Ned Johnson III, the former CEO of Fidelity Investments is back in the news with another great idea. He has launched something called Luminex which is a private trading platform that currently has just nine club members. You have to be managing at least a billion dollars to become a member. Its purpose is to thwart the high-frequency traders that have become a scourge in the market costing regular investors like you and me as much as 3 percent per year.
At the risk of sounding like a “name dropper,” I can’t resist pointing out that I was a guest at Johnson’s home in Maine about four summers ago, and when introduced to my host, I never made the connection that he was THE Ned Johnson. It happened to be a small dinner at a tasteful home for graduates of Garrison Forest, a women’s high school my wife had attended. Graduates who happened to be in Maine at the time were invited. Johnson was totally unpretentious as he dashed around trying to be the perfect host for a group of mostly female guests. Until someone pointed it out just recently, it never occurred to me that this was the same person who had been running what, at the time, was the world’s largest mutual fund organization.
Meanwhile, Luminex is a facility that will allow large blocks of securities to trade between major financial organizations on a platform that will bar any high-frequency traders. In past columns, starting as early as August 2012, I have pointed out the extent to which high-frequency trading is an impediment to our mutual fund managers who are trying to purchase or sell large blocks of stock.
The Michael Lewis book, “Flash Boys” spelled out in numbing detail how the game is played. It stems from the emergence of new electronic stock markets beyond the familiar New York, American, and Nasdaq exchanges. Now, over 30 new computerized exchanges trade stocks in milliseconds and these trades make up the vast majority of all stock trading today. The advantage for those who practice high-frequency trading is the ability to trade ahead of the major institutions like the mutual funds that service the rest of us. It costs our managers more to buy, and they get to sell for less, than would have been the case more than five years ago before this phenomenon reached full bloom.
Rapid-trading firms using artificial intelligence to trade massive amounts of stock create two problems for the rest of us. The 100 million of us that have $6 trillion in 401(k)s and IRAs invest through large mutual funds. Artificial intelligence (AI) manages to sniff the scent of when one of our funds is beginning to buy a position in a company, and they (the AI computers) start buying. This sets in motion a shark feeding frenzy that gets in the way of our mutual fund managers trying to gain a position at a reasonable price. For 80 years this has been known as “front-running” and it has been illegal for anyone in the brokerage industry who otherwise would have taken unfair advantage of customers.
What does it cost us? Well, one hedge fund manager quoted in the book claimed that he was losing 3 percent per year as a consequence. An estimate of what HFTs make overall is somewhere in the neighborhood of $22 billion per year, which would mean about one quarter of 1 percent of the total $17 trillion in U. S. equity assets. These traders take no risk and, in one publicized case, they make the claim that they never have a day in which they lose money.
Why our elected representatives and regulatory authorities allow this to happen is a question that has been asked repeatedly since about 2009. The answer, as presented in the Lewis book, is that over 200 staffers of the Securities and Exchange Commission since 2007 have left to go to work for high-frequency trading firms.
Early in my career of operating retirement plans, I recall seeing a picture of Johnson. It was in Fortune magazine some 30 years ago, and he was standing beside four huge diesel generators in the basement of Fidelity’s Boston headquarters. They were there to provide backup power to protect the computerized data base of customer accounts — which totaled about 13 billion dollars at the time. Today, with his company responsible for over a trillion dollars, Johnson is back in the saddle in a commendable effort to protect us against predators. He will undoubtedly succeed where our elected officials and bureaucrats have failed.