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Things are changing the way CEOs and CFOs have to deal with the Street. While everyone is focusing on GAAP vs. non-GAAP and Blackstone’s letter on short termism, the market participants are changing significantly. What’s more, stocks are trading in more volatile, and sometimes inexplicable, ways.

Three major shifts in forces impacting the markets:

  1. Stocks are increasingly being held by more passive, and therefore less influence-able institutions. A new report by Broadridge Financial Solutions notes the ongoing switch from active to passive funds. During the first half of 2016, net new assets for passively-managed ETF funds increased by $37 billion, or 14 percent, while investments at actively managed funds were down by $24 billion, or about 1 percent. The trend accelerated in the second quarter of 2016.
  2. Quant Funds (not ETFs) are now the fastest growing hedge funds on the Street. Two of the fastest growing hedge funds are Two Sigma (managing $35 billion) and Renaissance Technologies (managing $65 billion). They have been consistently posting solid returns. In recent years, most other hedge fund strategies, which are centered around the trading decisions of human beings, have struggled mightily to deliver above market returns. Well respected hedge fund leader of PDT Partners, Pete Muller said, “Eventually the time will come that no human investment manager will be able to beat the computer.” Apparently Paul Tudor Junes agrees – his firm has just reduced its workforce by 15 percent and is making a sweeping organizational change that will emphasize more technologically driven and big-data trading approaches.
  3. Alpha is more likely to come from speed of trade execution, not fundamental analysis. The Wall Street Journal reported that a handful of financial technology startups are arming many of the world’s most powerful trading firms and exchanges with devices that promise to handle stock market transactions at close to the speed of light. Think the Fast Boys. Rolling out switches that take four nanoseconds to make trades. The leading provider of this technology, Metamako, told the Wall Street Journal that more than half of U.S. high-frequency firms already use its devices. This could account for up to one-quarter of the trading volume in U.S. stocks on any given day – and rising!

The real loser is the actively managed hedge funds, which rely on people to make decisions. They are becoming less of a force. Funds in the $2.9 trillion hedge-fund sector have now experienced three consecutive quarters of withdrawals for the first time since 2009, according to HFR. The average hedge fund is up 3 percent through the end of July, less than half that of the S&P 500, and with nearly four times the average fee of an index fund.

Some companies’ management teams are still telling their Board of Directors that “investors don’t understand their investment story.” They might be missing the point. With the move toward more passive investing, “bot” decision-making and the resulting decline in sell-side research, maybe these management teams don’t appreciate that fewer and fewer investors will be around to listen to them.

 

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