Vanguard, Schwab take different approaches to HFT

Divergent views of the two cost-conscious investment firms illustrate the contentious nature of debate over high-frequency trading

Apr 7, 2014 @ 1:24 pm

By Trevor Hunnicutt

high frequency trading, vanguard, charles schwab, michael lews, hft, trading, equities, stocks
+ Zoom
Author Michael Lewis: Are markets rigged or not? (Bloomberg News)

Two providers of some of the cheapest exchange-traded funds on the market are striking a different tone on the impact of high-frequency trading.

In a letter last week, The Charles Schwab Corp. chairman Charles Schwab and president Walter Bettinger II sounded off aggressively against traders who they said profit by using faster access to data and exchanges to gain advantage over retail investors.

“High-frequency trading undermines that integrity and causes the market to lose credibility and investors to lose trust,” they wrote. “This hurts our economy and country. It is time to treat the cancer aggressively.”

Meanwhile, The Vanguard Group Inc., which says it does not engage in the practice, has been more conciliatory. While the firm said “some” traders may be “unfairly taxing the system,” they chose more sanguine language to describe the impact of most traders.

“We believe the majority of 'high-frequency traders' play within the rules governing our current equity markets,” the firm said in a statement. “We believe a majority of 'high-frequency traders,' which is not a defined term, add value to our current structure by 'knitting' together today's fragmented market centers.”

The divergent tone of the two famously cost-conscious investment firms illustrate the contentious nature of the technical and political debate over high-frequency trading, which describes a range of trading practices driven by computer algorithms.

Some financial advisers expressed concern about the impact on investors of high-frequency trading in the aftermath of the release of a book called "Flash Boys: A Wall Street Revolt" (W. W. Norton & Co., 2014), whose author, Michael Lewis, takes a critical view of the practice.

In the case of Schwab and Vanguard, the practice has important ramifications on the various areas of its business, including the execution quality achieved by its fund managers, the quality of the market for its ETFs and, for Schwab, the execution quality achieved by investors on its brokerage platform, according to market experts.

“Even within those firms, I'd imagine it depends who you speak with [as to what opinion they might have on high-frequency trading],” said Kevin McPartland, principal for market structure and technology at Greenwich Associates, a consulting firm.

In an interview, Joseph Brennan of the Vanguard’s equity index unit, said regulators should revisit market rules in light of a fragmented market that consists of public exchanges and “dark pools” in which institutional traders also execute trades. He said regulation and technology have helped to bring “down the cost of trading for all investors."

In 2010, Vanguard moved to explain to advisers a large market drop May 6, called the flash crash, when prices dove and markets in ETFs unraveled, only to rebound within minutes.

High-frequency traders are often blamed for the disappearance of liquidity during that crash. But at the time, Vanguard wholesalers told advisers to be cautious in assigning blame.

Meanwhile, discount brokerages, including Schwab, have come under scrutiny for a practice called payment for order flow, in which they sell their customers' orders to high-frequency traders. Schwab declined to comment.

Many analysts think the jury is out on the calculus of how the trading strategies ultimately affect mom-and-pop investors.

“Let's say you're a long-only asset manager whose job it is to frequently buy relatively large blocks of stocks … It's a lot harder to do that now than it was 10 or 15 years ago and the electronification of the market is a big part of that. It can be easily argued that these types of trading strategies have encouraged a smaller average trade size,” Mr. McPartland said. “On the flip side, I think a huge part of why you and I and retail investors can trade only for $7 a share is because of this liquidity in the market.”

0
Comments

What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Apr 30

Conference

Retirement Income Summit

Join InvestmentNews at the 12th annual Retirement Income Summit - the industry's premier retirement planning conference.Much has changed - and much remains to be learned. Attend and discuss how the future is full of opportunity for ... Learn more

Featured video

Events

Adviser marketing: 3 strategies for success

To help advisers sift through the noise and execute a marketing plan that will deliver the most ROI, three executives from Carson Group sit down with Shannon Rosic to deliver some strategies you can implement today.

Video Spotlight

The Search for Income

Sponsored by PGIM Investments

Recommended Video

Path to growth

Latest news & opinion

T. Rowe Price steps up its game to serve financial advisers

The Baltimore-based mutual fund giant is more aggressively targeting financial advisers with a beefed-up wholesale crew and placement on custodial platforms.

The most important tax changes for 2018

The Internal Revenue Service issued inflation adjustments to more than 50 tax provisions for 2018.

Shift to Roth 401(k)s 'highly likely' part of tax reform: former Treasury official Mark Iwry

Mandated contributions to Roth accounts would likely only be partial, as opposed to having a full repeal of pre-tax accounts.

E*Trade acquiring custodian Trust Company of America

Discount broker buying second-tier custodian for $275 million.

Another thousand Dow points higher, and investors yawn

Market milestones keep falling like dominoes, with 51 records broken so far this year.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print