Guys and Dolls, ETF Schills, and Disclosure

Guys and Dolls. I never did see the movie. I actually never saw the play… before this past weekend. And this past weekend I got the pleasure of seeing it for three nights in a row! Why would I do that? Well, my son, Billy, who you may remember for his High Frequency Trading Documentary, played the role of Lieutenant Brannigan, and we could not have been more proud. So yes, I did find a way to brag about him this morning; that’s him in the trench coat below:

But really, there is a tie in to what we want to talk about this morning. My favorite line from the play is one Sky Masterson tells of his father’s advice to him years earlier:

“One of these days in your travels, a guy is going to show you a brand-new deck of cards on which the seal is not yet broken. Then this guy is going to offer to bet you that he can make the jack of spades jump out of this brand-new deck of cards and squirt cider in your ear. But, son, do not accept this bet, because as sure as you stand there, you’re going to wind up with an ear full of cider.”

He is warning to be wary of folks who out of the blue present a situation, or a bet, a study, or an interview, that supports their specific agenda or point of view as unbiased (or expertly credible). We have spoken out about this frequently, most recently in our blog post about Professor Angel’s studies supporting the merit and benefits of High Frequency Trading: Click to Read.

Today we have the opportunity to speak about it again! Many of you may have heard of the website Index Universe. It is a website full of content supportive to the ETF industry. Just look at the ads all over the site if you don’t believe me (for example ads for Proshares Vix Short-Term Futures ETF (VIXY) and Proshares VIX Midterm Futures ETF (VIXM)). The site generally is rich in content, and we have spent time on it ourselves researching the creation/redemption processes employed by ETF “Authorized Participants”. Well anyway, the website has just published an interview about ETF’s with the extremely esteemed Burton Malkiel, the professor who published “A Random Walk Down Wall Street”. Remember studying the “Random Walk Hypothesis” back in college? You know… stock prices are random; just diversify and hire a chimp to throw darts at the WSJ stock quote pages?

The interview link is here: Malkiel High Frequency Trading Is Good , and yes, they named it that, and not Joe and I. Shocked eh? Here is an excerpt:


Malkiel: Yes. I believe in the keep-it-simple-sweetheart school. I generally prefer buying something that represents the underlying securities, like a broad-based index fund.

And, incidentally, while we’re on the subject of what people think is bad, a lot of people are very negative about high-frequency trading, and I don’t buy it. I hear all the time that we ought to ban high-frequency trading, and that the little guy is getting hurt because it’s just the people with the huge computers that are going to make money out of this.

They may be picking up some loose pennies, but they’re helping the small investor, and this is another reason why I like ETFs. Suppose you have a broad-based ETF, say, the Russell 1000, and it gets out of line from the value of its underlying stocks. The high-frequency trader can create a unit and do an arbitrage the minute those prices get pennies out of line. And what that does is it forces the price of the ETF to represent the price of the underlying assets. I like that arbitrage. And yes, if these guys pick up some loose pennies doing it, that’s fine. It helps the small investor; it doesn’t hurt the small investor.

Ludwig: I imagine you’ve taken measure of some of these critical reports that have come out about ETFs, including two from the Kauffman Foundation. Do you have an opinion about these?

Malkiel: I saw the first Kauffman report, which I didn’t like. If somebody is shorting an ETF to get its price in line, but owns the underlying stocks, I’m not worried about that. And I don’t think one should be worried about that. I don’t care what the short interest is.


So, what is our beef? Aside from the fact that it is the old simplistic “high frequency trading lowers costs; you can even buy ETF’s for no commission” argument? (red-flag). Disclosure.

Mr. Malkiel is on Vanguard’s board: Vanguard Board Member and Trustee for Numerous ETF’s. He is paid by Vanguard. In 2008 he did a promotional world tour for Vanguard, even visiting Australia, promoting its ETF product line.

Mr. Malkiel is also the founder and Chief Investment Officer of Alpha Shares LLC, a China-focused ETF firm! His biggest ETF’s at Alpha Shares is YAO (Guggenheim China All Cap ETF). Here is Forbes’s Matt Schifrin calling out Malkiel for talking his book LOL: Malkiel Schills for Indexing Again, But Backs Baidu Just In Case.

So here you have the expertise of an ”Esteemed Professor” on Index Universe, a website that, umm, is not averse to ETF’s, lending all the credence of his Princeton-ness, and Harvard-ness, and Random-Walk-ness, making statements about highly complex high frequency trading, and how good it is, because……  ETF’S depend on high frequency market making.  [High frequency market making is the art of making a security look liquid, with robust bid-asks, despite the propensity for that robust quote to go “poof” should you actually really need it. See May 6th]  

He does this in an interview with no disclosure of his board memberships, how he is paid, and how he is staked.

Again folks, follow the money, especially when out of the blue someone tries to get you to bet on a card trick. Damn. Now I need a wash cloth to get the cider of out my ear. And I need a smoke.