Respect for markets and judging High Frequency Trading
A report card from AQR’s tenth anniversary seminar in Sydney covering two of the presentations. One on market respect and strategy, the other in defence of High Frequency Trading and the role it plays.
AQR Capital Management marked its tenth year of operations in Australia with a series of thought-provoking presentations in June. Over the ten years, Australia and New Zealand have grown to become AQR’s largest client base outside of the US, representing nearly one sixth of the firm’s total assets under management. Among the presenters were two of AQR’s principals, David Kabiller who spoke on what makes a good investment strategy and Michael Mendelson on the misconceptions of High Frequency Trading (HFT).
Long term optimism and short term paranoia
Kabiller, who heads up Client Strategies for AQR, oversees client relationships, business development and strategic initiatives. In his presentation, Kabiller said that “long term optimism and short term paranoia” is a core element of a good investment strategy. He discussed AQR’s development and the lessons from his experience that he brings to investors.
According to Kabiller a ‘depression era mentality’ and a respect for markets and competition are things that inform a sound investment strategy. Investors must have the discipline to follow their chosen path while having the humility to adapt. He also spoke of AQR’s desire and curiosity to understand markets.
AQR has itself experienced a short-term crisis while working towards a long term goal. Founded in 1998 during the tech bubble, AQR saw their portfolio lose nearly 40% from 1998 to 2000 before rebounding with 79% growth until 2001. Kabiller said that the lesson to be taken from this volatile period is to maintain a great respect for markets and competition.
In his presentation Kabiller also touched on diversification and its importance in today’s market. He referred to a “very big retirement problem in the world”, suggesting that too many people still have undiversified investment strategies. He believes that people should have a respect for the market in aggregate and work to have a better understanding of risk and return sources.
Kabiller suggests that an allocation to hedge funds is necessary for diversification as they are not as reliant on economic health as other traditional assets. He did, however, warn investors to be wary of hedge fund managers using leveraged strategies with high beta as these funds have a greater risk of being at the mercy of a falling market.
High Frequency Trading shouldn’t cause panic
Michael Mendelson showed his support for High Frequency Trading (HFT) while speaking at AQR’s seminar.
Mendelson said that markets have been under more criticism than ever before but defended HFT for the liquidity it brings to the market. He believes that the technology used by high frequency traders and the nature of their strategies have lowered transaction costs for investors and been largely beneficial.
Mendelson addressed the misconceptions of HFT, stating that high frequency trading is a strategy and not low latency technology. Furthermore, he made a point to mention that quantitative and algorithmic trading is not high frequency trading.
In reference to Michael Lewis’ new book ‘Flash Boys’ which has recently brought some negative media attention to high frequency traders, Mendelson states that the claims made by Lewis about the profits of high frequency traders are greatly exaggerated and that the reality is a US$1.1bn annual profit for the industry as a whole.
Mendelson condemned what he called the ‘salacious criticism of markets’ and said that the negative publicity directed at high frequency traders has largely stemmed from people who have had their business model disrupted.
When asked about how investors can be certain that high frequency traders aren’t accessing information on the way to the exchange Mendelson responded, “it would be illegal” and he would find it hard to believe that traders who wanted to remain in the market would risk it.
Mendelson did point out however that investors don’t live in a market that is free of problems. For investors who wanted reassurance from their fund managers, he suggested that they ask managers what they are doing to protect themselves from systems risk and to ensure that they understand the markets they are trading in.
While concluding, Mendelson urged people to resist any proposals by governments, regulators or exchanges to introduce transaction taxes as these would be detrimental to investors worldwide. As well as simultaneously taxing banks and hurting high frequency traders, they are ultimately a tax on all investors.
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