I’m thrilled that we were able to get Charley Ellis to come speak at our upcoming Evidence-Based Investing Conference. Ellis is a legend in the field of both individual and institutional investing. I’m currently working my way through his new book, The Index Revolution: Why Investors Should Join It Now.
The book is something of a personal account of Ellis’s time in the investment management industry and how things have changed since he got his start. One of the most eye-opening passages in the book provides a brief account of the changes the industry and markets have experienced over the past 50 years:
- Trading volume of New York Stock Exchange listed stocks increased from 3 million a day to 5 billion, a change in volume of over 1,500 times.
- The dollar value of trading in derivatives rose from zero to more than the value of the “cash market.”
- The investors executing this surging volume of trading have changed profoundly. Individual amateur investors did over 90 percent of all New York Stock Exchange (NYSE) trading 50 years ago. They may have read an article in Forbes, Barron’s, Business Week, or a newspaper or taken advice from their busy broker, but they were market outsiders. They were not regular traders. They averaged less than one trade in a year, and almost half their purchases were AT& T common stock, then the most widely owned U.S. stock.
- Fifty years later, the share of trading by individuals has been overwhelmed by institutional and high-speed machine trading to over 98 percent. Today, the 50 most active (and ruthless) professionals— half of them hedge funds— do 50 percent of all NYSE listed stock trading, and the smallest of these 50 giants spends $100 million annually in fees and commissions buying information services from the global securities industry. These institutions are all market insiders who get the “first call”— and they know what to do with new information.
- Investment research from major securities firms in all the major markets around the world, produced by expert analysts of companies and industries, economists, political analysts, demographers, and geologists, amounts to an enormous volume of useful information. It is distributed almost instantly via the Internet to hundreds of thousands of analysts and portfolio managers who work in fast-response decision-making organizations worldwide.
- Competitors of all sorts and sizes all over the world operate out of vast trading rooms dominated by many large computer screens displaying multiple instantaneous data feeds processed by commercial and proprietary computer programs.
- Bloomberg machines, unheard of 50 years ago, now number over 320,000 and spew unlimited market and economic data virtually 24 hours a day.
- The population of CFAs (Chartered Financial Analysts) has gone from zero 50 years ago to 135,000, with over 200,000 more in the queue studying for the tough annual exams where pass rates are less than 60 percent.
- Algorithmic trading, computer models, and corps of inventive “quants” (quantitative analysts) were unheard of years ago. Today, they are major market participants.
- The Internet, e-mail, and blast faxes have created a revolution in global communications: instantaneous, worldwide, and accessible 24/ 7. We really are all in this together.
- National securities markets, once isolated, are increasingly integrated into one nearly seamless global megamarket operating around the clock and around the world. And this megamarket is increasingly integrating with and transforming bond markets and currency markets as well as the major markets for such commodities as oil, gold, and wheat.
- Regulations have changed to ensure simultaneous disclosure to all investors of all potentially important investment information. Since 2000 in the United States, the Securities and Exchange Commission’s Regulation FD (Fair Disclosure) has required that any significant corporate information be made simultaneously available to all investors. (Years ago, such information— when proprietary— was central to successful active investing.) Regulation FD is a game “changer” that has effectively commoditized investment information from corporations.
- Hedge funds, acquisitive corporations, activist investors, and private equity funds have all— with different perspectives and different objectives— become major participants in price discovery in today’s securities markets, now the world’s largest and most active prediction market.
Ellis says that all of this activity and complexity, “diverts our attention from the profoundly important long-term investment policy decisions on which all investors should concentrate their time, energy, and thought.”
But I also think investors don’t spend enough time thinking about the changes we’ve seen in the market structure over the decades. There is an insane amount of competition in the markets these days that simple did not exist in the past. This point cannot be stressed enough to investors who don’t understand market history.
Because of the increase in computing power and data storage you see investors or firms using backtests or market data going back 50 or 100 years with complete certainty. There’s nothing wrong with using historical data (I do it all the time), but you have to provide context around the past. Investors didn’t have the same firepower back then as we do today. They didn’t know all of the things we know today. If investors had access to the same data we now all take for granted their perceptions of the markets would have been altered and the outcomes may have been much different.
I can’t even imagine what things will be like 50 years from now. I’m sure investors will look back at today’s markets and consider much of what we do antiquated.
Investors are always telling themselves, “Here’s how I would have handled the markets in the past.”
What they should be focusing is on, “Here’s how I will handle the markets in the future.”
Trading Costs & The New Market Averages