Thursday, 8 March 2007

Investors are increasingly short-termist - WSJ article

Thanks to Peter C for pointing this one out to me!

It's an increasingly common complaint from companies that may shareholders aren't interested in the long term. This is often directed at hedge funds (who sometimes don't even appear on the share register). As many people, such as Warren Buffet (see 2005 letter to shareholders), have pointed out, increased trading is mainly just an extra cost for investors. That messsage doesn't seem to be getting through though...

Wrong Way?
Street Signs
Point to Speed
Wall Street Journal
February 26, 2007; Page C1
Investors are trading so quickly they may not see the risks in the market for the speed.
In the stock market, the idea of holding on to an investment for the long term doesn't seem to hold much allure any more. According to Sanford C. Bernstein chief investment officer Vadim Zlotnikov, the average holding period for stocks on the New York Stock Exchange and American Stock Exchange last year was less than seven months. In 1999 -- stereotyped as a time of rapid-fire day trading -- the average holding period was more than a year.

In fact, the last time stocks were being held for as short a period as they are now was 1929, when students of history may recall something happened to the market.

Mr. Zlotnikov's analysis doesn't include the increasingly popular, and complex, derivative strategies that investors use to gain exposure to stocks without actually holding shares. On the Chicago Board Options Exchange, for example, the trading volume on individual stock options was 40% higher last year than it was in 2005.

Technology has a lot to do with the increase in turnover. Increased computing power means strategies that 10 years ago existed only in theoreticians' notebooks now can be put into everyday use. Lower trading costs and the 2001 switch to decimalization -- the pricing of stocks in dollars and cents rather than dollars and fractions -- have let investors profit from price anomalies that used to be too expensive to exploit.

Also driving the increase: the rising prominence of hedge funds. Because they tend to be judged by each year's performance, few professional fund managers have the luxury to ignore short-term price swings and invest for the long haul. Losing your job and then having history prove your investing acumen right is nobody's idea of fun. For hedge-fund managers, the short-term performance pressures can be intense -- first, because the high fees they charge make their investors intolerant of losses, second because some of the trading strategies they use mean the losses they face if a position goes wrong can be steep.

The result is a constant trading in and out of positions to capture returns. In today's marketspeak, hedge funds are emphatically working to "generate short-term alpha." What it boils down to is the age-old practice of stop-loss trading -- automatically buying and selling stocks when they rise or fall to specified levels.

Despite all the moving in and out of stocks, stock-price movements have been remarkably quiescent. Stock market volatility -- as measured by actual price movements, rather than the options price-generated "implied" volatility measured by CBOE's market volatility index -- is at its lowest level in 10 years. (Implied volatility is near a decade low.) It may be that the combined effect of all the sophisticated trading strategies in place today have put the stock market into a state of dynamic tension, where all the tugging and pulling effectively cancels each other out, muffling price movements.

At the same time, investors' intolerance of short-term losses could mean that if the stock market seriously stumbles, the droves of fund managers engaging in stop-loss selling could overwhelm the market. When volatility comes back, it could do it in a grand fashion.

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