Rise of the Machine: The Digital Evolution of Investing (Part II)

This article was written in collaboration with the Dimensional Fund Advisors trading team. Read Part I here.

Technology is changing the world we live in every single day — and if you tuned into OneBite earlier this week, then you know that it has also bred a new phenomenon in the financial markets: high-frequency trading (HFT), which has been met with both praise and skepticism from investors, legislators and all sides of the industry.

In Part I of this piece, we sat down with the trading team at Dimensional Fund Advisors — an Austin-based asset manager whose philosophy and mutual funds are a cornerstone of our investment approach — to shed some light on a few of the tough questions surrounding HFT, specifically whether the practice is harmful to long-term investors.

To reiterate the trading team’s point, long-term investors shouldn’t lose sleep over HFT and the markets in general, so long as they abide by time-tested keys for investment success: broad diversification across a variety of asset classes, disciplined trading and a focus on cost and tax management. The truth is that HFT has been shown to contribute to market liquidity, which can work in long-term investors’ favor, especially from a cost and efficiency perspective.

Here are three final conclusions you should take away from our conversation with Dimensional.

There is no compelling evidence to prove that HFT activity is harmful to long-term investors. Investors are best served by ignoring the noise of day-to-day market events, and focusing on their long-term financial plan and goals instead.

Dimensional’s trading team says:

“We are in a world where there is much faster, more automated and more computer-driven trading than in the old days, when things moved more slowly, there were fewer trades and more people were involved.

What effect do these developments have on the cost of implementing a long-term investment strategy? As HFT activity has grown over the past 15 years, we have observed decreases in both implicit costs and explicit costs, such as brokerage commissions. The end result is the ability to deliver more cost-efficient investment solutions to our clients.”

Unlike the vast majority of asset managers, Dimensional strives to deliver better returns to investors by practicing patience in trading — a core reason we choose to incorporate their funds into our own portfolios.

Dimensional’s trading team says:

“Most fund managers — whether they’re stock pickers, index funds or a hybrid between the two — generally demand some sort of immediacy when executing trades. What Dimensional has done differently from the beginning — and it’s become more sophisticated, as our trading processes have evolved with technology and markets over time — is balance maintaining consistent exposure to market premiums with costs and diversification. This balance reduces turnover and allows for flexibility and patience on the execution side, which give us opportunities to trade at more favorable prices. We have choices and substitutes on the trader’s desk, so we can avoid crossing spreads or pushing prices when buying or selling stocks.”

A disciplined investment philosophy, ongoing research and expertise that comes with 35 years of experience make Dimensional well-equipped to handle a variety of market conditions, and nimble enough to adapt as markets evolve.

Dimensional’s trading team says:

“The world is always changing. Over the past 20 to 30 years, markets have been electronic, but they’re even more so now. Our basic philosophy about market prices reflecting the best estimate of a security’s value hasn’t changed at all, but it has evolved on the technical elements. We’ve always been ahead of the curve on electronic trading and understanding the market structures, and are really focused on getting good execution.

One example of this commitment is our comprehensive tick database, which includes trade and quote data from exchanges around the world. These data give us the ability to conduct studies that deepen our understanding of markets and help us improve our trade execution. Specifically, we use the tick database to analyze price-setting dynamics, trading algorithms and trading costs. Further, our highly customized approach to algorithmic trading allows us to monitor execution in real-time, giving us the ability to quickly and systematically adapt to changes in markets globally.

We have a deep commitment to the integration of research and trading, and it’s consistent with the same kind of evidence-based approach you’ll see across everything at Dimensional. We’ve been fortunate to work for a firm where people are encouraged to be forward-thinking and to put a lot of resources into trading. Our approach to trading is similar to how we approach the entire investment process — it’s all about trying to get the best outcomes for our clients.”

Want to learn more about Dimensional’s investment approach and philosophy?

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