A Brief History of TCA, Its Shortcomings, and a Proposed Framework for Integrating Trading into the Investment Process

Abstract

This article provides a brief survey of the history of transaction cost analysis (TCA), from its humble beginnings on the compliance/marketing front to its modern-day de rigeur usage on the trading desk. Despite becoming an essential part of the execution process, by and large TCA tools have still not been able to realize their potential as they have not been fully integrated into the investment process. The next step in the evolution of TCA is to look at the investment process and execution process more holistically, connecting them rather than allowing them to co-exist, divorced from one another. Accordingly, we propose an integrated framework for achieving consistency in alpha capture. Three of the seven steps in the proposed process actually occur even before the pre-trade estimate is calculated, a place where many TCA tools and providers start today, ignoring the necessity of gaining a true understanding of the investment style, portfolio manager's motivations and trading environment in order to maximize alpha capture.