The Death of Buy and Hold

Last Updated Jan 13, 2011 9:43 AM EST

"Computer trading, dark pools and exchange-traded funds are dominating market action on a daily basis, statistics show, killing the buy and hold philosophy still attempted by many professional and retail investors alike." [emphasis mine] So begins the article "Investing Dying as Computer Trading, ETFs & Dark Pools Proliferate."

The article went on to explain that high frequency trading accounts for 70 percent of market volume on a daily basis and that the average holding period for U.S. stocks is now just 2.8 months. Alan Newman, author of the Crosscurrents newsletter, went so far as to state: "The theory that buy-and-hold was the superior way to ensure gains over the long term, has been ditched completely in favor of technology."

The article also discussed the fact that so-called "dark pools," of off-exchange trading, accounted for more than a third of the trading volume in December, supposedly damaging price discovery, an essential element for a fair securities market.

As Mark Twain famously put it: "The report of my death is an exaggeration." If the advent of hyper trading and dark pools actually created advantages for active investors, we should see evidence of that. Yet, according to data from Bank of America Merrill Lynch, the failure of active management had never been as bad as it was for the first 11 months of the year. Overall, about 25 percent of active managers beat their benchmarks, with BoAML calling this the "toughest year on record" for active managers. Looking deeper, about 33 percent of growth managers, 18 percent of value managers and 12 percent of core managers demonstrated outperformance.

And if anyone should be exploiting those buy-and-hold investors it should be those sophisticated hedge funds, the ones doing all that hyper trading. Yet 2010 was a terrible year for hedge funds, as the 5.2 percent return for the HFRX Global Hedge Fund Index lagged behind most major indexes.

And while many bemoan the high-frequency trading, all that trading is actually a plus for buy-and-hold investors. All of the computerized trading has led to a significant drop in trading costs as bid-offer spreads have narrowed. Gus Sauter, who runs Vanguard's index funds with about $1 trillion of assets under management, told Forbes that, "We do think [high-frequency trading] enhances the marketplace for all traders."

Sauter is referring to the fact that the increased trading has enhanced liquidity, providing benefits for long-term investors. Multi-million dollar portfolios can be now be purchased or sold in a matter of minutes, with minimal transactions costs, thanks to the presence of many other market participants trading shares back and forth. Imagine trying to do that an assortment of real estate properties.

Here's another way to think about this: Suppose all those "dark pools" and the other active traders disappeared. We would probably be reading articles about "the death of liquidity."
All the noise surrounding the high-frequency-trading is created by those that stand to benefit from investors who abandon the winner's game of passive investing. It's nothing more than what my MoneyWatch colleague Jane Bryant Quinn called investment porn. It's designed to get you to alter your strategy to one that makes them more money.

More on MoneyWatch:
Stocks Are Dying, Again Why Buy-and-Hold Isn't a Good Strategy Active Managers Continue Lagging Their Benchmarks Setting the Record Straight on Municipal Bonds Why Good Economic News Isn't a Good Indicator for Stocks
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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.