A PM picks the right stock, sizes the position correctly, and still underperforms by 80 basis points because the trader chased the market. Execution converts alpha into realized return, or burns it.
Why a trade exists controls how it should be executed. Five buckets.
Profit-seeking (alpha-driven). Information-based. Decay matters. Trade fast before the signal evaporates.
Risk management (hedge or rebalance). Tolerance for delay is moderate. Cost matters more than speed.
Cash flow needs. Subscription or redemption-driven. Size is dictated, timing fixed by the cash event.
Corporate action. Index reconstitution, M&A, spin-offs. Timing is exogenous, benchmark is usually close-of-day.
Margin or collateral call. Forced. Speed dominates everything; cost is secondary to liquidity.
KEY: Alpha-decay trades are price-sensitive; rebalancing trades are time-sensitive. The exam tests this distinction directly.
Four input families.
Order characteristics. Size (vs ADV), urgency, side, alpha thesis.
Security characteristics. Liquidity (spread, ADV, depth), volatility, market cap, name-specific news risk.
Market conditions. Volume profile, volatility regime, correlation, news flow, time of day.
Common mistakes
- Quoting IS as just (execution − arrival). That captures only trading cost. True IS includes delay, opportunity, and fees. Trap: missing 40 to 60% of the total cost.
- Using a VWAP benchmark for an alpha-decay trade. VWAP rewards average participation, which is the wrong incentive when speed matters. Trap: a "VWAP-beating" execution can still bleed alpha relative to arrival price.
- Treating fixed-income trades like equities. FI is dealer-quoted and episodic; an "arrival price" often is not a continuous mark. Trap: applying equity TCA mechanically.
Bottom line
- Trade motivation drives urgency: alpha-decay demands speed, rebalancing tolerates patience, margin calls override everything (motivations span alpha, risk, cash, corporate action, margin)
- Strategy inputs are order characteristics, security characteristics, market conditions, and risk tolerance; the optimum balances market impact against timing risk
- Implementation Shortfall = paper return minus actual return, divided by paper investment; decomposes into delay, trading, opportunity, and fees
- Execution evaluation decomposes IS to assign blame: the PM owns delay, the trader owns trading plus opportunity
Exam shortcut
Place every trade on the urgency × size grid first. High urgency with small size means IS-aggressive. Low urgency with large size means scheduled POV/VWAP. The grid resolves most strategy-selection questions in one step. For IS questions, compute the four components separately (delay, trading, opportunity, fees) and sum. Never short-cut by quoting (execution − arrival) alone; the exam writes wrong answers that match that error.
The full lesson (about 2,307 words, 15 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
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