Tagged: Themis Trading

The Fortress

Happy birthday to Karen Quast! My beloved treasure, the delight of my soul, turns an elegant calendar page today. It’s my greatest privilege to share life with her.

Not only because she tolerates my market-structure screeds.

Speaking of which, I’m discussing market structure today at noon ET with Joe Saluzzi of Themis Trading and Mett Kinak from T Rowe Price. In an hour you’ll mint a goldmine of knowledge.  Don’t miss it.

A citadel by definition is a fortress.  I think of the one in Salzburg, Austria, the Hohensalzburg castle perched on the Salzach, “Salt River” in German, for when salt mined in Austria moved by barge.  We rode bikes there and loved the citadel.

It’s a good name for a hedge fund, is Citadel. We were in San Francisco last week and joined investor-relations colleagues for candid interaction with Citadel. IR pros, hedge funds are stock-picking investors capable of competing in today’s market.

Blasphemy?  Alchemy?  I’ve gone daft?

No, it’s market structure. Exchange Traded Funds (ETFs) have proliferated at the expense of what we call in the IR profession “long-only” investors, conventional Active managers buying stocks but not shorting them.

Since 2007 when Regulation National Market System transformed the stock market into a sea of changing stock-prices around averages, assets have fled Active funds for Passive ones.  ETF assets since 2009 have quadrupled, an unmatched modern asset-class boom.

Underperformance has fueled the flight from the core IR audience of “long-onlys.” Returns minus management fees for pricey stock-pickers trails tracking a benchmark. So funds like SPY, the ETF mirroring the S&P 500 from State Street, win assets.

Why would a mindless model beat smart stock-pickers versed in financial results? As we’ve written, famous long-only manager Ron Baron said if you back out 15 stocks from the 2,500 he’s owned since the early 80s, his returns are pedestrian. Average.

That’s 1%. Smart stock-pickers can still win by finding them.

But. Why are 99% of stocks average? Data show no such uniformity in financial results. We come to why IR must embrace hedge funds in the 21st century.

Long-onlys are “40 Act” pooled investments with custodial assets spent on a thesis meant to beat the market.  Most of these funds must be fully invested. That is, 90% of the money raised from shareholders must be spent.  To buy, they most times must first sell.

Well, these funds have seen TRILLIONS OF DOLLARS the past decade leave for ETFs and indexes (and bonds, and target-date mixed funds). Most are net sellers, not buyers.

Let’s not blindly chase competitively disadvantaged and vanishing assets. That confuses busy with productive. And “action” isn’t getting more of the shrinking stock-picking pie.

First, understand WHY ETFs are winning:

  • ETFs don’t hold custodial assets for shareholders. No customer accounts, no costs associated with caring for customers like stock-pickers support.
  • They don’t pay commissions on trades. ETFs are created and redeemed in large off-market blocks (averaging $26 million a pop, as we explained).
  • They don’t pay taxes.  ETFs are created and redeemed tax-free through in-kind exchanges.
  • ETFs avoid the volatility characterizing the stock market, which averages about 3% daily in the Russell 3000, by creating and redeeming ETFs off-market.
  • And fifth, to me the biggest, stock-market rules force trades toward average prices. All stocks must trade between the best bid to buy and offer to sell. The average.

So.  Stocks are moved by rule toward their average prices. Some few buck it.  Stock-pickers must find that 1%. Money tracking benchmarks picks the 99% that are average. Who’s got the probability advantage?

Now add in the other four factors. Who wins?  ETFs. Boom! Drop the mic.

Except dropping the mic defies market rules prohibiting discrimination against any constituency – such as stock-pickers and issuers.

SEC, are you listening? Unless you want all stocks to become ETF collateral, and all prices to reflect short-term flipping, and all money to own substitutes for stocks, you should stop. What. You. Are. Doing.

Back to Citadel. The Fortress. They admit they’re market neutral – 50% long and short. They use leverage, yes. Real economic reach isn’t $32 billion. It’s $90 billion.

But they’re stock-pickers, with better genes. Every analyst is covering 25-55 stocks, each modeled meticulously by smart people. Whether long or short they meter every business in the portfolio. Even analysts have buy-sell authority (don’t poo-poo the analysts!). And they’re nimble. Dry powder. Agile in shifting market sand.

They can compete with the superiority modern market structure unfairly affords ETFs.

So. Understand market structure. Build relationships with hedge funds. This is the future for our profession. It’s not long-onlys, folks. They’re bleeding on the wall of the fortress. And don’t miss today’s panel.

Bourbon Street Market

The equity market is like Bourbon Street.

No, we don’t mean the stock market is home to “Big Daddy’s World Famous Love Acts.” We mean it’s a bit off, a party, somewhat wanton, full of folks in disguise doing things they wouldn’t do anywhere else. Fantastical.

I interviewed Joe Saluzzi at the NIRI Southwest Regional Conference last week in New Orleans. Joe and co-founder Sal Arnuk at Themis Trading are the reason we all know about “high frequency trading.” Their white paper on toxic equity trading went viral in 2008, and the rest is history.

We sat down Charlie-Rose-style at the Hotel Monteleone and talked candidly about Joe’s new book, “Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street Are Destroying Investor Confidence.”

If you haven’t done so, buy it for yourself (I have it on my Kindle) and get a copy for your CFO or CEO. Everybody who at some time utters the word “equity” should read it.

If you’re in the IR chair, executives expect you to deliver a story to investors that advances shareholder value. You want a market that supports those efforts by helping risk-taking capital connect to the opportunity in your shares. Most executives generally conclude that it’s working. Stocks seem to be trading comparably to historical S&P 500 earnings multiples.

So why would Joe and Sal argue that markets are broken? (more…)

Broken Markets

Our good friends Joe Saluzzi and Sal Arnuk, proprietors of Themis Trading and experts on market structure, have at last written a book about markets. They guest-blog today at the Market Structure Map.

We’re out this week Riding the Rockies from Gunnison to Fort Collins, covering 450 miles and some 25,000 feet on pedals and small seats. Assuming we survive it, we’ll tell you about it next week. Meantime, read this, and buy the book, Broken Markets. Every IRO, every executive, should read it.

Mark your calendars: Plan to attend the NIRI Southwest Regional Conference Aug 15-17 in New Orleans. I’ll be there, where I’ll interview Joe Saluzzi on the state of modern markets.

Now, Joe and Sal:

Trust and confidence in the stock market has been shattered in the past few years.

Events like the May 2010 Flash Crash, the failed BATS IPO and the Facebook fiasco have frustrated investors, leaving them wondering “what the heck is going on?”

In response, they have pulled their money out of domestic equity mutual funds week after week.

Since the Flash Crash, nearly $300 billion has been withdrawn from domestic equity mutual funds, according to the latest report from the Investment Company Institute. (more…)

Public Companies, Pay Your Market-Makers

 Apparently, exchanges are not bastions of deep liquidity.

 In a bombshell dropped at a congressional hearing yesterday, top executives for the NYSE and the Nasdaq proposed – to borrow from humorist Dave Barry, we SWEAR we are not making this up – that you pay them fees, small-cap companies, which they will distribute to market-makers to incentivize trading in ETFs that trade your shares.

 Exchanges already incentivize most trades, but in the hundred most liquid names there’s great profit in the data off the consolidated tape. You small-caps offer no profit. So in addition to charging you listing fees, they now want to charge you market-making fees – but in the ETFs that hold your stocks.

 Congresspersons unfamiliar with how arbitrage works and how ETFs are principally one-day investment vehicles won’t see through this self-serving and patently ridiculous proposal. The SEC may also overlook the glaring contradiction to well-functioning capital markets and approve it. Public companies don’t read exchange proposals as they should and don’t comment on them.  No opposition? Approved.

 For more, we’ve asked permission to re-run a blog post today by Joe Saluzzi at Themis Trading: (more…)

A Lighter Shade of Dark

Want to know about dark pools? Join the NIRI Virtual Chapter at noon eastern time Wednesday May 25.

I’m moderating the discussion. The all-star panel includes Nicole Olson of storied dark pool Liquidnet; Adam Sussman of expert market-structure research firm TABB Group; and Joe Saluzzi at Themis Trading, one of today’s leading voices on the nature of trading markets. You know him from Bloomberg, 60 Minutes and CNBC.

Two weeks ago at the NIRI finale for the season here in Denver, we were indulging in the benefits of having brewery Molson Coors in the chapter. And someone was talking to me about “black pools.”

I thought, “IR folks don’t get dark pools yet.”

This afternoon an IR pro in California emailed, asking how to figure out what percentage of their shares trade in dark pools. You can’t know, exactly. (more…)