Man Versus Machine?

This week CNBC has been running a relatively in depth series called Man Versus Machine. While I have not seen every installment I tend to get the same message from these things which is that anyone working without algorithms and plugged into the best hardware is at a serious disadvantage. I don't know the magnitude to which people are disadvantaged but the idea that a PHD from MIT has better technology and access to better information than some guy who works outside the industry and is trying to decide whether Microsoft (MSFT) still fits into his portfolio has plenty of merit.

As opposed to fighting this from here in the woods or from wherever you might be I think the solution includes a measure of using the "machine's" weight against it in a manner of speaking as a form of avoidance or deflection. To the extent that "the machine" is looking for beta, index replication, scalping other large traders or anything else they might be trying to game you can simply avoid the most popular ETFs.

SPY averages 198 million shares per day. IVV, the iShares version of the S&P 500 averages a little under three million shares. There is probably more opportunity for the machine in SPY than IVV. iShares Emerging Market ETF (EEM) trades 54 million shares per day while the Schwab Emerging Market ETF (SCHE) trades 110,000. It's not often you read an argument for going with the thinner fund but these two examples are not that thin and to the extent the machine bothers you it is obvious in the numbers that the machines are doing less in these funds.

The better path involves looking yourself in the mirror and figuring out just what type of market participant you are and how much any of this matters to you. If you have owned EEM continuously for the last five years with no plans to sell how much does it matter in the context of you being on the path having enough money in the future that one quant shop is trading this fund every ten seconds or that an HFT shop is trying to pick off some endowment fund's trade?

I would be more interested in the fact that in the last five years EEM is up 57% versus a 9% decline for SPY and my decision to keep it or not would be based on my expectations for the future like maybe the next five years but there is no right answer. Anyone who cannot overcome this issue would be justified in selling and figuring another way to get the exposure.

One word of caution would be that it is often mutual fund companies, as in traditional mutual funds, getting scalped, picked off or whatever they are calling it. You can buy individual stocks that are off the beaten path but Cementos Lima (CEMTY), to pick one example, hasn't traded since August 24 and that was only 500 shares. You could go with Compania de Minas Buenaventura (BVN) which is NYSE traded, averaging 900,000 shares per day, but then you are possibly at the whim of the machine again.

For people looking to trade actively with a goal of something like making $1000 per day, people do do this successfully, then you probably just live with this. Perhaps you resign yourself to the fact that if it takes you 25 trades to know whether you have succeeded or failed for the day that 10 of your trades will not get a very good execution for being beaten to the punch one way or another.

Likewise if you are an investor, as opposed to trader, and you make a dozen trades in a year or two there will be some number where you have to pay a few more cents than you otherwise might have to sell for a few cents less than you otherwise might have, however bad you think that is, a few years ago stocks were quoted in twelve and half cent increments. If someone tried to make that much off of you on trade now you'd think it was a felony.

If you bought PetroBras exactly a year ago and still have it you are down 22%. The last thing on your mind now is whether you paid four cents too much on your trade execution. If you bought the stock yesterday mid day and were out by the close then that four cents matters a lot. Chances are there are not a lot of people reading this post where the four cents does matter but a reminder of that can be useful.

An important thread on this site, and more importantly what I try to do for clients, is to manage a portfolio with an eye toward adding value over the course of the entire stock market cycle with a diversified portfolio. This means some combo of stocks, ETFs and maybe an open end mutual fund or two. Ideally anything purchased would be so correct of a decision that it could be held forever. In the current portfolio there are 15 holdings that have been there five years or more with a couple more on the verge of having been held for five years and a couple more that were temporarily out of the portfolio for a short while in that time. The 15 is a large number versus the total number of holdings.

You understand whether or not any advantage the machine has on you is actually a determining factor in the outcome you seek. If not, then I would not devote a whole lot of time to this. If so, then you'll need to figure a solution that you can live with.