Computerized trading is once again headline news as U.S. regulators examine how the use of technology can provide unfair advantages. Considering that computerized trading has also been blamed for gut-wrenching “flash crashes,” one may wonder: Have we created a monster? Our answer is no. Tech advances are on balance a very good thing for long-term investors such as ourselves.
Real-time data at the granular level – and lots of it – is a major plus for long-term investors. LNWM is constantly researching investment managers to find the best fit for our clients’ portfolios. So access to more data in real time allows us to dig deeper and faster. And because we spend less time getting and processing data, we can focus more on what that data is telling us.
Technology also lets us communicate more quickly and expansively with our clients, especially during bouts of rising market volatility.
There is little doubt that day-to-day volatility has increased. And we suspect that much of this has to do with computerized trading. Currently, HFT (high-frequency trading) comprises about half of daily stock-trading volume — up from just 10% in 2000. HFT firms use super-fast computers and proprietary algorithms to skim a profit from the spread between buy and sell prices, regardless of market direction.
According to a Vanguard study released in 2012, daily stock-market volatility (as measured by standard deviation in the S&P 500) has increased since 2000. From 2000 through 2011, daily volatility was 1.4%, up from 1.1% for most of the previous century (1929 through 1999). This may not seem like a lot. But it is a 27% increase.
However, stock-market volatility does not seem to have risen on a longer-term basis. In the same study referenced above, Vanguard shows that on a monthly, quarterly and annual basis, stock-market volatility is down or flat since 2000, compared to historical levels. Instead of being distracted by the daily market swings, we think it makes more sense than ever to stay well-diversified, value-oriented and focused on the long term.
Eyes on the Prize
Technology has made risk management even more important. In the new world of more information (and misinformation), more investment options and higher short-term volatility, astute risk management is crucial. There is lots more advice and data out there, but there is often very little focus on the downside, when things start to veer away from expectations, both in regard to the markets and in an investor’s personal situation.
At LNWN, technology has allowed us to expand and fine-tune our risk measurement and management process, so we can provide clients with a more well-rounded view of the risks involved and ways to potentially offset those risks.
As the 2008 crisis showed, stocks and most types of bonds can lose value at the same time. So true diversification may now entail a more expansive list of investment options, including alternative assets.
Portfolio risk calibration also means weighing the entire gamut of risks – not just volatility but worst-case scenarios (episodic risk), as well as the risk that a portfolio will not generate the income a client expects. Risk management should be multi-faceted, ongoing and interactive, taking into account each client’s changing needs and concerns.
Ye olde tax and legal system. While technology has revolutionized the world of finance and investments, it hasn’t done much yet for the framework in which we invest — the tax and legal systems. In fact, it seems these systems have become more complex and difficult to maneuver in recent years.
Changes to tax and estate-planning structures can take a bite out of investment gains over time. So tax and estate planning continues to be a big part of our risk-management process here at LNWM.
Another aspect of risk-management in the tech age is keeping client information safe and secure. In a future blog post, LNWM’s Director of Technology Bill Frizzell will address how we do that.
We look forward to what technology has in store for us. In the meantime, we’ll continue to do our best here at LNWM to make sure we’re leveraging technology to give clients the best possible experience.