The "Michael Lewis effect" has landed on high-frequency trading -- and has changed the conversations several advisors say they are having with their clients.
After Lewis' surprise publication of a high-profile book (Flash Boys) and the airing of a segment this week on an even higher-profile TV show (60 Minutes), high-frequency trading has become part of the investment conversation.
"People don't understand it, but it sounds bad," says Gary Wunderlich, CEO of Wunderlich Securities, a Memphis-based regional brokerage firm. "High-frequency trading has given the industry a black eye."
As the term suggests, high-frequency trading involves virtually countless transactions, executed at incredible speeds. Using software programs that anticipate moves by slower traders, HFT practitioners aim to squeeze tiny profits from these multiple buys and sells, adding up to huge gains over time.
Amid accusations that HFT "rigs" the stock market, federal and state officials are investigating the practice; HFT firm Virtu Financial reportedly has postponed an IPO that was scheduled for early April.
The heightened interest in HFT is driving internal discussions about how to discuss the issue with clients, advisors say. "We've received a few calls on the 60 Minutes piece, including some from key clients," says Mark Wilson, chief investment officer at Tarbox Group, a wealth management firm in Newport Beach, Calif. "After a team discussion, we decided not to send out a specific 'Tarbox Alert' on this topic."
Instead, the firm will address HFT in the commentary included in its quarterly performance reports, according to Wilson. "Our points -- we do not buy individual stocks, we are not trading excessively, we use limit orders for large block trades, we don't invest in large hedge funds, etc. -- will reinforce how we manage client portfolios and how our clients are not greatly impacted by HFT," he says.
Bob Phillips, managing principal at Spectrum Management Group, a wealth management firm in Indianapolis, also reports getting several questions about HFT from clients.
How has he responded? "There are core points we discuss with those clients," says Phillips. "We tell them that there have always been market makers that take a spread on trades, and that the effect of HFT on our individual clients is probably miniscule. It is mostly a matter of perceived fairness and a question of whether these traders provide any real value.
"Michael Lewis is correct in his comments, but they give the impression the public should avoid the stock market," he adds. "This is sensationalism."
Portfolio strategy may determine how and whether advisors should raise HFT issues with clients.
At Palisades Hudson Financial Group, clients are long-term investors, not traders moving in and out of securities within hours (or seconds), notes Shomari Hearn, vice president in the firm's Fort Lauderdale, Fla., office. "It is not disconcerting if a high-frequency trader is able to get a slightly better price for a security than our client does, as long as our client gets a fair price," he says.
"The majority of the investments our clients hold are mutual funds and ETFs," he adds -- "and it is a good chance that when we or the fund manager places a trade, a high-frequency trader is on the other end of that transaction, providing liquidity to complete the transaction."
Hearn adds that his clients haven't shown much interest in the issue. "So far we're not getting any inquiries on high-frequency trading," he says. "Although I cannot speak for our clients, I can only speculate that they have not expressed concern so far because we have not conveyed to them that this is an issue they should worry about."
'NOT A GAME CHANGER'
Robert Luna, CEO of Surevest Wealth Management in Phoenix, also reports a lack of client concern over HFT. "High-frequency traders are trying to get an advantage of a penny or two per share," he says. "Pennies make a big difference when you are trading tens of millions of shares a day. However, pennies are not a game-changer for an individual investor who is buying a few hundred shares of a given stock."
The real problem for retail investors is emotional response, argues Luna, citing a recent Dalbar study showed that retail investors have underperformed market indexes by almost 4% per year over the past 20 years.
"The reason retail investors underperform is not because there is not a level playing field," he says. "Psychological biases lead to poor investor behavior. The high-frequency trading story is an excuse some investors may use to justify avoiding the stock market -- however, at the end of the day, it is just noise. The stock market arguably offers a more level playing field than ever before, with lower trading costs, better transparency, and access to more asset classes and investment vehicles."
Indeed, other advisors blame Big Media for hyping a problem that barely affects their clientele. "We haven't fielded a single call," says Marc Freedman, who heads a financial planning firm in Peabody, Mass. "I believe the noise about HFT from both 60 Minutes and CNBC is an opportunity to boost ratings during a time of low volatility in the market. The consumers that I serve -- mass affluent baby boomers -- are talking more about VCRs and rotary telephones than HFT."
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