High-frequency trading has been good to billionaire Ken Griffin.
His Citadel LLC returned more than 300 percent in a fund started as a high-frequency strategy in late 2007, according to two people familiar with the Chicago-based money manager. The $830 million pool, which added other strategies in recent years, beat the 44 percent gain of the U.S. stock market in the six years through 2013 as well as Griffin’s two main hedge funds, which together have $8.8 billion in assets and rose 45 percent in the period.
The returns of Citadel’s Tactical Trading fund give a glimpse of the fortunes made in high-frequency trading -- the rapid buying and selling of securities that relies on ultrafast computers to exploit market inefficiencies -- following the financial crisis, and before profits shrank with increasing competition. The practice is facing unprecedented scrutiny following Michael Lewis’s latest book, “Flash Boys,” which argues that it has helped rig the U.S. stock market.
“High-frequency trading hit its high in 2008 through 2010,” said Larry Tabb, founder of market-research firm Tabb Group LLC. “Then the trades started getting crowded in U.S. equity markets and it got harder to generate revenues.”
Citadel’s Tactical Trading fund jumped about 31 percent in 2008, when the S&P 500 Index of U.S. equities slumped 37 percent and hedge funds broadly lost 19 percent. The fund has returned an annualized 26 percent since the beginning of 2008, with just five losing months, said the people, who asked not to be identified because the fund is private. The worst drop was a loss of 1 percent.
Mike Geller, a spokesman for Citadel at Edelman, declined to comment on the fund performance.
The return profile is very different from Citadel’s Kensington and Wellington funds, which plummeted 55 percent in 2008, a $9 billion loss that the firm didn’t recoup until 2012. The funds, which invest in everything from corporate debt to global stocks, lost much of the money on credit-market wagers in 2008. The funds returned 62 percent the following year as fixed-income markets rebounded.
Man, Machine and the U.S. Stock Market
Griffin, 45, has since seen improvement in his main hedge funds, which have returned an annualized 26 percent since their 2008 losses. His plan to build an investment bank following the financial crisis failed less than three years later amid departures of top executives.
Citadel Securities, its business of filling buy and sell orders for clients, pays retail brokers like TD Ameritrade Holding Corp. hundreds of millions of dollars to send orders its way, Lewis reported in his book, which also describes the unit as using high-frequency trading. Citadel Securities says it executes about 14 percent of U.S. consolidated volume in equities and 20 percent in U.S.-listed equity options volume.
The Tactical Trading fund has morphed over the years from being a pure high-frequency trading vehicle to getting about a quarter of its profits, on average, from the strategy, according to one of the people. In 2008, it engaged exclusively in high-frequency trading of stocks and futures.
In 2009, the fund added traditional market-neutral long-short equity trading, according to the person, and the following year, it also started using statistical arbitrage -- making money off of small price differences in correlated securities. The high-frequency trading is now exclusively in non-equity futures.
Earnings for high-frequency trading firms from U.S. stocks have been falling as more competitors entered the market, dropping to $810 million in 2012 from $4.9 billion in 2009, according to estimates from Rosenblatt Securities Inc., a New York-based brokerage firm.
To combat the lower returns, firms have started to add other kinds of trading much in the way Citadel has.
“In order to stay ahead you need to diversify your source of income and strategies,” said Sang Lee, managing partner at Boston-based research firm Aite Group LLC. “By introducing non-HFT strategies, they are looking to get more consistency in their returns.”
Lewis, an author who also writes for Bloomberg View, argues that the $23 trillion U.S. stock market is rigged in favor of speed traders, who he says prey on slower investors by getting early access to nonpublic information. The book and the media attention it has received have revived and magnified concerns that have circulated for years.
The FBI had already been probing potential criminal activity associated with high-speed trading. On April 4, U.S. Attorney General Eric Holder said the Justice Department is investigating whether the strategy violates insider trading laws. So is New York Attorney General Eric Schneiderman. In a March 31 interview on Bloomberg TV, Schneiderman urged the U.S. Securities and Exchange Commission to speed up its review and quickly issue new regulations.
One criticism of speed traders is that they use sophisticated algorithms to detect the moves of big institutional investors and then jump in front of their large orders. Speed traders can then profit from buying and then quickly selling a stock for a slightly higher price to the bigger, slower investor.
Joe Brennan, global head of equity investing at Vanguard Group, the world’s largest mutual fund company, said the majority of high-frequency traders “play within the rules” and even “knit together” the fragmented market by ensuring that prices stay in line with each other across different trading venues. That makes the markets more efficient and lowers trading costs for many participants, he said.
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