Dirk Lever, AltaCorp Capital Inc.
Technology has brought with it many changes. Initially the changes were small, almost unrecognizable, but with time they became more dramatic. Originally the mobile phone was kind of a novelty owned by few and envied by many, with limited functionality. Cellphones followed – big, clunky, again with limited functionality. Now cellphones are effectively minicomputers; they are multifunctional and support a wide array of applications, some of them free. Virtually everyone everywhere has a cellphone, even little children.
In this new world of technology, the application of ideas (some new) by way of programming and reprogramming everyday functions in a myriad of industries is happening real time. Couple the proliferation of such programs with the ever-increasing speed and strength of computing power and, clearly, some industries have fundamentally changed while others are about to change. Consider the possibilities of driverless cars, coupled with the Uber business model; rather than decades or years away this may be months away, depending on location.
Technology has the potential to make changes very rapid. The costs of technology have fallen quickly and the greater the adoption rate, the faster costs fall. Simple computers, once costing thousands, today cost hundreds. From a functionality standpoint, the computer of yesterday is effectively obsolete.
Stock Trading; Doing More Volumes for Less Commission
With the ability to do complex computations at relatively unimaginable speed, coupled with the ability of computers to talk to each other, the trading of securities has witnessed massive change. Years ago, there were likely a couple of stock exchanges in each country, and typically these exchanges did not interact. Now there are alternative exchanges running nearly 24/7. Where there was only one New York Stock Exchange to trade its listed stocks, there are many today (well over 20). All are competing for trade volumes.
Consider that a trader cannot simultaneously transact a stock order on multiple exchanges without the help of computing power. It is hard to find an exchange where traders yell and scream orders in a big room to each other with crazy hand signals. Today a collection of computers is silently communicating and transacting. The issues of the alternate exchanges, high frequency trading and the manipulation of orders are addressed in the excellent book by Michael Lewis, Flash Boys. The bottom line is that speed and efficiency increased while transaction costs fell.
For broker dealers this has meant fewer salesmen and traders. Many who still trade are computer savvy. More interesting still are the new jobs of pouring over trading data (post trade) to identify more optimal computer trading strategies. This has also meant a ramp up in technology spend; faster computers, better trade algorithms and analysis –all for less commission. Trading has become a volume business with thinner margins. It’s an arms race of sorts and when you add in a significant drop in corporate financings, the result has been the demise of many smaller firms, unable to compete.
Research: Wider, Deeper and with More Reach
Research analysts too are using technology to drill through data to help them evaluate businesses. And as trade commissions have fallen, analysts are either under pressure to pick up more companies and write more reports, or they are being let go. With technological aid, research analysts try to reach a wider and wider audience. Country boundaries are effectively disappearing. Under a new proposal in Europe, the practice of paying for research through trade could end and be replaced by actual payments. The traditional model is potentially changing rapidly.
Portfolio Managers Compete with ETFs
Exchange Traded Funds (ETF) have proliferated; portfolios designed to track the performance of specific indexes or subindexes. The intention is to meet index or subindex performance at a minimal cost. Consider that an industry ETF, with low, low fees, has been proven difficult to beat. ETF investor inflows or outflows are automatically matched with corresponding trade orders (and cheaply executed) to balance the portfolio daily. When index or subindex changes occur, shares are automatically traded to balance portfolios. Programmers with knowledge of portfolio theory and algorithms are replacing portfolio managers. Statistical analysis is supplanting human judgement. Like bits of Lego, ETFs are combined to create whatever it is an investor needs; the combinations and permutations are virtually endless, and even the process of ETF selection is becoming automated.
What Does this Mean for You?
There are fewer and fewer dealers, analysts and portfolio managers. Clearly all aspects of the market cannot yet be fully automated. There are ‘human touch trades’ that help set the market, with the ‘bots’ merely following along, looking for aberrations caused by human nature. But unless your company is part of an index, you may have to search further and wider to find your audience. And investment dealers, owing to the economics of their industry and yours, will either be fighting for your business, or you will be fighting to get their attention.
The Exchanges are Concerned
Many of the changes noted have unintended consequences. The market, for all the technological changes that have occurred, is still going through learning curves. We know that some exchanges are concerned with the squeezing out of junior and intermediate companies, and the exchanges are looking for ways to expand their services. Again, they will be looking for ways to leverage technology to expand business. After all, they too are feeling the squeeze.
What Should You Do?
Put technology to work. Fight fire with fire. Learn just who your competitors/peers are, both locally and globally. Build a database and update it regularly. Use tools to find out who is interested in your industry. Then learn to pitch your business relative to your peers. If you find yourself very much alone at first, you will likely find your audience through the process of building up your peer base and reaching out to others.
Dirk Lever is Managing Director, Institutional Equity Research, AltaCorp Capital Inc.