tag:theconversation.com,2011:/au/topics/share-trading-7998/articlesshare trading – The Conversation2018-08-08T21:04:38Ztag:theconversation.com,2011:article/1012972018-08-08T21:04:38Z2018-08-08T21:04:38ZWhat is insider trading, the crime Rep. Chris Collins was charged with?<p>The <a href="https://www.cnn.com/2018/08/08/politics/chris-collins-indicted-insider-trading/index.html">arrest</a> of Congressman Chris Collins shines light on one of the sexier crimes that the securities laws has to offer: insider trading. </p>
<p>It’s the subject of many iconic movies like “Wall Street,” television shows like “Billions” and <a href="http://articles.latimes.com/2013/jan/19/business/la-fi-sec-celebs-20130119">real-life scandals</a> involving celebrities, politicians and others.</p>
<p>But despite all the media attention, <a href="http://fortune.com/2013/08/15/the-gray-art-of-not-quite-insider-trading/">very few people</a> actually know what insider trading is under the law and how it gets people into trouble. As finance <a href="https://scholar.google.com/citations?user=y_ViJ7oAAAAJ&hl=en&oi=ao">experts</a>, <a href="https://theconversation.com/profiles/karen-kunz-340855">we</a> are here to fill that gap.</p>
<h2>What is insider trading?</h2>
<p>As its most basic, insider trading is when someone – usually a corporate insider – buys or sells securities such as a stock or bond based on “non-public information.” </p>
<p>For instance, Martha is a board member at Company X and learns of an incredible breakthrough at her company that hasn’t been disclosed to the public. If she then uses that information to buy her company’s stock – knowing that the stock price will go up after the announcement – Martha is likely guilty of insider trading. </p>
<p>Under current laws, the insider can also get into trouble if he or she shares that information with others – who could face prosecution as well if they make a trade using the information.</p>
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<iframe width="440" height="260" src="https://www.youtube.com/embed/rM7TW_O0YCs?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">‘Billions’ on insider trading.</span></figcaption>
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<h2>Why is it illegal?</h2>
<p>For much of the 20th century in the U.S., insider trading <a href="http://www.sechistorical.org/museum/galleries/it/counterAttack_d.php">was not generally considered illegal</a>. It was only in the 1950s that various court rulings strengthened the power of Wall Street’s beat cop – the Securities and Exchange Commission – to go after inside traders under federal securities law. </p>
<p>Under the classical legal theory for insider trading, an insider – whether an employee or a corporate director – has a fiduciary obligation to a company to keep secret information secret. Insiders who breach that duty by either trading on the information or sharing it for personal benefits violate that duty. This appears to be the case with <a href="https://drive.google.com/file/d/1KSIMuRjRNOJ4WK5WuSguKEnoxSHwpYQt/view">Collins</a>. </p>
<p>But what if the stock you traded wasn’t from a company to whom you owed a fiduciary duty? </p>
<p>That was at the heart of a <a href="https://www.oyez.org/cases/1996/96-842">1997 Supreme Court case</a> that spawned something known as the misappropriation theory, which broadened what was considered illegal insider trading. In that case, attorney James O’Hagan used information he gained from his position at his firm to trade in another company’s stock. Since it wasn’t O’Hagan’s client, he argued, there was no duty and, hence, no breach.</p>
<p>The court disagreed. Since O'Hagan used confidential information that was given to him to perform his job and instead used it for his personal gain, he breached his duty and was therefore found guilty of insider trading. </p>
<p>Since then, prosecutors have used this theory to find <a href="https://caselaw.findlaw.com/us-1st-circuit/1030702.html">wives</a> who trade based on marital secrets, <a href="https://www.marketwatch.com/story/sec-charges-therapist-with-insider-trading-on-confidential-patient-disclosures-2017-12-14">therapists</a> who trade based on therapy sessions and even <a href="https://www.reuters.com/article/us-trading-cyber-plea/ukrainian-hacker-gets-prison-in-u-s-insider-trading-case-idUSKBN18I2DF">hackers</a> who trade based on computer theft all to be guilty of insider trading.</p>
<p>As for Collins, he sat on the board of biotechnology company Innate Immunotherapeutics. He was also the Australian company’s largest shareholder. When Collins learned that a trial involving a new multiple sclerosis drug failed, he allegedly sold shares in the company – to avoid significant losses – and passed along that information to his son, who in turn, shared it with others.</p>
<p>Not quite the plot of a “Billions” story line, but, give it a year and we’re sure that Hollywood can come up with something.</p><img src="https://counter.theconversation.com/content/101297/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Insider trading, like what Rep. Chris Collins is accused of engaging in, is one of the sexier crimes in securities law.Jena Martin, Professor of Law, West Virginia UniversityKaren Kunz, Associate Professor of Public Administration, West Virginia UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/734172017-05-03T01:14:23Z2017-05-03T01:14:23ZWhy Dodd-Frank – or its repeal – won’t save us from the next crippling Wall Street crash<p>Republicans <a href="http://www.latimes.com/business/la-fi-dodd-frank-20170504-story.html">appear poised to roll back</a> Wall Street regulations passed after the 2008 financial crisis. Democrats <a href="http://www.cnbc.com/2017/02/07/if-trump-repeals-dodd-frank-it-would-be-a-monumental-mistake-bart-chilton-commentary.html">argue doing so</a> would be a “monumental mistake.” </p>
<p>It’s been framed as a typical fight over regulation. <a href="http://www.latimes.com/business/la-fi-dodd-frank-demoocrats-20170206-story.html">Democrats want more</a> to protect taxpayers and investors from the next crisis; Republicans want less because it <a href="https://www.nytimes.com/2017/02/03/business/dealbook/trump-congress-financial-regulations.html">stifles economic growth</a>. </p>
<p>So who’s right? </p>
<p>Based on our combined 35 years of experience with securities markets and the research we’ve done for our new book, “<a href="https://www.amazon.com/When-Levees-Break-Re-visioning-Regulation/dp/0739196049">When the Levees Break: Re-visioning Regulation of the Securities Markets</a>,” we think both sides are wrong. The issue isn’t about more or less regulation but about the need for a streamlined system that supports 21st-century investing. </p>
<p>If we had our way, the whole system of financial regulation would be burned to the ground and replaced with something entirely different. </p>
<h2>Of bonds and banks</h2>
<p>Before we go any further, let’s clarify what we’re talking about. When we think of financial markets, we tend to jumble securities markets like stocks, bonds and commodities with conventional bank lending such as checking accounts and lines of credit. </p>
<p>The <a href="http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm">Dodd-Frank Act</a>, for example, was ostensibly focused on regulation of securities markets, but the rules that got the most attention were those that affect the “too big to fail” banks. That those banks straddled both worlds made the market crash life-threatening. </p>
<p>But securities trading, and in particularly derivatives, were at the root of the 2008 financial crisis. For our purposes, when we talk about financial regulation, our focus is on the securities markets. </p>
<h2>How did we get here?</h2>
<p>The financial markets meltdown in the fall of 2008 devastated our economy, but it still <a href="http://online.wsj.com/mdc/public/page/2_3024-djia_alltime.html">pales in comparison</a> with the stock market rout that preceded the Great Depression in October 1929. The Dow Jones Industrial Average <a href="https://finance.yahoo.com/quote/%5EDJI/history?period1=475822800&period2=1493697600&interval=1d&filter=history&frequency=1d">fell</a> 23 percent from Oct. 28 to Oct. 29 that year, compared with a two-day slide of at most half that throughout the 2008 crisis. </p>
<p>After the 1929 crash, lawmakers reacted by passing laws aimed at ensuring investor protection. Two groundbreaking pieces of legislation, passed in 1933 and 1934, <a href="https://www.sec.gov/about/laws/sa33.pdf">required companies</a> to submit quarterly and annual reports and <a href="https://www.sec.gov/about/laws/sea34.pdf">established the Securities and Exchange Commission</a>. These laws form the cornerstone of modern securities markets regulation. </p>
<p>But they were only the beginning. As markets expanded and changed, Congress continued to craft new laws that added more agencies to oversee Wall Street activities. As a result, we have more than two dozen agencies, self-regulatory organizations and exchanges (including the <a href="https://www.cftc.gov">Commodities & Futures Trading Commission</a>, the Treasury and the <a href="https://www.dol.gov/">Departments of Labor</a> and <a href="https://www.justice.gov">Justice</a>), not to mention state securities agencies, all with overlapping regulatory jurisdictions. </p>
<p>Moreover, the laws have been reactionary – rather than visionary – resulting in competing concerns and duplicative audit and enforcement procedures. Not surprisingly, there is largely no coordination or communication between them. </p>
<p>Meanwhile, the SEC – as primary regulator – is bogged down with too many directives, many of which are under- or unfunded. For decades, whenever Congress passed a bill to “regulate” big changes in the markets – from market crashes to “advancements” such as mutual funds and investment advisors – the SEC has been required to add oversight of these new practices to their existing responsibilities. Dodd-Frank, for example, expanded the SEC’s role and called for additional internal audits of existing practices but – like past market-related legislation – failed to include funding for those activities.</p>
<p>Amid all the regulation, investor protection seems to have gotten lost. </p>
<h2>Enter Dodd-Frank</h2>
<p>The severity of the 2008 crash and its economic impact (including investment company failures and unprecedented government bailouts) goaded Congress into action. </p>
<p>In 2010 Democratic lawmakers passed the <a href="https://www.sec.gov/about/laws/wallstreetreform-cpa.pdf">Dodd-Frank Act</a>, <a href="https://corpgov.law.harvard.edu/2010/11/20/the-financial-panic-of-2008-and-financial-regulatory-reform/">the most extensive revision of securities regulation</a> since the 1930s, with the hope that more regulation would prevent another crisis. </p>
<p>Republicans have argued for its repeal ever since, claiming <a href="http://financialservices.house.gov/dodd-frank/">the law</a> and the regulations designed to implement it (<a href="https://www.davispolk.com/Dodd-Frank-Rulemaking-Progress-Report/">many of which are behind schedule</a>) inhibit prosperity. </p>
<p>Both parties are missing the point. The current system of financial regulation is built on how stocks were traded in the 1930s – when computers and algorithmic trading had yet to be a glimmer in a <a href="https://www.merriam-webster.com/dictionary/quant">quant’s</a> eye. To paraphrase the <a href="https://www.youtube.com/watch?v=bAJ3-mbP1pY">Oldsmobile commercial</a>, it’s not your father’s stock market anymore.</p>
<h2>My, how markets have changed</h2>
<p>Financial markets have undergone a fundamental transformation over the past 80 years. </p>
<p>First of all, there are the investors themselves. The mom and pop investor that the SEC was created to protect has by and large been replaced by institutional investors, including quantitative analysts or <a href="http://www.nytimes.com/2010/02/21/business/21shelf.html">“quants”</a> that use complex algorithmic formulas to predict the best trading strategies. In fact, algorithmic trading makes up the <a href="https://www.wired.com/2010/12/ff_ai_flashtrading">majority</a> of volume in today’s markets.</p>
<p>Then there’s the issue of disclosure. Since the dawn of federal securities regulation, lawmakers and regulators have relied on <a href="http://heinonline.org/HOL/Page?handle=hein.journals/wvb118&div=6&g_sent=1&collection=journals">disclosure</a> to protect investors. Public companies are required to disclose volumes of information, from <a href="https://www.sec.gov/news/pressrelease/2015-160.html">financial information</a> to dealings with <a href="https://www.sec.gov/divisions/corpfin/cfannouncements/itr-act2012.htm">Iran</a> and even their <a href="https://www.sec.gov/rules/final/33-8177.htm">Code of Ethics</a>. As a result, <a href="https://www.transactionadvisors.com/insights/considering-ipo-costs-going-and-being-public-may-surprise-you">a company can spend</a> <a href="https://www.quora.com/How-much-time-does-a-US-company-typically-spend-on-SEC-filing">over a million dollars each year</a> complying with disclosure regulations that few people actually read. Yet every time there’s a new disaster, Congress piles on the disclosure requirements, as happened with Dodd-Frank. </p>
<p>But for all the hundreds of pages of disclosure, at no time in the past 80 years has there been a mandate to review the actual securities products issued by public companies and investment banks. There are no “safety” standards for stocks, like there are for cars or toasters. The products that brought down the house in 2008 – mortgage-backed securities and products derived from them – continue to be offered to the public, including new ones backed by credit card debt and <a href="https://www.theatlantic.com/business/archive/2013/03/dont-panic-wall-sts-going-crazy-for-student-loans-but-this-is-no-bubble/273682/">student loans</a>.</p>
<p>Finally, the SEC and other regulators are unequipped to keep up with the breathtaking changes in technology, let alone anticipate potential advances and challenges. To understand why, one must only consider the breadth of organizations that have fallen victim to hackers, from <a href="https://www.bloomberg.com/news/articles/2014-03-13/target-missed-warnings-in-epic-hack-of-credit-card-data">Target</a> and <a href="https://www.nytimes.com/2017/03/15/technology/yahoo-hack-indictment.html?_r=0">Yahoo</a> to the <a href="http://www.politico.com/story/2013/06/computer-hacking-veterans-affairs-department-092227">Veterans Administration,</a> and the <a href="http://www.reuters.com/article/us-usa-fed-cyber-idUSKCN0YN4AM">Federal Reserve itself</a>.</p>
<p>Unfortunately, however, Congress <a href="https://cup.columbia.edu/book/how-they-got-away-with-it/9780231156912">does not fund the SEC</a> in a way that would allow it to pay for the skills or systems it needs to keep up with technological and other market advances. Following Dodd-Frank, for example, the SEC’s budget was actually reduced, even as its responsibilities multiplied.</p>
<p>In sum, what we have is a regulatory system that fails in its mission to protect investors. The structure used to oversee current investment practices, corporate disclosures, product development and technological advances is based on the market failures of 1929. It’s a bit like trying to surf the internet using a typewriter. </p>
<h2>Preparing for the next crash</h2>
<p>The next “big” crash will likely be bigger than the last one. So how do we prepare for it? </p>
<p>Dodd-Frank is largely an extension of the patchwork structure and won’t protect us in the future. Yet the Republican answer, to repeal it and let markets self-regulate, won’t stop the proliferation of products that nearly brought the house down in 2008. After the next crash, institutions will not be too big to fail, they’ll be too big to save.</p>
<p>The answer, in our view, is <a href="https://revisioninginvesting.com/">a complete rethinking of how we regulate investing</a>. As the White House moves to dismantle Dodd-Frank, this is the perfect time to do exactly that. Let’s get rid of what doesn’t work – which is pretty much everything – and replace it with a system that does. </p>
<p>What we envision is a contemporary, 21st-century holistic structure built on proactive, thoughtful and streamlined laws that takes into account markets that are technology-driven and move in nanoseconds. </p>
<p>Think of it this way: Our regulatory structure is like the dike that keeps springing leaks – the makeshift plugs we’ve used are so ineffective that the dike isn’t leaking – it’s crumbling. We need to build a new dike, using all available technology, before the next tidal wave hits. </p>
<p>We don’t claim to have all the answers. But we want to get the conversation started. We invite you to join in.</p><img src="https://counter.theconversation.com/content/73417/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Instead, we need to burn the entire system of financial regulation to the ground and replace it with something that supports investing the way it’s done today.Jena Martin, Professor of Law, West Virginia UniversityKaren Kunz, Associate Professor of Public Administration, West Virginia UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/733102017-02-23T13:46:16Z2017-02-23T13:46:16ZWarren Buffett’s latest stock play is a clue for reading the Trump-era economy<p>While political analysts and journalists obsess about President Donald Trump’s executive orders and their constitutional significance, the investor Warren Buffett has made his judgement clear on how the economy could look during the Trump years. In a massive stockmarket move, he has dumped nearly a billion dollars of long-held shares in retailer Walmart in favour of tech and airline stocks.</p>
<p>This demonstrates an <a href="https://news.thestreet.com/independent/story/14006576/1/you-didn-t-think-warren-buffett-sold-out-of-walmart-for-no-reason-did-you.html">astonishing change of heart</a> for Buffett, who as recently as 2013 referred to the US airline industry as a “deathtrap for investors”. He was equally renowned for dubbing Apple’s shares “grossly overvalued”. His perennial faith in retail stocks seems to have evaporated, too, with the world’s most influential investor selling off his entire $900m stake in Walmart. </p>
<p>Buffett’s complete divestment of his Walmart stock, a company he once deemed his <a href="http://uk.businessinsider.com/warren-buffett-drops-walmart-stock-2017-2">safest and most prized investment</a>, comes at a time when America’s traditional retail giant has seen its market share eaten up by Amazon and other online competitors. While Buffett is by no means a short-term trader, his sale of Walmart shares reveals a potential long-term shift in the tide of e-commerce and online retailing. </p>
<p>Former Walmart boss Mike Duke <a href="http://uk.businessinsider.com/warren-buffett-drops-walmart-stock-2017-2">acknowledged in 2012</a> that his greatest regret as CEO was not pursuing e-commerce more aggressively to stave off competition from Amazon. “Right now we’re making tremendous progress, and the business is moving, but we should have moved faster to expand e-commerce,” he said at the time. This is reflected in a declining trend in Walmart’s share price, <a href="https://www.bloomberg.com/quote/WMT:US">which has fallen</a> from almost US$92 in January 2015 to US$71.45 in February 2017. </p>
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<img alt="" src="https://images.theconversation.com/files/157898/original/image-20170222-6431-1ptrk7z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/157898/original/image-20170222-6431-1ptrk7z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=216&fit=crop&dpr=1 600w, https://images.theconversation.com/files/157898/original/image-20170222-6431-1ptrk7z.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=216&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/157898/original/image-20170222-6431-1ptrk7z.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=216&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/157898/original/image-20170222-6431-1ptrk7z.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=272&fit=crop&dpr=1 754w, https://images.theconversation.com/files/157898/original/image-20170222-6431-1ptrk7z.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=272&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/157898/original/image-20170222-6431-1ptrk7z.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=272&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Walmart Stores Inc Share Price.</span>
<span class="attribution"><span class="source">https://www.bloomberg.com/quote/WMT:US</span></span>
</figcaption>
</figure>
<p>Even though Walmart has since invested heavily in e-commerce, it remains a niche player compared to Amazon. In 2015, Walmart’s online sales of US$13.7 billion <a href="http://uk.businessinsider.com/warren-buffett-drops-walmart-stock-2017-2">were dwarfed by</a> Amazon’s mammoth US$107 billion. </p>
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<img alt="" src="https://images.theconversation.com/files/158117/original/image-20170223-24107-18a1ub1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/158117/original/image-20170223-24107-18a1ub1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=448&fit=crop&dpr=1 600w, https://images.theconversation.com/files/158117/original/image-20170223-24107-18a1ub1.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=448&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/158117/original/image-20170223-24107-18a1ub1.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=448&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/158117/original/image-20170223-24107-18a1ub1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=563&fit=crop&dpr=1 754w, https://images.theconversation.com/files/158117/original/image-20170223-24107-18a1ub1.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=563&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/158117/original/image-20170223-24107-18a1ub1.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=563&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Walmart has been fighting off the challenges from e-commerce.</span>
<span class="attribution"><span class="source">Mike Mozart</span>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>Moreover, 2017 could prove to be a particularly challenging year for Walmart. Since the last quarter of 2016, the US economy has witnessed increases in gas and food prices, <a href="http://www.forbes.com/sites/judeclemente/2017/01/11/short-term-outlook-for-u-s-natural-gas-prices-january-2017/#65a27c7167c8">pushing up inflation</a>. In addition, <a href="http://fortune.com/2017/01/23/tax-refund-delay-2017/">delays in tax refunds</a> will further crush consumer spending. Walmart’s sales <a href="http://uk.businessinsider.com/warren-buffett-drops-walmart-stock-2017-2">thrive during the tax refund period</a>, with almost 35% of its yearly sales coming from the tax season alone. Walmart’s flagship two-day shipping subscription service, ShippingPass, is also expected to struggle against the more popular Amazon Prime. </p>
<h2>Big bite of Apple</h2>
<p>The sale of Walmart shares enabled Buffet’s Berkshire Hathaway to quadruple its stake in Apple and <a href="http://www.independent.co.uk/news/business/news/warren-buffett-quadruples-investment-apple-american-airlines-delta-united-monsanto-billionaire-a7580786.html">raise its stake seven-fold</a> in the four biggest US airlines. The recent regulatory 13-F filings to the Securities and Exchange Commission reported Berkshire Hathaway owning 57.4m shares of Apple worth US$7.74 billion. This is up from 15.2m shares in September 2016. The investment seems to have raised a few eyebrows since Buffett has always been a <a href="http://www.kiplinger.com/article/investing/T052-C008-S001-3-reasons-warren-buffett-is-buying-apple-stock.html">reluctant tech-stock buyer</a>.</p>
<p>Berkshire took advantage of periodic dips in Apple’s share price during the final quarter of 2016 by amassing its stake in the company when the <a href="https://www.bloomberg.com/quote/AAPL:US">price was fluctuating</a> between $90 and $118 per share. Apple’s share price <a href="http://www.kiplinger.com/article/investing/T052-C008-S001-3-reasons-warren-buffett-is-buying-apple-stock.html">currently stands at $136 per share</a> owing largely to high retention rates among iPhone buyers. In addition, analysts are expecting record sales of the new iPhone later this year, which is expected to push Apple’s share price even further. </p>
<p>Apple is also set to benefit from <a href="http://bgr.com/2017/02/20/iphone-8-rumors-wireless-charging-battery/">Samsung’s misfortunes</a>, due in no small part to the farcical battery problems of its Note 7 and the resulting delay in the Samsung Galaxy S8. In the event of bumper iPhone 8 sales, the projected 16.6% gain in Apple’s share price would leave Berkshire Hathaway with a $1.1 billion profit in 2017 alone. </p>
<h2>High-flyer</h2>
<p>Moreover, Berkshire also reported a $9.3 billion share <a href="http://www.independent.co.uk/news/business/news/warren-buffett-quadruples-investment-apple-american-airlines-delta-united-monsanto-billionaire-a7580786.html">purchase in the airline industry</a>, with investments spread across American Airlines Group, Delta Air Lines, Southwest Airlines and United Continental. His stake in the four biggest US airlines follows his remarkable turnabout on airline stocks, an industry he <a href="http://www.chicagotribune.com/business/columnists/ct-buffett-united-airlines-robert-reed-0216-biz-20170215-column.html">famously detested</a> for two decades after an unhappy yet profitable investment in US Air Group. Buffett’s interest in airline stocks reflects the overall strength of the US airline industry and – from a consumer perspective – the lack of product differentiation in terms of flight quality, air fares and customer service. </p>
<p>The US airline industry has <a href="http://uk.businessinsider.com/warren-buffett-10-billion-airline-investments-reveal-2017-2?r=US&IR=T">experienced astonishing growth</a> since the financial crisis. All four airlines have reported record profits aided by consistent passenger capacity, lower labour costs, cheap oil and expansion to domestic and international destinations. The industry is also set to receive a <a href="http://fortune.com/2017/01/30/donald-trump-paris-agreement-climate-change-withdraw/">significant operational boost</a> following Trump’s announcement of plans to scrap the Paris agreement on climate change, which would otherwise restrict airlines’ ability to expand flight frequencies and new routes. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/158116/original/image-20170223-24077-17kmpma.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/158116/original/image-20170223-24077-17kmpma.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=392&fit=crop&dpr=1 600w, https://images.theconversation.com/files/158116/original/image-20170223-24077-17kmpma.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=392&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/158116/original/image-20170223-24077-17kmpma.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=392&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/158116/original/image-20170223-24077-17kmpma.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=492&fit=crop&dpr=1 754w, https://images.theconversation.com/files/158116/original/image-20170223-24077-17kmpma.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=492&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/158116/original/image-20170223-24077-17kmpma.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=492&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Soaring to new heights?</span>
<span class="attribution"><span class="source">Sergii Kononenko/Shutterstock.com</span></span>
</figcaption>
</figure>
<p>In addition, a wave of airline mergers and consolidations, coupled with homogeneity of air fare and in-flight services, have made the big four airlines a <a href="https://www.bloomberg.com/news/articles/2017-02-15/airlines-rise-to-a-record-as-buffett-s-berkshire-deepens-bet">dominant force</a> in the domestic market. According to Jim Corridore, a research analyst at CFRA, the big four US airlines are following a cost-control and flight demand model, which bodes well for shareholders – as their focus is not to be the biggest carrier, but the most profitable one. The Bloomberg US Airlines Index has witnessed a steady rise over the past five years. The combined share price of the index has surged from US$30.91 in February 2012 to its current price of $131.53. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/157904/original/image-20170222-6440-vihanx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/157904/original/image-20170222-6440-vihanx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/157904/original/image-20170222-6440-vihanx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=216&fit=crop&dpr=1 600w, https://images.theconversation.com/files/157904/original/image-20170222-6440-vihanx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=216&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/157904/original/image-20170222-6440-vihanx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=216&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/157904/original/image-20170222-6440-vihanx.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=272&fit=crop&dpr=1 754w, https://images.theconversation.com/files/157904/original/image-20170222-6440-vihanx.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=272&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/157904/original/image-20170222-6440-vihanx.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=272&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Bloomberg US Airline Index.</span>
</figcaption>
</figure>
<p>While the jury is still out on Buffet’s astounding investment coup, they highlight Buffett’s favourite investment axiom:</p>
<blockquote>
<p>The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot … And if people are yelling, ‘Swing, you bum!’ ignore them. </p>
</blockquote>
<p>It seems traditional retail companies are no longer palatable to Buffett’s precise investment delectation. The future, according to Buffett’s recent stock trades, lies in industry consolidated, demand-led tech and airlines.</p><img src="https://counter.theconversation.com/content/73310/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Hassaan Khan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The billionaire investor has dumped groceries in favour of tech and airline stocks.Hassaan Khan, Deputy Head of Department (Accounting & Finance), Anglia Ruskin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/619642016-07-03T05:37:05Z2016-07-03T05:37:05ZAn uncertain election result may lead to stagnant financial markets<p>For the second time in the space of ten days, it appears that betting markets and pollsters have got it wrong. First, despite <a href="http://www.bloomberg.com/news/articles/2016-07-01/how-brexit-caught-investors-and-oddsmakers-off-guard">odds showing a 90% likelihood</a> of “Remain” winning, the UK voted to “Leave” the European Union in its June 23 referendum. </p>
<p>Now, a mammoth federal election campaign has resulted in political stalemate in Australia, and the result will not be known <a href="http://www.news.com.au/national/federal-election/2016-federal-election-uncertain-outcome-as-recriminations-begin-to-fly/news-story/fe06e93dc38df56861eb7b6a5e01f180">until Tuesday</a> at the earliest. </p>
<p>Clearly, the repercussions of a hung parliament are not as <a href="https://www.theguardian.com/business/live/2016/jun/24/global-markets-ftse-pound-uk-leave-eu-brexit-live-updates">wide-ranging as “Brexit”</a> and we are unlikely to see Canberra’s streets <a href="http://www.reuters.com/article/us-britain-eu-protests-london-idUSKCN0ZI0FA">flooded with protesters</a>. However, when Australian markets open on Monday they will still be faced with a high degree of <a href="https://theconversation.com/the-market-wants-turnbull-why-close-election-races-increase-volatility-for-investors-59171">political uncertainty</a>. Investors do not tend to react favourably to such ambiguity. </p>
<h2>Investors reduce risk under political uncertainty</h2>
<p>Investors tend to respond in one of two ways. The <a href="http://onlinelibrary.wiley.com/doi/10.1111/acfi.12107/abstract">most-common situation</a> is for the political uncertainty to manifest in higher levels of market volatility and a flight to quality as investors try to reduce their exposure to risk. </p>
<p>This was what we witnessed post-Brexit: Australian stockmarkets and the dollar fell by more than 3%, while “safe” government bond <a href="https://au.news.yahoo.com/thewest/a/31913757/aust-bonds-soar-as-brexit-confirmed/">yields hit an all-time low</a>. </p>
<p>An alternative is for markets to become locked in stasis – where investors sit on their hands, unsure as to whether they should buy or sell. Market liquidity falls and asset prices become resistant to change. </p>
<p>This is effectively what happened following the hung parliament of August 2010. In the aftermath of that election, stock prices remained within a tight trading range and the dollar hardly budged over the course of the following week. </p>
<p>When the result of the <a href="http://www.abc.net.au/news/2016-07-03/election-result-what-happens-now/7564250">2016 election</a> is finally known, it appears that the outcome will be either a minority Coalition government or a hung parliament. The Senate is likely to be more fractious than prior to the election. </p>
<p>Talk has already started about potential unrest among the conservative faction of the Liberal Party who supported former prime minister Tony Abbott. There is even discussion of an <a href="http://www.smh.com.au/federal-politics/federal-election-2016/election-2016-arthur-sinodinos-suggests-election-rerun-may-be-needed-given-cliffhanger-result-20160702-gpx8dz.html">election re-run</a> if the parliament proves ungovernable. Clearly, this uncertainty could linger for months.</p>
<h2>Concerns for jobs and growth</h2>
<p>The likelihood of a lengthy period of uncertainty is important. It means it will be <a href="http://www.smh.com.au/federal-politics/federal-election-2016/federal-election-2016-messy-result-may-lead-to-credit-downgrade-weigh-on-shares-economist-20160703-gpxajj.html">difficult to pass any economic or budgetary reforms</a>. Without such reforms, it is unlikely the budget will return to surplus in the near future (if ever) and it becomes more likely that the AAA credit rating will be lost. </p>
<p>This creates multiple concerns for Australian financial markets, and the broader economy. A credit rating downgrade will likely <a href="http://www.smh.com.au/business/big-four-banks-should-fear-a-downgrade-to-australias-credit-rating-20160414-go699i.html">increase the cost of funding</a> for Australia’s banks. </p>
<p>The <a href="https://theconversation.com/au/topics/big-four">Big Four banks</a> will be particularly impacted given the significant role that offshore funding plays in their balance sheet management. This will mean higher interest rates for borrowers – which would not be beneficial for the housing market.</p>
<p>A prolonged period of uncertainty will make it difficult for firms to finalise investment decisions. At a time when the economy is still attempting to transition away from the boom in mining investment this will dent economic growth and employment. So much for “<a href="https://www.liberal.org.au/coalitions-policy-more-jobs-and-growth-through-increased-trade-and-investment">jobs and growth</a>”. </p>
<p>Essentially, this is a recipe for a “<a href="http://www.sciencedirect.com/science/article/pii/S1544612316300228">risk-off</a>” environment of declining stockmarkets and a depreciating Australian dollar. It is also likely that the market will price a <a href="http://www.smh.com.au/business/markets/brexit-not-enough-to-force-july-cash-rate-cut-20160626-gpshgd.html">higher likelihood</a> of a reduction in the RBA target rate at the July or August meeting. This will further aid a continued rally in relatively safe government bonds (bond prices rise as yields fall).</p>
<p>If you consider the ongoing political uncertainty resulting from Brexit and the forthcoming US presidential elections in addition to the federal election, then months of nervous markets may lay ahead.</p><img src="https://counter.theconversation.com/content/61964/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lee Smales does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The prospect of a hung parliament or minority government may lead to investor uncertainty and little movement in asset prices.Lee Smales, Senior Lecturer, Finance, Curtin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/445702015-07-13T01:56:12Z2015-07-13T01:56:12ZHow China’s bull market could bleed into its economy<p>Don’t bet more than you can afford. Don’t borrow to play. Don’t chase your losses. Quit while you’re ahead.</p>
<p>If only Chinese stock market investors had followed these basic gambling rules. Seduced by dreams of getting rich quick, millions of inexperienced Chinese investors have lately been treating China’s stock market like a casino. With the help of social media, the optimistic sentiment spread quickly, pulling more in. The index for the main board of the Shanghai Stock Exchange almost doubled in the past year. The index of small cap stocks has tripled or better. It became a classic asset bubble. Then it all came crashing down.</p>
<h2>The role of the Chinese government</h2>
<p>The government-engineered bull market was meant to help resolve China’s real estate bubble and over-leveraged local governments, incentivise innovation and facilitate reform of state-owned enterprises. Instead, it was hijacked by highly-leveraged greedy individual investors. As the government became concerned and began to deleverage margin trading, it set off a stampede, with everyone rushing to the blocked exit doors because of the 10% price limit trading rule. Over the past three weeks the market dropped by 30%. Even after this correction, many small cap stocks remained over-valued.</p>
<p>In an effort to calm the market, the government has taken measures to buoy the prices of blue chip stocks, temporarily halted IPOs and lifted insider trading rules to make it easier for company directors to buy back their own shares. It has also imposed a one year stock sale ban on anyone owning 5% or more of shares in a company. When the government began focusing support on blue chips, at least 1,439 Chinese listed companies — 50% of overall listings — applied for a temporary trading halt in order to protect themselves. This also contributed to the panic.</p>
<p>Even Chinese companies listed in other markets were affected by the crisis. The hashtag #ChinaMeltdown began to spread on international social media. US investors began selling off stocks in Chinese companies listed there even though they are not affected by the liquidity crisis in the Chinese stock market.</p>
<p>Just before the Chinese market plunged, there had been a surge in US-listed Chinese companies planning to go private hoping to chase the higher valuations in the Chinese market with an eventual Chinese IPO. Many will have to delay these plans.</p>
<h2>China’s economy at ‘new normal’</h2>
<p>The Chinese market crisis is a reflection of the over-valuation and over-leveraging of small-cap stocks, and is not comparable to what happened in the US in 1929, which reflected a fundamental crisis in the US economy. The Chinese economy has already moved to a “new normal” stage in anticipation of a slower rate of growth as it transitions from manufacturing to consumption. China’s GDP growth rate is still 7%.</p>
<p>Investors in emerging markets tend to overestimate growth which leads to overvaluation. In China 85% of investors are individuals, unlike in developed markets where they are institutions. The turnover rate of <a href="http://www.chfsdata.org/chfs.html">these Chinese investors</a> is more than 900%, the highest in the world. The account balance of 84.1% of these investors is less than 100,000 RMB, and 10.39% have a balance between 100,000 and 500,000 RMB. Only 6% have a college degree. </p>
<p>Chinese investors also understand that the priority of the government is social stability; the government will step in when anything threatens that objective. This recent bull market can also be seen as a typical example of investors hijacking this sentiment.</p>
<p>The government knows it must rebuild investor confidence or the pessimistic sentiment could spill over into the banking sector. Some insiders believe that a significant portion of the capital that was used for margin trading actually came from the asset management products that were issued by the banks. If the banking sector is impacted, then the negative sentiment could spill over to consumers’ willingness to spend, which would then impact the overall economy. There have also been reports that some entrepreneurs have speculated in the stock market using their company’s operating capital.</p>
<h2>A lesson in market risk</h2>
<p>Any stock market is built on confidence and the expected value of future cash flow. The objective of the government should be to mitigate the systemic risk rather than managing the stock index. The government is over-protecting retail investors. The function of the capital market is to charge different prices or risk premium on firms relative to their risk levels. Everyone should understand the rule of the market: higher returns mean higher risk.</p>
<p>At the end of last week, as the market realised how determined the government was to handle the problem, some experienced investors began returning in a hunt for bargain stocks. I expect the market will gradually bounce back, though with some short-term volatility because small-cap stocks are still mostly overvalued and some investors are still highly leveraged.</p>
<p>The bull market spirit is still here, but hopefully both the government and retail investors will learn a valuable lesson from this crisis. The market is designed for long-term financing, not short-term speculation. Investors should respect the power of the market.</p><img src="https://counter.theconversation.com/content/44570/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Oliver Rui does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Chinese investors are learning to respect the power of the market, but the banking sector should know better.Oliver Rui, Professor of Finance and Accounting, China Europe International Business SchoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/346592014-12-21T18:50:47Z2014-12-21T18:50:47ZDark pools don’t deserve shady reputation<p>Dark pools are growing in popularity and now account for more than 15% of total trading in some stock markets. But despite such trading being blamed by some commentators for everything from market instability to a decline in market liquidity, new research shows dark pools may not be as menacing as first thought.</p>
<p>Dark pools are alternative trading venues that do not communicate the trading interest of individual traders to the rest of the market prior to a trade. </p>
<p>Ten years ago, someone looking to buy 100 Vodafone shares would have little choice but to place an order on the London Stock Exchange (LSE). However, changes to securities trading rules around the world and advancements in technology have led to a proliferation of new trading venues that compete with traditional exchanges. Nowadays that same trader, or their broker, can transact on a host of different venues that offer an array of trading protocols and fee structures. </p>
<p>These changes have been so effective at encouraging competition between venues that the market share of the LSE has fallen from upwards of 95% to around 50% in the past decade. In the United States, the market share of the New York Stock Exchange has fallen from around 80% to around 25% over the same period. </p>
<p>One advantage of dark pools is that they facilitate trading in between the existing best bid and offer, thereby lowering the trading costs for the buyer and seller. They may also <a href="http://www.economist.com/blogs/schumpeter/2011/08/exchange-share-trading">help large institutions</a>, such as pension funds, prevent “front-running” of their orders that need to be executed over long periods of time. </p>
<p>Naturally regulators are wary of how the migration of trading away from ordinary “lit” venues to their less transparent competitors will affect stock markets. By the very nature of their trading rules, it is easier for traders to “hide their hand” in a dark venue and hinder the transmission of information throughout the market. </p>
<p>Drawing trading activity away from the main exchange may also make markets less stable and could make trading more expensive for traders who only have access to that venue, such as smaller institutions and retail investors.</p>
<h2>Do dark trades make stock markets less stable?</h2>
<p>Using transaction data in 2012 from the Financial Conduct Authority, I <a href="https://sites.google.com/site/jamesbrugler/home/research/job-market-paper">investigated</a> the effect of dark trading on market stability. </p>
<p>This is measured in terms of liquidity, loosely defined as the ability to buy or sell shares without adversely affecting the price, and volatility on the LSE. Both liquidity and volatility have important implications for financial stability and for understanding who wins and loses in this new financial landscape. </p>
<p>The main challenge is to estimate this relationship while accounting for traders choosing when and where to trade in a strategic fashion. A crucial factor in making these decisions are expected transaction costs and liquidity on the main exchange. This “reverse causality” issue makes it impossible to understand how dark trading affects liquidity on the main exchange from looking just at the raw correlations between these variables. </p>
<p>To solve this problem, I exploited trading patterns of certain computer algorithms that are programmed to trade at regular, predictable intervals throughout the day, regardless of expected market conditions. Focusing on these predictable intervals circumvents the problem of reverse causality and allows us to understand the effects of dark trading at a high frequency. </p>
<p>At the levels occurring in the UK equity market in 2012, dark trading did not lead to a deterioration of liquidity on the LSE. Some measures of liquidity actually improved following dark trades, while others did not significantly respond one way or another. Dark trading also led to reduced price volatility compared with trades of similar size on the fully transparent main exchange. </p>
<p>These results suggest dark pools help to create new trading opportunities that otherwise would not exist. They also appear to be well integrated with other trading venues, a role that is filled by institutions trading actively across many venues simultaneously. </p>
<p>There are a number of important caveats to these conclusions and the results should certainly not be interpreted as an unconditional endorsement of dark pools. </p>
<p>Perhaps most importantly, <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2183392">other research</a> has shown the negative impact of dark trading may only manifest when it accounts for relatively high fractions of total volume. </p>
<p>Nevertheless, regulators should keep an open mind about the potential benefits of these venues, especially in terms of competition and the associated reductions in trading costs, when considering new legislation.</p><img src="https://counter.theconversation.com/content/34659/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>James Brugler does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Dark pools are growing in popularity and now account for more than 15% of total trading in some stock markets. But despite such trading being blamed by some commentators for everything from market instability…James Brugler, Ph.D Student, Faculty of Economics, University of CambridgeLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/203422013-11-18T19:19:19Z2013-11-18T19:19:19ZIn defence of active fund managers<figure><img src="https://images.theconversation.com/files/35377/original/chdm4d5g-1384492947.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">New research highlights the informed nature of buy-sell-buy trades.</span> <span class="attribution"><span class="source">Publik16/Flickr</span></span></figcaption></figure><p>Australian investors and superannuation funds have invested hundreds of billions of their life savings with active fund managers. These funds have very high fees compared with index funds to cover not only much higher trading costs but also better paid managers. Do Australians receive a benefit in exchange for high fees? </p>
<p>Many researchers believe that fund managers (i.e. institutional investors) actively intervene in company affairs to improve corporate governance and thus firm performance. If true, this would be a benefit.</p>
<p>But in a forthcoming article in the Critical Finance Review, I and Gavin Smith debunk the empirical evidence for this. To the contrary, concentrated institutional investor influence does not appear to raise either managerial incentives or lower chief executive pay. </p>
<p>Our findings are entirely contrary to what a prominent <a href="http://onlinelibrary.wiley.com/doi/10.1046/j.1540-6261.2003.00608.x/abstract">article</a> by well-known researchers <a href="http://cfr.ivo-welch.info/2014/smith-swan-2014.pdf">Jay Hartzell and Laura Starks</a> claim. See also <a href="http://cfr.ivo-welch.info/2014/hartzell-starks-2014.pdf">their rebuttal</a>.)</p>
<p>What then is the justification for active fund managers that typically turn over their entire portfolio in a year or less? Is this just useless churning or expensive “make-work”, as a number of researchers believe? </p>
<p>Are they simply appearing to do something to justify high fees and charges, and would we not gain if we all invested in passive funds simply holding the index? </p>
<p>And wouldn’t putting these institutional-churners out of business make us all better off?</p>
<p>The answer to all these questions is no! </p>
<p>My <a href="http://ssrn.com/abstract=2312325">research</a> shows that actions taken by the ASX Corporate Governance Council since 2003 to discourage participation by non-executive directors with “skin in the game” has actually damaged the Australian economy. </p>
<p>It has reduced the market value of the assets of the mostly large firms adopting these recommendations of majority “independent” boards by as much as 25% after five years “under treatment”. It gets progressively worse over time.</p>
<p>At the same time, firm responses to these recommendations have dramatically raised the pay of poorly performing CEOs and directors.</p>
<p>The good news is that not all monitoring of management needs to be done by boards with a flawed composition and lack of incentives.</p>
<p>In my article just published in the top finance journal, <a href="http://journals.cambridge.org/action/displayAbstract?fromPage=online&aid=8958525">JFQA</a> with two co-authors, David Gallagher and Peter Gardner, we show that firm performance considerably improves following informed trading and “price discovery” by Australian fund managers. </p>
<p>For the first time, we identify informed trades as sequences of trades such as “buy” followed by a “sell”, and then a subsequent “buy”. We dub these, “swing trades”.</p>
<p>The top echelon of Australian fund managers participated in this study in an unprecedented way by revealing their daily trades to us as researchers. </p>
<p>This kind of close cooperation is almost unprecedented, especially as in Australia there is no provision for compulsory revelation of portfolios. The United States requires quarterly snapshots for large fund managers.</p>
<p>Surprisingly, we show that our sample of fund managers was able to predict successfully relatively short-term changes in stock prices. </p>
<p>These trade sequences with frequent changes in direction are not simply mindless churning, as the critics maintain, since they are profitable even after transactions costs. </p>
<p>In fact, active funds make their money for investors by over-weighting stocks in their portfolio for which they actively trade.</p>
<p>The mechanism by which this informed trading raises firm performance is enlightening. </p>
<p>Prior to these trade sequences, information asymmetry is high, meaning that it is risky for uninformed investors to trade as those taking the other side of their trades are likely to be highly informed.</p>
<p>Following these trade sequences, not only are market spreads significantly lower, but stock prices now more closely align with the CEO’s actions.</p>
<p>This greater responsiveness to the CEO’s actions means that the very limited “skin in the game” of Australian CEOs is far more effective in disciplining poorly performing managers. </p>
<p>It is this disciplining role, actively discouraged by the ASX Governance Council, which results in the subsequent firm out-performance.</p>
<p>Unlike index-funds, active fund managers generate liquidity that is sadly declining in the ASX market. More importantly, by undertaking price discovery and informed trading, they drive stock prices to fundamentals. </p>
<p>Contrary to widely accepted views, a more efficient secondary stock market results in better investment decisions and greater wealth in the pockets of Australian investors and retirees. </p>
<p>Active fund managers are a crucial part of this process and as a result deserve our encouragement.</p><img src="https://counter.theconversation.com/content/20342/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Swan receives funding from the Australian Research Council. He is also a member of the Institute of Public Affairs.</span></em></p>Australian investors and superannuation funds have invested hundreds of billions of their life savings with active fund managers. These funds have very high fees compared with index funds to cover not…Peter Swan, Professor of Finance, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.