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Respect for markets and judging HFT

AQR Capital Management marked its tenth year of operations in Australia with a series of thought-provoking presentations in June. Over the ten years, Australia and New Zealand have grown to become AQR’s largest client base outside of the US, representing nearly one sixth of the firm’s total assets under management. Among the presenters were two of AQR’s principals, David Kabiller who spoke on what makes a good investment strategy and Michael Mendelson on the misconceptions of High Frequency Trading (HFT).

Long term optimism and short term paranoia

Kabiller, who heads up Client Strategies for AQR, oversees client relationships, business development and strategic initiatives. In his presentation, Kabiller said that “long term optimism and short term paranoia” is a core element of a good investment strategy. He discussed AQR’s development and the lessons from his experience that he brings to investors.

According to Kabiller a ‘depression era mentality’ and a respect for markets and competition are things that inform a sound investment strategy. Investors must have the discipline to follow their chosen path while having the humility to adapt. He also spoke of AQR’s desire and curiosity to understand markets.

AQR has itself experienced a short-term crisis while working towards a long term goal. Founded in 1998 during the tech bubble, AQR saw their portfolio lose nearly 40% from 1998 to 2000 before rebounding with 79% growth until 2001. Kabiller said that the lesson to be taken from this volatile period is to maintain a great respect for markets and competition.

In his presentation Kabiller also touched on diversification and its importance in today’s market. He referred to a “very big retirement problem in the world”, suggesting that too many people still have undiversified investment strategies. He believes that people should have a respect for the market in aggregate and work to have a better understanding of risk and return sources.

Kabiller suggests that an allocation to hedge funds is necessary for diversification as they are not as reliant on economic health as other traditional assets. He did, however, warn investors to be wary of hedge fund managers using leveraged strategies with high beta as these funds have a greater risk of being at the mercy of a falling market.

High Frequency Trading shouldn’t cause panic

Michael Mendelson showed his support for High Frequency Trading (HFT) while speaking at AQR’s seminar.

Mendelson said that markets have been under more criticism than ever before but defended HFT for the liquidity it brings to the market. He believes that the technology used by high frequency traders and the nature of their strategies have lowered transaction costs for investors and been largely beneficial.

Mendelson addressed the misconceptions of HFT, stating that high frequency trading is a strategy and not low latency technology. Furthermore, he made a point to mention that quantitative and algorithmic trading is not high frequency trading.

In reference to Michael Lewis’ new book ‘Flash Boys’ which has recently brought some negative media attention to high frequency traders, Mendelson states that the claims made by Lewis about the profits of high frequency traders are greatly exaggerated and that the reality is a US$1.1bn annual profit for the industry as a whole.

Mendelson condemned what he called the ‘salacious criticism of markets’ and said that the negative publicity directed at high frequency traders has largely stemmed from people who have had their business model disrupted.

When asked about how investors can be certain that high frequency traders aren’t accessing information on the way to the exchange Mendelson responded, “it would be illegal” and he would find it hard to believe that traders who wanted to remain in the market would risk it.

Mendelson did point out however that investors don’t live in a market that is free of problems. For investors who wanted reassurance from their fund managers, he suggested that they ask managers what they are doing to protect themselves from systems risk and to ensure that they understand the markets they are trading in.

While concluding, Mendelson urged people to resist any proposals by governments, regulators or exchanges to introduce transaction taxes as these would be detrimental to investors worldwide. As well as simultaneously taxing banks and hurting high frequency traders, they are ultimately a tax on all investors.

 

Miles Hellyer is the founder of Chalk Marketing, a Sydney-based marketing agency.

3 Comments
Paul
July 02, 2014

One of the more fallacious arguments is that of HFT being a "liquidity" provider.
Proponents of HFT misuse this term as a synonym for velocity, which does not of itself provide liquidity. Liquidity in my view is the ability to trade an asset, in various volumes, without affecting it's price. HFT attempts to capture small pricing opportunities in small increments as opposed to providing "liquidity" in meaningful volume. The increasing use of dark pools would appear to highlight institutional investors lack of confidence in market "liquidity" despite the no doubt plethora of (perfectly legal as they don't want to be in trouble and are completely able to self regulate) HFT driven "bids/"offers".

Economist
June 27, 2014

Fancy someone making money out of trading stocks. Shame, shame, shame.

Oh wait, that's what stock brokers have been doing for years. Aren't HFT just fast moving stock brokers?

Seems to me that it's brokers and other short term traders who are losing out to these guys. An investor just needs to place a limit order so they don't ever pay more than they want to or sell at a lower price than they want to, and they aren't hurt at all.

Personally I don't give a fig if brokers and short term traders make less money than they used to. And any investor who doesn't use limit orders only has themselves to blame if they get set a couple of cents away from their target price.

Methinks that most of the hype about this is due to ignorance, fed by Michael Lewis' insatiable need to make money writing books that 'blow the lid' on something, even if the pot wasn't actually boiling.

Tim
June 27, 2014

If HFT does not infact give the users an unfair advantage, why then do they spend tens of millions of dollars on the most powerful computer systems that money can buy, utilise the fastest pipes direct to the exchange, spend millions on employing the best software programmers and IT experts, etc etc.?

Do they undertake this expenditure for the purely selfless reason as to provide liquidity to the market? Gee what nice, caring guys. All that effort for the glory of liquidity. Like a king feeding scraps to the poor.

As to the profitability, perhaps ask Danny Bhandari?

 

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