We thought we were going to need a boat.
Driving into Kansas City, a torrent fell in such proportion that the sky, the landscape, the topography of the roadway, disappeared into a pelting gloom that had our wipers humming on high amid the beating din on the roof for 40 minutes. Rarely has the first sliver of cutting light seemed so blessedly hopeful.
It had me thinking how darkness about markets prevails in the Boardrooms of America and investor-relations holds the light and the capacity to chase it out. Boards don’t understand the market. Perception about equity-trading is disconnected from data reality.
Across our client base reflecting $1.3 trillion of market capitalization there isn’t a single member not held by both Blackrock and Vanguard. In most cases, the two rank in the top ten if not the five largest holders. Below these are a sea of fellow asset-allocators ranging from the Powershares Exchange Traded Funds (ETFs) offered by Invesco to the explosion in so-called robo-advisors like Betterment and Charles Schwab’s ETF-powered Intelligent Portfolios.
This community claims to be “perpetual owners” – they hold things. But if an investment vehicle has inflows, it buys. Redemptions, it sells. If it tracks a market benchmark like the S&P 500, it relentlessly buys and sells to track movements. Combine those two and the result is uniformity around supine volatility.
With a lot of volume. Bloomberg in a July article on ETF trading described how these derivatives of indexes drive dollar-volume of $18 trillion annualized now. The market’s most active stock is the ETF SPY generating billions daily and $6 trillion annually. Three of the four most active stocks by dollar-volume are ETFs. Derivatives are pricing the underlying assets.
Thanks to Michael Lewis’s riveting nonfiction thriller Flash Boys (and more), many understand traders in the middle are distorting outcomes. It’s worse. Intermediaries are half the volume. Nearly three billion of six billion daily shares are chaff. No ownership-moves, just cash in a register drawer for making change.
What’s a reasonable commission for service? Real estate agents split 4-6% on home-sales. Hedge funds want 2% plus 20% of profits. Your waiter will like 20% on a restaurant dinner. The government takes about 30%.
Virtu (Nasdaq:VIRT), a high-frequency trader deploying its own capital, had revenues of $148 million last quarter and net income of $77 million, a 52% net margin. Having no customers they charge no commissions. But sitting between they keep half.
When trading firms, or exchanges, or members of Congress, or regulators tout the benefits of low-cost trading, the proper response is to ask how a market can be efficient in which the middle men are responsible for half of all sales. Groceries stores as middlemen for producers and consumers have single-digit margins, often about 2%.
What Boards should conclude is that somebody is getting jobbed. But they don’t know.
Finra oversees 4,400 brokers. Yet in trade-execution data, 30 control over 90% of volume. The reason is that rules require brokers with customers to meet defined execution standards comprised of averages in the marketplace.
The biggest brokers are handling order flow for the most active sources of trades: Indexes and ETFs. So the biggest brokers define the standards. Since Finra fines brokers for failing to meet standards, smaller brokers route their trades to big brokers, who roll them up in algorithms powered by the central tendencies defining the bulk of their trade-executions. That’s again the Massive Passives – indexes and ETFs.
Here’s a key to why 80% of stock-pickers underperform indexes. Their trades are not setting prices.
And there’s little true “long only money” in markets now, because everybody hedges macro uncertainty related to globalism, central-bank intervention and floating currencies. Data from Sifma and the Bank for International Settlements show currency, interest-rate, commodity, credit, equity and other swaps total $630 trillion of notional value, ten times global GDP. Any currency ripple can become a splash in the S&P 500.
Risk Management, Asset Allocation and Intermediation converge around borrowing – the amount of shares short every trading day. That’s 43%. Nearly half of all market-volume comes from borrowed shares, lent by big owners through margin accounts at big brokers, often rented by intermediaries to reduce cost and risk.
Only investor-relations professionals can report these facts to Boards. This is how you get a seat at the table. The only actions worth taking are ones planted in fact (and we can help you on both counts –measures and actions). It begins with casting a bright IR light that lifts the shroud and defines reality.
