wasn't sure where to put this, but in general my question is this - does the proliferation of most daily volume being HFT, passive, and quant have a meaningful impact on traditional buy & hold?
I know that pennies and fractions of pennies matter greatly if you're RenTech, and that's not a game I'm trying to play, so I'm simply asking if because of the presence of so much HFT (legal front running in some sense) has a material impact on LO guys longer term?
mathematically I can't seem to get myself to worry about it because if I buy TJX and it's a 10 bagger, the extra pennies per share back in 2014 percentage wise don't amount to much of a difference (CAGR will be lower by fractions of a percent), but I wonder if I'm missing something
The proliferation of HFT, passive investing, and quant strategies has undoubtedly reshaped market dynamics, but traditional long-only (LO) buy-and-hold strategies still have a place and can function effectively. Here's a breakdown based on the most insightful WSO content:
Impact of HFT on LO Strategies:
High-frequency trading (HFT) primarily impacts short-term market participants by exploiting inefficiencies in microseconds. For LO investors, who focus on multi-year horizons, the impact of HFT is minimal. As you mentioned, the fractions of pennies HFT might skim off during execution are negligible when you're holding a stock for years and aiming for significant returns (e.g., a 10-bagger like TJX). The key is to focus on the bigger picture—fundamentals, valuation, and long-term growth prospects.
Passive and Quant Investing:
The rise of passive and quant strategies has led to increased market efficiency, particularly in large-cap, highly liquid names. This can make it harder for LO investors to find mispriced opportunities in these areas. However, it also creates opportunities in less-covered, smaller-cap stocks or niche sectors where passive and quant strategies are less dominant. As noted in WSO threads, value often lies in areas ignored by the "herd."
Market Functionality for LO Investors:
Markets still function well for LO investors, but the game has evolved. The presence of HFT and passive flows can create short-term volatility, which disciplined LO investors can exploit. For example, passive flows might cause temporary mispricings in individual stocks, presenting buying opportunities for those with a long-term view.
Execution Considerations:
While HFT might not materially impact long-term returns, LO investors should still be mindful of execution costs. Using limit orders, trading during less volatile periods, and working with brokers who minimize market impact can help mitigate any potential disadvantages.
The Bigger Picture:
As you correctly pointed out, the CAGR impact of HFT or minor execution inefficiencies is minimal over the long term. The real challenge for LO investors lies in maintaining discipline, adapting to changing market conditions, and finding differentiated insights in an increasingly efficient market.
In summary, while the market landscape has changed, traditional buy-and-hold strategies remain viable. The key is to focus on areas where you can still find an edge, such as under-researched stocks or sectors, and to stay disciplined in your investment approach.
Sources: Associate positions at AMs will die off at an accelerated rate, How does LT investing work?, Random Thoughts on the HF Industry, Will robots replace your consulting or financial career?, Q&A: I'm the head trader for a Multi-strat HF
No, LOs are underperforming just fine in this regime just as they were in the old one.
Still better to clip a low-risk $3ml TC annually as a PM at a LO working 40hrs per week than blowing up every 1-2yrs at a MM HF working 70hrs per week. I don't know a single LO who blew up from Independence Day momentum unwind but MM HF pods were blowing up left and right
For boutique single managers, whether long-only or long-short, there are plenty of opportunities, dare I say it maybe even more opportunities than there used to be (although to be honest I haven't been around long enough to tell). For LOs with hundreds of billions under management, I suspect life is more challenging.
The US market is aggressive, quick to react to news. But stock moves are exaggerated, there is intense crowding (whether by pods or quant or retail or whomever), and the catalysts that move stocks are (at least for certain names I look at) sometimes different from what I think drives long term value and shareholder returns.
There are certain companies with very close comparables in the international market (i.e. near identical earnings drivers) where the stock behavior is apples to oranges. That provides opportunity. This is not to say it's easy to beat, certainly not, only that I am finding plenty of opportunities.
So there’s more opportunity internationally than in the US? What about in terms of size? Do you think there’s more opportunity in smidcap/microcap than large?
I can see why the latter would give boutique firms more opportunity, but it seems to me like large firms would be just as good at finding international opportunities. Can you explain?
Thanks!!
I didn't say there is more opportunity internationally than in the US. I don't know if that is true. In the case I'm thinking of where the US stock(s) and international stock(s) behavior are apples to oranges, it's the US names that get most of misaligned.
Perhaps there are more opportunities in small & mid cap stocks, it would be logical. But keep in mind you're more valuable as an analyst/PM if you can pick the big stocks because you can put meaningful capital to work. You don't want your only edge to be that you're an expert in a $300m market cap company that nobody else cares about.
If you naiively think of the specific inefficiencies any investment strategy attempts to capitalize on as being characterized by 1. the timescale of such inefficiency 2. the scale in $ of the inefficiency, then, assuming one exists in the LO space, the targeted timescale and $ scale of any inefficiencies in HFTs, or lower frequency quantitative strategies are pretty different from traditional LOs. So, opportunities are still there unless your opportunity is something like buy when cash flows are positive and sell when they're negative, something simple like that is better captured by quant funds so you will lose against them.
I run a long only strategy on my PA, there is definitely opportunity and have done quite well.
The problem with the LO industry is less market structure (I would argue there is a whitespace for these kind of strategies right now) and the issue lies with the business model. With a focus on management fees and tax locked capital, the incentive structure lends itself to asset gathering rather than performance. Almost by definition, anyone good is going to be pushed into managing more money than they have capacity to handle and ultimately underperforms (but still gets rich off fixed fees / clients who can't leave without paying a tax bill). As Charlie Munger said "show me the incentive and I'll show you the outcome".
In my view a lot of MM outperformance over both SMs and LOs comes from much better incentive alignment between managers and LPs as opposed to something inherent shifting about the profitability of short term vs. long term investing. Of course, it is often easier to create incentive alignment with short term strategies...
Best comment on the issue I've read.
Makes sense to me.
With the more intense competition for AUM that passive funds, alts, and L/S and other HF strategies, do you think LO will be forced to improve incentives in order to improve performance and avoid bleeding out AUM? Or do they have enough of a lockin effect that you think that won't materially happen over the next, say, 20-40 years?
Also, what about tax-aware strategies? I'd imagine tax-loss harvesting in SMAs could provide a pretty big value-add, though obviously that adds a lot of layers of complexity and is probably only economical for clients of very large AUM. Do you think that will rise in popularity?
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