Vanguard Says Minority of High-Speed Traders May AbuseChristopher Condon
Vanguard Group Inc., the world’s largest mutual-fund company, said only a minority of high-frequency traders may be hurting other investors.
Regulators should seek ways to prevent abuses without blocking high-speed firms that may actually benefit investors by providing liquidity to the markets, Joe Brennan, global head of Vanguard’s equity investment group, said in a telephone interview.
“There are high-frequency traders that probably unfairly tax the system by taking it too far,” Brennan said. “We’re in favor of market structure rules that continue to evolve to make sure liquidity providers are just that, and get paid for liquidity and nothing more.”
Money managers such as Vanguard, which buy and sell trillions of dollars worth of stocks on behalf of their investors, for years have sought to determine the impact of high-frequency trading on the assets they run. Vanguard, which handles more than $2 trillion, has been waging a battle to make sure it gets the best prices possible for its funds, Brennan said, using its own computer software and other tactics. Capital Group Cos., with $1.14 trillion in assets, has backed a startup exchange that seeks to protect investors from predatory traders.
“Unfortunately this is coming out in a way that looks like a brand new thing, and an ‘Aha’ moment on ‘60 Minutes’,” Brennan said, referring to Lewis’s interview on the television program that aired March 30. “Honestly, we’ve been working to improve market structure through regulators, with brokers and exchanges for years. This is an ongoing piece of work.”
High-frequency traders have come under unprecedented scrutiny after author Michael Lewis published “Flash Boys,” a book released March 31 that says high-speed traders, Wall Street brokerages and exchanges have rigged the $23 trillion U.S. stock market. New York Attorney General Eric Schneiderman is examining privileges such as enhanced data feeds marketed to high-speed firms, while the Federal Bureau of Investigation is looking into whether those traders are breaking U.S. laws by acting on nonpublic information.
Bill Gross, chief investment officer of Pacific Investment Management Co., said in a Bloomberg Radio interview with Tom Keene today that Lewis has an argument and changes should be made in equity trading. Each individual investor should have an equal opportunity to place an order and get it to its final destination, Gross said.
Lewis’s book centers around Brad Katsuyama, president and chief executive officer of IEX Group Inc., an exchange that opened in October. While IEX welcomes high-frequency traders as market makers, the firm has curbs that slow the pace of buying and selling. It’s pitching itself as a haven for asset managers who want protection from trading practices they consider predatory.
IEX doesn’t allow brokerages to own stakes in the company, an attempt to prevent conflicts of interest. Money managers including Capital Group, David Einhorn’s Greenlight Capital Inc. and Bill Ackman’s Pershing Square Capital Management LP are shareholders.
Brennan declined to say whether Vanguard, the Valley Forge, Pennsylvania-based firm that pioneered the index mutual fund in the 1970s, routes trades through IEX.
“If a venue is a good one for us to trade in, we would absolutely use it,” he said. “If a particular market participant improved market structure, we would welcome it.”
Capital Group, whose American Funds unit runs the $142 billion Growth Fund of America and is the third-biggest U.S. mutual fund family, uses IEX for some trades and helped start the company by investing the firm’s own capital in it.
“If in the modern market structure you see a better way to do things, you do it,” Chuck Freadhoff, a spokesman for the Los Angleles-based firm, said in an interview. He declined to say what portion of Capital Group trades are directed through IEX.
Scott Glasser, co-chief investment officer at ClearBridge Investments, said in an online commentary his firm doesn’t try to compete in “millisecond-sensitive trading activity.”
“We look to take advantage of price dislocation due to high-frequency trading where we can, and take steps to try and protect our clients’ assets from predatory trading activity where necessary,” Glasser wrote in an April 1 note posted on the firm’s website.
ClearBridge, with about $90 billion in assets, is the largest stock investing unit of Baltimore-based Legg Mason Inc.
The new exchange’s success hinges on investors persuading their Wall Street intermediaries -- brokerages such as Goldman Sachs Group Inc. and Morgan Stanley -- to send their stock orders to IEX. For its part, Goldman Sachs endorsed it in a memo to employees last month and is the biggest broker on the platform, according to IEX.
Capital Group’s Freadhoff and Vanguard’s Brennan said their firms hadn’t experienced difficulty in having trades routed through preferred venues when they make such a request.
“If we ever gave a broker instructions to route somewhere or to trade or not trade through someone, and we do that, it would be a big deal if the broker did not honor that request,” Brennan said.
Freadhoff said Capital Group doesn’t entirely side with Lewis in the debate his book has spawned.
“We believe he’s raised some interesting questions, but wouldn’t make them in quite the provocative way he has,” he said.
Vanguard’s Brennan agreed, saying the majority of high-frequency traders “play within the rules” and help “knit together” trading across multiple stock exchanges by seizing on small price differences to make a profit.
Vanguard, in a letter to the U.S. Securities and Exchange Commission in 2010, estimated that high-frequency traders had helped to reduce transaction costs in the previous 10 years by 1 percentage point for every “round-trip” transaction, which includes a buy and sell.
On a $10,000 investment over 30 years, the difference between a 9 percent annual return and an 8 percent annual return is about $32,000, according to the Vanguard letter.