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It is getting harder and harder to find an edge these days.
Back in the day, fund managers achieved good results by cultivating company executives to get an early sniff of looming problems and successes. Then regulators cracked down on the practice of selective information sharing. The US passed regulation FD (for fair disclosure) in 2000 and the UK began enforcing rules requiring prompt disclosure of material information. The rise of the internet and high-frequency trading also cut down on information asymmetry and sped up market reaction to news when it occurred. Professionals are also finding that there are fewer inattentive punters to exploit. Institutional investors now hold more than 60 per cent of US shares, up from just 10 per cent in the 1970s; and the average holding period of UK shares has dropped from five years in the 1960s to well under a year now.
So the money managers have resorted to other strategies. Eric Schneiderman, New York Attorney General, this week announced that BlackRock had agreed to stop surveying equity analysts about their views in what he alleged was an attempt to trade ahead of changes in their ratings. His agreement with the US-based fund manager cited an internal email that said: “We are trying to front-run rec[ommendations]”. BlackRock neither admitted nor denied wrongdoing, but it agreed to pay $400,000 and co-operate with Mr Schneiderman’s investigation into what he calls “insider trading 2.0” – traders’ efforts to create and exploit small information gaps with the rest of the market. Last July he pressured Thomson Reuters into stopping its practice of releasing closely watched consumer survey data two seconds early to customers who paid extra fees. Since then, trading around the release window has collapsed.
UK regulators are also attacking the ways that connected people gain advantage, by bringing civil market abuse cases against financial professionals for allegedly sharing market-moving information with current and potential clients. The UK is also taking aim at brokers who charge fees for arranging meetings between investors and company executives.
Back in New York, US attorney Preet Bharara’s office this week opened its case against Matthew Martoma, the former SAC Capital portfolio manager who has pleaded not guilty to trading in drug company shares after learning the confidential results of a clinical trial. The office has already won 77 insider trading convictions in its drive to stop hedge funds from trading on non-public information.
All this should be reassuring to ordinary investors. Today’s watchdogs really seem to care about creating a level playing field and they are having a measurable impact. In London, abnormal trading ahead of deals has dropped to its lowest level in a decade.
But the crackdown does raise a question: if many fund managers got their edge by skirting the rules, what do the rest have to offer? Innumerable studies suggest that ordinary investors can get better returns, once fees are subtracted, by putting their money in tracker funds. Fees are already under pressure. Investment managers who want to keep growing had better come up with a convincing answer.