Last week, I came across a story involving Wall Street, helicopters and the business of collecting and selling private data. It sounds like the perfect setup for an article in The Onion, but it’s true and a perfect example of Wall Street’s obsession with the speed of information.
A firm specializing in nonpublic data collection and analysis hired a helicopter to fly over oil storage tanks. Using a heat-sensitive camera, the helicopter recorded tank levels. The goal? Get an early estimate of oil stocks on hand in the United States before the official numbers were released.
This kind of data is like catnip to traders who deal in oil, but it doesn’t come cheap. The oil report costs $90,000 a year.
Despite the big price tag, we keep seeing more stories about how Wall Street firms and traders keep trying to one-up one another. The result seems to be bigger and bigger trades and bigger and bigger paydays for the people who use this information and happen to end up on the right side of a trade. And it doesn’t stop with data.
Today, trading firms pay for the privilege of placing their servers in the same building as stock exchange servers so trades can happen in milliseconds. As Jerry Adler wrote for Wired in 2012, To “make things fair, engineers scrupulously add extra lengths of cable to equalize the runs among all the servers. Yes, we are talking about a few feet plus or minus. At nearly the speed of light.”
This sounds insane to the average investor, particularly when we put it in the context of our investing experience. Most of us are focused on making sure food gets on the table, keeping a roof over our heads, putting a little toward college and maybe saving enough to retire before we turn 70.
The trading game is clearly rigged, but what we should care about — investing — isn’t. When we’re talking about Wall Street firms, we’re usually talking about traders. Traders by profession are much more interested in moving money around and finding ways to extract some in the process.
Average investors, on the other hand, have specific goals that they’re saving for in the long term. In fact, I think the explanation for Wall Street’s focus on speed comes down to something really simple: time.
Wall Street changes its mind (trades) every millisecond. Investors (in theory) change their portfolios as life changes over the years. Wall Street focuses on quarterly earnings. Investors focus on retiring in 30 years. It’s the ultimate short-term versus long-term strategy, and speed matters in the short term, but not so much in the long term.
We’re talking about two completely different universes. Traders care about trades measured in milliseconds and servers separated by a few feet. Investors care (or should, anyway) about our goals and values. Those two perspectives will rarely align because again, it’s about short term versus long term.
However, I understand how tempting it is to think we ought to play the trading version of the game.
After all, there’s a lot of money on the table, right? But we already have access to what these firms are doing in the form of hedge funds or “alternative” mutual funds, and they haven’t exactly been a game changer for most individual investors. For the fifth year in a row, hedge funds on average have trailed the Standard & Poor’s 500-stock index, this year by a wide margin — 8.31 percent returns compared with the S.&P.’s 29.1 percent through November.
At Research Puzzle Pix, Tom Brakke highlighted a great example of one such fund that sounds like an excellent investment on paper: the J.P. Morgan Market Neutral Fund. It “seeks to provide long-term capital appreciation from a broadly diversified portfolio of U.S. stocks while neutralizing the general risks associated with stock market investing.”
Unfortunately, the fund’s negative performance since 2010 (it didn’t even beat cash) seems to imply it’s falling somewhat short of expectations. Add the crazy fees on top of poor performance and it’s easy to see why we think individual investors are at a disadvantage.
Forget about hedge funds for a minute. Even most mutual funds disappoint, with almost 80 percent of them underperforming their index each year. But being hypercompetitive Americans, we don’t want to accept average. We work hard, so it shouldn’t be a stretch to find the 20 percent that will outperform.
Maybe it’s worth renting a helicopter after all!
Look, if your goal is to be a trader trying to play in the big leagues, then yes, you might be at a disadvantage if you’re competing against people who have more or faster information. But if your goal is to be an investor, then we already have the data that shows us how we win: Build a low-cost, diversified portfolio and hold on to it for a long time.
In the meantime, it’s helpful to remember that for all the supposed benefits of this data and technology arms race, there are still some pretty big what-ifs and even outright disasters that have resulted from Wall Street’s desire to act faster than the speed of light:
■ Knight Capital Group In 2012, this financial firm experienced every trader’s worst nightmare. A trading program went rogue and started making trade orders that cost Knight almost $10 million a minute. Even after employees saw the problem, it took 45 minutes to find the kill switch and shut down the trades. The firm ended up losing $440 million.
■ “Flash crash” In 2010, investors watched as almost $1 trillion in shareholder value disappeared from the market in 20 minutes. How? Automated trading. A series of events set off a response from certain programs. As a result, the market saw over double the average number of shares traded in a single day and 1.3 billion shares traded in 10 minutes.
■ BATS I.P.O. In 2011, BATS Global markets, an exchange in Lenexa, Kan., set up its own I.P.O. But when trading started, a bug froze the system. In a chain reaction, it took down another server that processed trades for ticker symbols with letters at the beginning of the alphabet. But as Mr. Adler at Wired wrote, one exchange, the Nasdaq, continued to quote the BATS stock, “and something strange was happening there as well. In 900 milliseconds, too fast for anyone to react, the stock plummeted from its $15.25 opening price to $0.28, reaching a fraction of a cent before trading was halted.”
A low-cost, diversified portfolio isn’t a strategy that will make big headlines, and it most definitely won’t help financial executives max out their annual bonuses. However, it will help you reach your investment goals, and it’s unlikely that a computer problem will wipe out your entire portfolio in a minute. I think those are results that most of us can live with.
This commentary appeared December 23 on NYTimes.com.
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