What RIAs need to know about systemic risks in the wake of the flash crash
Value investing is a casualty of about systemic risk related to high-frequency trading
This is perhaps the most important article that RIA BIZ has ever published. Brilliantly done.
Thank you for this compelling article. I am interested to hear your specific regulatory recommendations so that readers can help influence regulatory decisions.
We actually chose to only focus on one part of the issue – HFT. There are issues with convergence as well with Stat Arbs and Quant Funds using similar models in various timeframes.
What needs to be considered is the change in market strucutre that is taking place and how the key players interact. Exchanges get revenue from transactions. HFTs and Stat Arbs do lots of transactions, far more than Investment Advisors or even fund managers, so they are important to fiscal soundness of the exchange.
The question may come down to philosophy on who and how the exchanges are supposed to serve the transactors on the exchange. The NYSE has always maintained that it is biased to the long term investor. But, a buy and hold investor creates few trades and little revenue.
Fortuntately our job is to manage risk, not to have to come up with regulatory solutions to market strucutre problems.
We said. Perhaps there is a commercial application you could reason through in conjunction with a custodian/ECN which would help RIAs wade through this on behalf of their clients in their best interests.
If I do I’ll need your help getting it to market. Actually, we are really working on a how it affects our overall allocation strategy by trying to better understand the bias it creates in different market cycles and asset classes.
For instance, are corrections now even more dangerous as convergence leads to computerized selling (May 6th)? Is this false sense of liquidity more or less likely to prevail now that we know about it?
Are bull markets/rallies likely to extend farther than projected because of what we feel is the natural price appreciation being elevated by increased intermediation. (remember when we talked about ATS/ECN causing disintermediation?). Is there a chance that we’ll see an increased use of dark pools if volumes thin thereby further skewing price/volume models?
Are there more stable equity markets to be in than the US? What happens as this spreads to Asian markets where assets are pouring in, and both volumes and choices are lower?
I think that given the market volatilty and the economic outlook most would do well to really think about and understand more fully the 'risk’ in their client portfolios. Wall Streets 'buy and hold’ pardigm is broken (if it ever really made sense in the first place).
Agree totally, if we can quantify increased intermediation we could play it to our advantage. I have a few friends with PhDs in applied mathmatics that might be able to crack the code.
Hmm, PhDs in applied mathematics are the guys who created the models…
As far as what the increased intermediation has 'cost’ portfolio managers there has been some work done (I think they used mutual fund managers) it came out to be 1-3% higher due to re-intermediation. I lean toward the 3% (and think it is low).