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IAI in Focus on High Frequency Trading Worries

Sweta Killa

High frequency trading (:HFT), though common in the U.S. over several years, has become more prevalent in recent months.

Worries over high frequency trading aggravated after the famous author Michael Lewis published "Flash Boys: A Wall Street Revolt” last week. The book criticizes the practice of HFT citing that super-fast computers, high-speed data networks and complex algorithms have resulted in profits of millions of dollars for the financial brokers and trading firms (read: 3 Diversified ETFs to Watch in Q2).

This is because traders take the benefit of fast-moving market information unavailable to other investors through advanced technology, and trade securities accordingly in blocks within a fraction of a second. This ends up in financial stock market manipulation and instability in the short-term price. Not only does this erode public confidence, it also affects professional traders and sophisticated market participants.

The book raised additional scrutiny on this type of trading by the Federal Bureau of Investigation. The agency is looking for the possible violation of insider trading law or any other law through high frequency trades, and joined with Securities and Exchange Commission and the Department of Justice for further investigation.

Market Impact

The increased scrutiny concern has led to the slump in the investment brokerage world with most of the stocks seeing terrible trading over the past week. E*TRADE Financial (ETFC) has seen the biggest drop of about 16% so far this month. This is followed by 10.7% loss for TD Ameritrade (AMTD) and 6.5% for Schwab Charles (SCHW).

The downslide was prompted by market speculation of a ban on the payment for order-flow deals by regulators. Trading and brokerage firms generate a big chunk of their revenues from lightning-fast trade and prohibition of order-flow deals would have a huge impact on their revenue streams (read: The Momentum Stock Crash Puts These ETFs in Focus).

The ETF world has also seen rough trading with iShares US Broker-Dealers ETF (IAI) down over 6% this month. This dip could be considered a buying opportunity for investors seeking to take advantage of this situation as HFT will stay alive and the ban on payment-for-order-flow is pretty unlikely.

IAI in Focus

This fund provides exposure to the investment services corner of the broader financial sector of the U.S. economy by tracking the Dow Jones U.S. Select Investment Services Index. The product holds 22 stocks in its basket with the largest allocation going to Goldman Sachs (GS), Morgan Stanley (MS) and SCHW. These three firms make up for over 6% share each (see: all the Financial ETFs here).

The ETF has a nice mixture of all cap securities with 41% going to small caps, 35% to large caps, and the rest to mid caps. It has a certain tilt toward value securities while growth and blend stocks collectively account for more than half of the portfolio. The product is rich in AUM with nearly $238.7 million and average daily volume of more than 114,000 shares. Expense ratio came in at 0.45%.

IAI pays out a decent yield of 1.20% per annum. The prospect of increasing dividend and buybacks calls for an optimistic outlook on the ETF. Financials has accounted for the largest increase in dividends in the last four years. This year has already seen dividend/buyback increases by finance companies following approval from the Fed after passing stress tests (read: 3 Financial ETFs to Play the Bank Stress Tests).            

Further, the fund currently has a Zacks ETF Rank of 1 or ’Strong Buy’ with a Medium risk outlook, suggesting that the product would outperform the broad market in the coming months. Moreover, the Zacks Industry Rank confirms the bullish trend for this space, as investment brokers actually have the best Rank (in the top 26%) for any industry at the time of writing. This suggests a bright outlook on these companies for the months ahead.

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