Re-visiting Institutional Capture Rate and High Frequency Trading

End of week thoughts on a variety of issues impacting investor relations, the markets and the investment community, from Chris Taylor, EVP, Global Research, Thought Leadership & Partnerships

We are jumping in the time machine to go back to a topic that we first addressed in 2009 with a BetterIR article titled “High Frequency Trading: Gauging the Impact on Your Stock.”

While we certainly weren’t the first to speak about HFT, our efforts were focused on bringing an understanding to its impact on the trading in our clients’ stocks via a measurement we call Institutional Capture Rate (“ICR”). Since our piece in 2009, the topic of HFT went from an arcane subject that was discussed only by participants in the equity markets to an arcane subject that caught the interest of both board rooms and bar rooms across America. We can thank the 2014 publication of Michael Lewis’s “Flash Boys” and his “the stock market is rigged” quote in an exposé by the television show “60 Minutes” for bringing HFT awareness to the masses. 

Let’s get back to ICR. While ICR is not meant as an exact measurement of HFT, it provides valuable context allowing IROs to see if the presence of short-term trading is more prevalent in their stocks compared to sector peers and companies with similar market caps. 

ICR is an inverse indicator of short-term trading. A higher ICR figure indicates a higher percentage of trading volume being transacted by investors with longer term investment horizons. A lower ICR figure indicates the opposite, a lower number of shares being transacted by long-term investors and a higher percentage of volume being transacted by short-term investors and traders. We calculate ICR by dividing the sum of the total quarterly institutional share increases and the absolute value of total quarterly institutional share decreases by total trading volume of the security in the same quarter. The resulting ICR “captures” the percentage of trading volume attributable to movements by traditional institutional investors. An ICR of 15% gives an indication that 85% of that stock was bought and sold within a three-month period. 

Again, ICR is not meant to be an exact measurement of HFT or overall short-term trading in a stock. Rather, ICR is best used as a barometer across periods of time to understand the short-term influences in your stock and across peer companies to determine if the trading in your stock diverts from what is typical in your sector or market-cap range. 

We have seen a meaningful decline in ICR throughout 2015 that has persisted into the first quarter of 2016. The dip is consistent across all market caps as measured by ICR averages for the S&P 500 (large caps), the S&P 400 (mid caps) and the S&P 600 (small caps).

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ICR as of March 2016 across market caps has hit its lowest points since late 2011 and early 2012. Conversely, ICR averages have continuously indicated that short-term trading is more prevalent in large caps than small caps. One positive of HFT, according to its proponents, is the liquidity they add to the marketplace. Unfortunately, this liquidity mostly goes to the stocks that need it least, large caps, and not to those that need it most, small caps.

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Since December 2011, ICR spent a vast majority of time above the linear trend line across all market caps. 2015 saw a reversal with ICR, and thus a decline in trading by long-term investors, across all market caps. So, what’s changed?

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Trading volumes, particularly for large caps, remain at historically low levels. However, volume did materially increase in 2015 across all market caps. Trading volume is a friend to short-term traders, particularly HFTs. Higher volumes equate to more opportunity for short-term trading, which then drives volumes higher.

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If volume is a friend to short-term traders, volatility is their soul mate. Figure D charts the 60-day moving average of the CBOE Volatility Index (“VIX”) along with the ICR of the S&P 500 from March 2008 through March 2016. The VIX, which measures the implied volatility of S&P 500 index options, is commonly used as a measurement of market volatility. If you look back to late 2008 and early 2009, the financial crisis brought an enormous rise in the VIX along with a sharp decline in ICR. Over the last couple of years, our markets have been much less volatile and ICR remained at relatively high levels. The VIX climbed off its lows in early 2015 and hit its highest point since 2Q 2012. As would be expected, ICR starting moving lower indicating that short-term trading became a bigger part of the day-to-day market.

Good or bad, short-term trading and HFT is going nowhere fast (sorry, pun intended). Reviewing your stock’s ICR and viewing it against industry and market-cap peers quarterly is an effective way of understanding the impact today’s equity-market structure is having on your stock.