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Opinion: We Need the Plus-Tick Rule, Part II

When it is a known fact that measuring best execution is a specious game to begin with, the measurements are not very effective at promoting careful attention to it. All the king's horses of data that participants are able to collect will not change the basic problem with the measurement. Unfortunately, all that data can be made to look pretty sexy, while really only providing false illusions. And these false illusions can be very powerful.

Further Distortions From the Fee Side

The profit-oriented trader, at least, might only cause sloppy pricing in a subset of the securities in a basket, in cases where the rest of the securities were executed well, so that the overall price objective be still obtained. Unfortunately, the fee-driven trader knows no such limitations, has no incentive to consider the relative level of prices received, and further, is under mandate to execute. When a significant portion of the capital being invested in the underlying index comes through such facilitators, the notion of comparative valuations between individual enterprises gets lost in the sea of broad-market trading, while correlations go to 1.

How many people, running how much money, were really aware of how ineffective the levered ETFs were (when used in their promoted direction) over multiday holding periods until Eric Oberg wrote that beautiful piece on them a few weeks ago? It may not be a coincidence that you could borrow the short ones such as the UltraShort Financials ProShares (SKF) all day long until just recently.

Anecdotally, my wife was at a conference last fall when a speaker, the CEO of a $10 billion-plus fund of funds who was clearly uncomfortable with the proliferation of those instruments, posed such a question about them to the 100-person audience, and received no response. When I emailed him the answer to his question, he was appreciative enough that I don't think he had received many others.

The good part is that as long as the capital committed to such strategies is a minor part of the overall capital employed in the market, the tail won't wag the dog; the market picture in any given security will not be affected much by the execution characteristics of the individual order in that security which is part of basket trades entered.

The problem, of course, is that quantitative strategies proved out pretty well for a long time, so they have attracted lots of capital. Go back, for example, to the granddaddy quant model of them all, the S&P 500. Since someone made the claim that only a small percentage of active asset managers actually outperform the S&P 500 over long periods of time, many investors have given up trying. This giant exercise in exalting mediocrity (guess where I stand on the issue) has all kinds of things to recommend it. It's cheap, because you don't have to pay managers to work hard to discover which companies might actually do better than their peers, you don't have to explain why you underperformed by picking your own portfolio, and it's diversified.

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