Asset owners, fund houses and distributors globally, including in Asia, have raised concerns that high-frequency trading (HFT) is eroding market efficiency and integrity, according to a new survey. It concludes they are changing their investment behaviour as a result of a loss in confidence.
A number of respondents to the survey, carried out by independent think-tank Create-Research, believe equity markets are stacked in favour of HFT firms. High on their list of concerns is the proliferation of dark pools, which the US' Financial Industry Regulatory Authority (Finra) is probing.
The respondents say such alternative trading venues have evolved from being used by buyside firms to trade large blocks undetected by HFT players to drain liquidity from lit exchanges.
“Worst of all, by concealing their trades, they [high-frequency traders and dark pools] hinder price discovery by ensuring that the latest information implicit in the trades is not incorporated into prices in real time,” a report into the survey findings says.
In all, 51% of institutional respondents said the erosion of market efficiency was denting their confidence, and bringing into question notions of risk premium, mean reversion and diversification.
“For long the bedrock of investing, the buy-and-hold culture is weakening as investors are obliged to adopt shorter horizons,” the report finds. “Investing is fusing with trading."
One in four respondents reported they had adopted shorter investment horizons; now factored in higher volatility; seen buy-and-hold investing weakening; argued that the benefits of diversification had been diluted; and thought broader market momentum trading had increased.
The report's author argues that regulations allowing HFT and dark pools, along with the Volcker Rule curtailing proprietary trading by banks, have had unintended market consequences, with the decoupling of equity markets from the real economy having given rise to new sources of capital outside traditional markets, such as mezzanine finance.
The report concludes that investors are increasingly doubtful that stock markets can deliver value in the long run. Big US asset managers are mulling the creation of a joint trading platform to mitigate the perceived negative effects of HFT, the report notes.
It wraps up its findings with a call from institutional investors for regulators to tackle abuses, particularly concerning HFT.
The survey, entitled Investing in a High-Frequency Trading Environment: Hurdles to Market Efficiency, was sponsored by US fund manager Principal Global Investors. It quizzed 704 pension plans, sovereign wealth funds, insurers, asset managers and fund distributors in 30 counties.
Institutional investors comprised 68 participants, collectively managing $5.9 trillion. Of these, 17 were domiciled in Australia, Japan, China, Singapore and Hong Kong.