Understanding Transaction Costs in Portfolio Management

John, a portfolio manager, is analyzing the costs associated with adjusting his client's portfolio to maintain optimal asset allocation. During his review, he identifies three types of transaction costs that could significantly impact the overall performance of the portfolio: explicit costs, implicit costs, and market impact costs.

Explicit costs refer to clear fee structures such as commissions paid to brokers, while implicit costs relate to the price impact of trading on the market, including slippage when executing orders. Market impact costs include the potential price movement of the asset due to large orders affecting overall liquidity in the market.

As John evaluates different trading strategies, he must consider which type of transaction cost will be most relevant when restructuring his client’s portfolio in a volatile market. Based on his analysis, he is ready to determine the most significant factor that could lead to an underperformance of the portfolio concerning transaction costs.