When a veteran like Robert Shapiro says he isn’t sure exactly how high-frequency traders operate and how they impact institutional orders, then it’s safe to say that he is not alone. At the Traders Magazine conference in September, Shapiro told attendees that there is greater mystery surrounding these rapid traders for the buyside than there is certainty.
As someone who oversees trade optimization and execution quality at Morgan Stanley Investment Management, Shapiro has a clear window into the trading process. But even he is flummoxed on this topic. "Forget it," Shapiro said. "You know just enough to be dangerous, but not nearly enough to understand what they do and protect yourself against it–assuming they’re even doing anything to you. Who knows? There’s no evidence. But you’ve got to be crazy not to want to explore this topic further."
His view echoes the rampant uncertainty and ambivalence among the buyside when it comes to high-frequency trading. In fact, a recent Greenwich Associates survey of the buyside offered a wide range of opinions on high-frequency trading.
Mostly, the Greenwich results showed that institutions are unsure whether high-frequency traders benefit or detract from the quality of liquidity and the marketplace. The buyside respondents were also mixed on whether there should be new regulation on high-frequency trading.
More than half–or 57 percent–of the participating institutions that interact regularly with high-frequency traders said such traders’ strategies should be regulated. But almost as many–or 55 percent–said they do not feel that those strategies put them at a disadvantage.
Still, 87 percent of survey participants agreed on one thing: There is no hard data available to determine definitively whether high-frequency trading increases or decreases trading costs.
"Both detractors and those touting the liquidity provision and spread-tightening benefits of high-frequency trading have little data to back them up," said one survey participant from a U.S. asset management firm.
In the survey, Greenwich defines high-frequency trading as "strategies that seek to take advantage of small market inefficiencies." Their activity accounts for between 50 and 70 percent of all market liquidity, according to estimates used or quoted in the survey.
Tacoma, Wash.-based Russell Investments did not participate in the survey. But Jason Lenzo, head of trading for equities and fixed income at the dually registered broker-dealer-investment advisor, still has opinions on the matter. Lenzo said that some research suggests that high-frequency trading strategies add liquidity and help tighten spreads. And the strategies shouldn’t get smeared or regulated with a broad brush, he added.
"I don’t think data show that high-frequency trading in and of itself is evil or bad," Lenzo said. "At what point do you start saying the ability to arb out price discrepancies is a good or a bad thing? Separately, firms are going to have different levels of investment into their execution technology. And certainly to the extent that people put more time and effort into creating better solutions, I’m not sure that that’s necessarily what needs to be regulated."
One respondent from a large U.S. investment management firm was critical of high-frequency strategies. These traders create "false liquidity," he said, and routinely trade "in front of legitimate market participants." In addition, they use "predatory algorithms" that encourage legitimate participants to complete their orders by trading at slightly worse prices.
One head trader at a large asset manager told Traders Magazine that high-frequency traders aren’t a major threat to institutional orders. Still, he said, they add practically no value to the long-term investment process.
The Greenwich survey reported that there were added complexities to the answers of those respondents who said they’d support new regulations on high-frequency trading. These respondents apparently got confused with the terminology and focused on the use of flash orders and indications of interest, specific controversial practices that "are widely viewed as elements of front-running and may have inaccurately been lumped into the debate on the merits of high-frequency trading," the survey said.
The Securities and Exchange Commission last month adopted a proposal to ban flash orders. Additionally, the SEC earlier this month spoke out against the use of actionable IOIs that link dark pools to one another.
For its survey, Greenwich interviewed 78 institutional investors at banks, hedge funds, investment managers, mutual funds, insurance companies and pension funds in the U.S., Canada and Europe.
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