HFT & Institutional Trading

Over the summer, amidst all the hullabaloo surrounding Michael Lewis’ take-down of high-frequency trading in “Flash Boys”, Ipreo weighed in on the topic. Well, mostly we stepped on the scale. Because when it comes to HFT, we’d been ahead of Michael Lewis by a mile (though we admit he totally scooped us with “The Blind Side”).

The reason we were ahead? Institutional Capture Rate (ICR).

We’d been discussing HFT for years, but from a slightly different angle. Most recently, in June 2014’s issue of our BetterIR newsletter, we looked at high-frequency trading from the perspective of our corporate clients: investor relations professionals. Because, for as ballyhooed as Lewis’ book was and as provocative as the topic was to financial pundits, few seemed to approach it from the IR side. We did, using ICR.

Ipreo determined that the questions that most investor relations professionals have in regards to high frequency trading – 1) Is it prevalent in the trading of my stock?; and 2) If so, how is it impacting the ownership of my stock? – could be answered by measurement of quarterly activity by long-term institutional investors, aka ‘Institutional Capture Rate’.”

Click to read the full BetterIR article.

In fact, we’ve been running ICR reports for our clients since as far back as 2006, and we’ve tracked the changes to market structure seen throughout this time with regular quarterly reports.

Earlier this week, we received ownership data giving us a complete picture of US ownership and trading data for 4Q 2014. Our report on the topic is available at the link below, but some key takeaways include:

  • S&P 500 median ICR falls slightly to 27.6% of volume sourced back to institutions. S&P 400 median ICR falls to 31.4%, S&P 600 falls to 35.2%.
  • Though all major groups showed lower ICR, as with prior Q’s, 4Q14 ICR continues to show the convergence of trading between large and small-cap stocks – likely less HFT overall impacting large-caps relative to small caps.
  • The major change to inputs here is a sharp increase in overall volume in 4Q thanks to energy / commodity prices, which generally tend to lower ICR all other things equal. Shorter-term traders represent a larger part of volume in these spaces as a whole.
  • S&P 500 volume increases slightly, with the spike in energy stock trading offset by flat trading in tech and consumer shares; ICR falls slightly on a mean/median basis.
  • S&P 400 volume jumps to its highest in over two years, with a heavier weighting of trading in the space associated with both energy and materials shares. ICR falls sharply in materials stocks, but rises in healthcare in particular.
  • One out of every ten shares traded on the S&P 600 in 4Q14 came from just three heavily traded stocks – Arch Coal, AK Steel, and Penn Virginia (the sharp drop in share-weighted ICR for the S&P 600 is sourced almost entirely to these three companies). Average ICR for S&P 600 Energy and Materials stocks dropped to about 17.5%, the first time we’ve seen this figure below 20% since 2009.

Click to read the full ICR report for Q4 2014.

Here’s a little background on the ICR metric itself:

Ipreo has developed the “Institutional Capture Rate” (ICR) metric to approximate the total amount of trading in a security that is driven by institutional activity. ICR attempts to measure the percentage of trading volume in a security that includes a long-term institutional investor on either side of the trade. ICR is calculated by dividing the sum of the total quarterly institutional share increases and the absolute value of total quarterly institutional share decreases by total quarterly trading volume of the security. Thus, the ICR “captures” the percentage of trading volume that is the result of long-term institutional movements with the balance being attributable to HFT and other fast money investors. In essence, the ICR is also an inverse indicator of high frequency trading. A lower ICR percentage indicates less trading volume coming from long-term institutional investors and more trading volume emanating from short-term traders, including high frequency outfits. For example, an ICR of 10% indicates that roughly 90% of that stock’s trading volume is bought and sold within a three-month period. The ICR, however, is not meant to be an exact measure; but when viewed over time and in context with your peer group, it is worthwhile indicator of trends and will help you understand the dynamics of trading in your stock.

Ipreo runs ICR percentages on a quarterly basis for all U.S. securities, grouped by their membership in the S&P 500 Index, S&P 400 Mid Cap Index, and S&P 600 Small Cap Index in an effort to gauge the impact of HFT on various market capitalization classifications.