Michael Lewis’ new book Flash Boys, highlighted during Sunday’s related 60 Minutes segment “Rigged,” has brought renewed criticism against U.S. equities market structure in general and high frequency trading (HFT) in particular. In HFT strategies, the fastest traders employ super-fast computers to post and cancel orders at rates measured in thousandths or even millionths of a second.
Lewis and others accuse these traders of using their speed advantage to figure out which stocks investors plan to buy, purchase them first, and then sell them back at a higher price. The impact on each trade might be only pennies, but the combined effect, says Lewis, has an enormous impact on the markets.
While the jury is still out on the benefits and hazards of HFT, here are some questions that we believe you should be asking:
Should every investor simply forego investing?
To answer that question, an investor should compare the cost of sitting out of the market due to the feeling of being “ripped off” to the presumed cost of these HFT strategies. From our readings of the information publicly available, we believe HFT costs the average mom and pop a few cents to a few dollars a year, while the cost of sitting out of the market un-invested can be very high.
We do acknowledge that a few cents on every trade, when multiplied the millions of trades made daily, adds up to a very large sum that is being made by someone in the marketplace, and that this practice affects the entire market structure.
What are GV’s money managers hires doing to overcome this unfair advantage?
We have spoken to several of the money managers we hire. The consensus is that they have been aware of the side effects HFT for some time. They have taken and continue to take steps to help mitigate the problem and believe that HFT has had only a minimal impact on their rate of return. Some managers trade through various exchanges, some have sophisticated technologies and some consistently urge regulators to maintain a level playing field.
We believe hiring professional money managers may be giving our clients a level of protection which they would not have if they were trading their own portfolio.
If ordinary investors are barely harmed by HFT, is there a concern of market fairness?
Clearly, the situation is still developing and therefore, our views may be subject to change in the future as we have a complex market structure. While there are unintended consequences, faster technology and innovation have caused trading costs to decline and liquidity, as measured by shares and dollar volumes traded, to increase.
For example, buying 1,000 shares of AT&T before 1975 would cost $800 in commissions, which is roughly 100 times more than the fees paid by some retail stock-pickers today.
In this instance, we believe technology has advanced faster than regulation. We are adamant that our overall market structure should and must be fair. We know bad actors like Bernie Madoff, inside traders, and the like have always existed in the market place and have always tried to game the system.
Today, the side effects of HFT are a difficult life reality. We hope that the noise from the media and recent investigations by the regulators help catch and stop each perpetrator. Since the impact of HFT to each individual investor is very small, we believe that you should maintain the focus on your long-term goals.
GV will continue to focus on structuring portfolios to help generate the returns you need to live the life you desire and focus time on the things that matter most in life.
Should you have any questions or concerns about High Frequency Trading and the impact on your portfolio, please contact your wealth advisor at GV.