Hedge fund managers clash on high-frequency trading

By Simone Foxman

Wed Apr 16, 2014

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A compendium of differing views.


A furor has erupted over author Michael Lewis’s new book Flash Boys, which peels back the layers of secrecy surrounding the practice of high frequency trading. Hedge fund managers have been making noise about Lewis’s contention that financial markets are "rigged," coming down strongly on both sides of the debate.

We’ve compiled their reactions here, and we’ll update this list as more people speak out. If you’d like to add a viewpoint we’re missing, please email simone.foxman@absolutereturn.net.

» Jaffray Woodriff, chief executive at Quantitative Asset Management, told Absolute Return he enjoyed Flash Boys, and admires the founders of IEX, but disagrees with Lewis. Read the Q&A.

» Rishi Narang, the founding principal of quant-oriented fund of funds T2AM, told Absolute Return, "There are potentially unintended consequences of waging this war…[particularly] a transaction tax…Before we throw out all the advances our market has made, we should remember that we’re in the situation of having a computerized market because humans have acted badly over and over again." Read the Q&A.

Narang published a book on high-frequency trading, Inside the Black Box: A Simple Guide to Quantitative and High Frequency Trading, and a recent critique of the anti-HFT argument at CNBC.com.

» Mike Hennessy, the managing director of fund of funds Morgan Creek Capital Management, tells Absolute Return that he’s more concerned about the prospect of a flash crash than he is high-frequency traders making a few bucks. Read more.

» "It is true that in an effort to sell a book, Michael Lewis and others have used language that undermines confidence in the marketplace. The problem is that it’s totally justified. Without that level of outrage, it will not be changed," said one executive at a multi-billion-dollar event-driven fund manager. He declined to be named because he was not authorized to speak on the record.

» GAM Alternative Investment Solutions sent a letter to clients last week providing color and background on high-frequency trading:

Much of the recent publicity has been focused on the negatives of HFT and the potential costs to non-HFT market participants. While some HFT approaches can impose costs on traders who use less sophisticated techniques to execute their trades, we believe that it would be unfair and incorrect to apply this categorization to all high-frequency traders…[A]n institutional trader who wants to transact a very large number of shares at once could endure greater costs from the market makers for this immediate access to liquidity. However, small investors such as retail investors who trade much smaller numbers of shares at once do not face this hurdle and actually may benefit from the very low bid-ask spreads brought about by HFT…[O]ur view is that the role of HFT is much more nuanced than has been made out in the media lately, and there are both benefits and costs to be considered.

» AQR Capital Management founder Cliff Asness and AQR portfolio manager Michael Mendelson took to the opinion page of the Wall Street Journal to voice their discontent about Flash Boys, writing:

The recent fusillade of hyperbole about HFT practices threatens to derail this effort and refocus attention where the problem isn’t…We doubt that these old-school managers were truly better off in the pre-HFT world, but it's hard to prove either way…

There has been one unambiguous winner [from electronic trading], the retail investors who trade for themselves. Their small orders are a perfect match for today's narrow bid-offer spread, small average-trade-size market. For the first time in history, Main Street might have it rigged against Wall Street.

» Greenlight CapitalPershing Square Capital ManagementScoggin Capital ManagementSenator Investment Group and Third Point Partners are all mentioned in Lewis’s book as investors in IEX, the new trading venue designed to make certain high-frequency trading strategies more difficult to execute. All declined to comment for this piece.

» Greenlight Capital told investors in a letter dated April 22 that it doesn't believe "the abuses identified in Flash Boys...significantly impact" its business. Nonetheless, its trading team is "vigilant about minimizing their impact" on the firm's funds:

Michael Lewis's new book Flash Boys, like all of his books, is a fun read and is based on a true story. It brings attention to some areas of the market that can improve further, and a few areas of possible abuse. There are many legitimate and even beneficial aspects to computerized trading, including market making and statistical arbitrage, yet there are also some areas that are ripe for reform. Most glaring is the latency arbitrage that is used to identify the presence of large institutional orders for the sole purpose of legally front-running them...

We believe that the best response for any investors that are worried about fast computers taking advantage of them is to ask that their orders be routed to IEX, a company in which we hold a small stake.

Read the full letter here.

» Nicholas Colas, chief market strategist at ConvergEx Group, a global brokerage company based in New York, recently surveyed 357 ConvergEx customers about their feelings on U.S. market structure. 65% of respondents said they worked on the buy-side.

Respondents to the survey overwhelmingly believed that markets were not fair. "Make no mistake: when 70% of market professionals think the game is unfair, that game is going to change," Colas wrote. A full half of respondents deemed HFT harmful; only 20%said such trading was "helpful" or "very helpful" to market participants. Then again, 71% of the people surveyed said recent debates about HFT haven't changed the way they interact with U.S. equity markets.

Colas concludes:

In short, our survey seems to tell a very clear story. Most professional investors and institutional brokers do not feel that markets treat all participants fairly.  They worry about how fragile markets might become during periods of abnormally high volume.  At the same time, they are cautiously picking their way through the minefield in which they find themselves and are unsure what role regulators should play.  How the landscape will change as a result of their unease is still unclear.  What is certain is that change is coming.

See also: A primer on IEX, the trading venue Lewis details in the book.

ISSN: 2151-1845 / CDC10004H