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How Sustainable is Your Advantage? Redux.

January 16, 2014

The ability to obtain information that leads to insights concerning market trends is frequently considered the mark of a savvy investor. However, as we noted last July, many methods of acquiring information are coming under increased scrutiny. Regulators and the public may deem even entrenched practices unfair. As we suggested then, managers and investors should take the time to review how they obtain their edge. If an advantage looks unfair, now is a good time to consider whether to defend it or to find a new way to make money.

 

Two recent developments underscore this point. 

 

First, a recent Department of Labor’s Inspector General report expressed concerns about the manner in which the DOL released market-moving information about unemployment claims. The report recommends either eliminating or terminating the current practice which was seen to favor some investors.  This particular issue impacts algorithmic traders.  However, the desire to reduce “unfair advantages” repeats a theme that we expect to continue for some time.

 

Second, the New York Attorney General settled an investigation into BlackRock’s alleged practice of obtaining insights into research reports by surveying investment banking analysts about the firms they cover. Part of New York’s “Insider Trading 2.0” probe, the Attorney General’s office is focused on taking “action against those who provide unfair advantages to elite traders.”  This follows New York’s effort last summer to have Thomson Reuters suspend its practice of giving higher paying customers a two second edge on the University of Michigan's Consumer Confidence Index.

 

Expect to see a lot more activity at the state level, according to RFG Senior Consultant Mona Benach.  “In particular,” she notes, “New York has more tools at its disposal under the Martin Act than federal regulators do. This legislative advantage will be used and could be powerful.”

 

And with the SEC creating greater incentives for whistleblowers, the inside scrutiny of competitive advantages could be amplified as well. In fact, it was an employee whistleblower that brought the Thomson Reuters service to the attention of the New York Attorney General.

 

Investors, concerned for the sustainability of a fund’s track record, should also ask whether fundamental practices are at risk in today's environment.

 

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