Wednesday, April 2, 2014

HFT Drama Versus Dramatically Lower Costs

Michael Lewis launched his HFT book, did Sixty Minutes on Sunday, and here we are on Wednesday and HFT is still dominating the news cycle. Whatever you think of HFT, Lewis has already won. In our ADHD society, that we are still talking about his book three days later is a great achievement.

Not that there was much doubt that Lewis' book would find a big audience. He is a great story teller, I've really enjoyed his work over the years. He can cover a lot of conceptual and in the case of Boomerang, geographic, territory.

But how big an issue is HFT for investors, meaning people with multi year time horizons? Maybe not such a big one.

Clifford Asness and Michael Mendelson wrote in WSJ today that Lewis and IEX were talking their book, in Lewis' case literally. They did note "The biggest concern we have with modern markets is their complexity and the associated operational risks. The market structure that enables the HFTs and provides us with their benefits may also be one that risks technological calamity."

The poster child for lower trading costs and standing up for the individual investor is Vanguard. I am inclined to agree with Gus Sauter who said

"There are literally hundreds of strategies that are high-frequency trading, ranging all the way from those that really perform much of a market-making and liquidity-providing function to perhaps some on the opposite end of the spectrum, where they are abusive and trying to manipulate the market, " he said.

"Obviously, we need to get rid of those types of high-frequency traders, but I think the bulk of them are creating liquidity and reducing spreads for us, which has dramatically reduced costs."

Indeed for all the HFT drama, dramatically lowered costs are a boon for investors. Consider Tadas Viskanta's trenchant observation that this is the best time to be an individual investor:

1. Easier:  Investors today can with a brokerage account and a computer is now only a few mouse clicks away from a globally diversified portfolio of ETFs that in terms of expenses rivals what institutions paid a decade ago.  For all intents and purposes the expense ratio on the big ETFs is closer to 0.0% that 1.0%.  Many brokers now allow online trading of individual bonds and overseas securities.

2. Cheaper:  Brokerage commissions continue to get driven towards $0 over time.  In fact, many brokers today provide commission-free trading of a range of ETFs.  Options strategies that would have been cost-prohibitive a few years ago are now viable strategies today.  Do you remember when you used to have to pay extra for real-time quotes?  Today real-time quotes are a commodity.

History matters, too. Jason Zweig:

First of all, as Viskanta also pointed out, there was never a golden age when the financial markets were safe or when investors were always represented by people who behaved liked angels.

As I wrote in my 2005 introduction to Fred Schwed’s classic book, Where Are the Customers’ Yachts?, the individual investor has always been “situated at the very bottom of the food chain, a speck of plankton afloat in a sea of predators.”

That was true in Exchange Alley in London in 1720. It was true when A.L. Bleecker and John Pintard started auctioning stocks in their Wall Street coffee house in 1791. It was true after Ferdinand Pecora and FDR and the newborn Securities and Exchange Commission flushed out the Street in the 1930s. It was true in the long bull markets of Eisenhower and Reagan. And it is still true.

The era we invest in today, however, is as good as any ever has been. 

Zweig goes into all the shenanigans, time, unpredictability and gyrations that accompanied his first trade in 1976. With commissions and long distance phone calls eating up around 50% of his profits. Its a great history lesson that concludes - "Yes, Wall Street is still a dangerous place. But it used to be worse."

It makes sense for investors to manage their risk, but the first step here is already a long term time horizon which negates much of the concern around HFT. There are policy and structural concerns as Asness points out, but the net result of the latest Lewis book is probably more drama than necessary for individual investors.

1 comment:

  1. Great post. Never thought about it this way, but this is actually a great time for the passive investor, who can almost guarantee himself returns as high as 7%-10% over time if judging by history.