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Paper Analyzes “Invisible” Costs of Fund Trading

A recent paper found that the “invisible” costs of fund trading, which are not reflected in the fund expense ratios, can have a negative impact on performance.  The paper found that funds’ annual trading costs were comparable in magnitude to the expense ratio (1.44% a year versus 1.19%, respectively).  Moreover, there was considerably more variation in fund trading costs than in expense ratios. For example, the difference in average expense ratio for small-cap growth and large-cap value funds was 0.32 percentage points (1.39% versus 1.07%), whereas the difference in average aggregate trading costs for the same funds was 2.33 percentage points (3.17% versus 0.84%).  The paper also found a strong negative relation between aggregate trading cost and fund return performance.  The difference in average annual return for funds in the highest and lowest quintiles of aggregate trading cost was –1.78%.  The full abstract and summary can be found here.