Theorists will find no profits to be made in doing it by the book

PUBLISHED : Sunday, 02 January, 2011, 12:00am
UPDATED : Sunday, 02 January, 2011, 12:00am

'The [stamp duty on stock transactions] is also an important source of income for the government,' Chan told the South China Morning Post. 'The duty is a good regulatory tool as it adds to the costs for short-term speculators such as high-frequency traders. That is good for Hong Kong as that's not the kind of trade we want to attract.'

SCMP, Dec 13

I have a question for you. If you ever find yourself in need of open heart surgery would you prefer a surgeon who has performed the operation hundreds of times or one who assures you he knows what he is doing because he has read all the books?

Stop wasting good newsprint with pointless questions, you reply.

You are quite right. I stand admonished. Now let me review the career of Professor Chan Ka-Keung, Secretary for Financial Services and the Treasury. He holds a degree in economics from Wesleyan University followed by an MBA and PhD in finance from the University of Chicago. He taught for nine years at Ohio State University and in 1993 was named Dean of Business Management and Professor of Finance at the Hong Kong University of Science and Technology.

There you have it, the equivalent in finance of the surgeon whose credentials consist of having read all the right books. Not once has Chan held a real job in finance with a client to please in front of him and the whip of the company's profit and loss account behind him. He has no market experience.

It shows. Among the many things he fails to understand is how much the long-term investors, over whom he fawns, value the short-term traders he disdains.

They value them because they allow them to buy and sell many stocks that would otherwise be illiquid. I now apologise for that sentence, an object lesson in how sorely the English language lacks a proper reflexive pronoun - all those 'theys' and 'thems' tripping over each other.

But the point is that if you are one of Chan's favoured pension fund managers and you invest in Asia, you don't want to be bothered with having to track many hundreds of small positions across Asian stock markets. It's costly and a huge effort.

You also cannot afford to hold large positions in many of these stocks as a large position for you may be the equivalent of two weeks or more of the total volume of trading in that stock.

Not only will you then find the price rise against you when you buy it and fall against when you sell it, but you will be effectively locked in if something goes seriously wrong with the stock. The embarrassment of having to explain again and again to your directors or trustees why you are still holding on to this dud is an experience you do not relish.

But, glory be, the range of stocks that have sufficient liquidity of trading to qualify for inclusion in your portfolio is much larger than it otherwise might be, thanks to the presence in the market of greedy day traders and shifty-eyed speculators. Their trading gives you the keys to enter where you could not otherwise go.

What Chan fails to appreciate (in company with almost all academics) is that a healthy functioning market is a dynamic, chaotic thing, which is rarely orderly. Out of this turmoil of trading comes a remarkable amount of business at prices that hindsight confirms remarkably often to have been exactly the right ones at the time.

He should pay heed to the advice given Little Bo-peep when she had lost her sheep and didn't know where to find them. Leave them alone and they will come home, dragging their trades behind them. It works. Don't bother yourself too much with why. Things that you do not fully understand may still work perfectly well.

Professor Chan's understanding, unfortunately, is a good deal less than full. Aside from being prey to the notion that short-term traders endanger rather than enable markets, he seems to think that he will do the Hong Kong stock exchange a good turn by maintaining stamp duties when these are increasingly being abolished in other jurisdictions.

All he has really done, however, is render our exchange increasingly uncompetitive in an increasingly competitive global market. By the time he has discovered how seriously this has undermined the exchange it may be too late to turn things round again.

And his championship of transparency in scorn of 'dark pools' of trading will only serve to give to the short-term traders he disdains the trading information that will allow them to front-run his favoured pension fund managers. What a lovely irony.

Master surgeon K.C. Chan, learned it from a how-to book.