place the order at $8. Assume entire order is executed Reliased profit or loss 100(8-12) … - 400 Tradding costs 50 IS -150 (200-400+50) Value of paper portfolio (costs) 100*10 = 1000 Value of actual portfolio(costs) 100*8 +50 =850 Saving of 150

Rakesh, In your example, it seems that my perspective is right. That is, IS : - ve => Lower cost relative to “paper portfolio”, i.e., Implementation Cost of actual portfolio is lower than the Implementation Cost of paper portfolio. Actually it is cost saving (comparing with the cost of paper portfolio) rather than “gain”. Can I say so ?

Yes AMC you are correct …probably for sell order we would use the term gain if IS is -ve

Here’s how I think it works (and I am open to correction/refinement): There is an example in Schweser where the “paper” portfolio earns 0.42% over the time period in question. However, the return to the market during that same time period was 0.8%. The beta of the stock was 1.2 which means the expected return was 0.96%. So, in this case, the stock underperformed RELATIVE to the market. Thus, any delay in getting into what is a “relatively losing” position is actually beneficial. Even though the absolute return to the paper portfolio was positive, the relative-to-market return was 0.42 - 0.96 = -0.54% Where I get hung up on this is that if you have a buy order in, I expect there is some cash sitting there ready for the transaction and at best it is just earning the risk-free rate which may still be less than the absolute paper portfolio return?

Rakesh Wrote: ------------------------------------------------------- > Yes AMC you are correct …probably for sell order > we would use the term gain if IS is -ve Good ! Then we may say : IS : - ve => 1. Buy order => Lower cost relative to “paper portfolio”, i.e., Implementation Cost of actual portfolio is lower than the Implementation Cost of paper portfolio. 2. Sell order => Higher gain relative to “paper portfolio”, i.e., Implementation Gain (benefit) of actual portfolio is lower than the Implementation Gain (benefit) of paper portfolio. Correct me if I am wrong !

Correction IS : - ve => 1. Buy order => Lower cost relative to “paper portfolio”, i.e., Implementation Cost of actual portfolio is lower than the Implementation Cost of paper portfolio. 2. Sell order => Higher gain (benefit) relative to “paper portfolio”, i.e., Implementation Gain (benefit) of actual portfolio is higher than the Implementation Gain (benefit) of paper portfolio. Correct me if I am wrong !

amjf088, I don’t understand your question. But it seems the paper portfolio return is compared with the market return. Maybe someone else can answer to your question.

I think we are over analyzing here. (I say we are overanalyzing, then i write a long post) If you gain more in real life than the paper portfolio from a trade, you will have negative implentation shortfall. Implementation shortfall is bad. You have a shortfall in implementing your trade strategy. When implementation shortfall is positive, it means you paid more than the decision price for the stock. (If you are selling, positve implementation shortfall means you are selling it for less than the price was when you made the decision.) I say implementation shortfall is bad, but in most cases it will happen. It is hard to beat the paper portfolio due to transaction costs and the effect your order has on the market price. When looking to see if an analyst is good at executing, you would compare his implementation shortfall to other analysts. So know on the test, you use this measure to evaluate managers relative to each other. You should not just say, his implementation shortfall is above zero, therefore he does not execute trades well.

CFAdreams, Agree with you, TKVM !

CFAdreams For sell order you need to reverse the shortfall computation (Source: Managing Invt Portfolios: A dynamic process, Chapt 10 Execution of Port Decisions, pp657) : SF implementation (sell order) = Return on actual portfolio less Return on paper portfolio/ Paper portfolio investment. So if it is positive, the manager must have sold it at a higher price MORE than the decision price to sell the stock.

Oh, yes. If you are selling, positve implementation shortfall means you are selling it for MORE (not less) than the price was when you made the decision.