Within 24 years at The Nasdaq Stock Market (Nasdaq), Adena Friedman went from working as an M.B.A. intern (1993) to making history as the first woman to head a global exchange on January 1, 2017, when she was named President and Chief Executive Officer (CEO). Prior to taking the helm as CEO, Friedman spent almost three years driving efficiency, product development, and growth across all Nasdaq business segments as President and Chief Operating Officer (COO) (2014 to 2016).
There were a couple of detours along the way, including The Carlyle Group, the fourth largest private equity firm in the world, where she served as Chief Financial Officer (CFO) and Managing Director from 2011 to 2014. As CFO, she played a critical role in taking Carlyle public in 2012, which gave the future CEO of Nasdaq invaluable, first-hand experience of the other side of IPOs: being a prospect pursued for an IPO listing.
Before Carlyle, Friedman held key positions on Nasdaq’s management team for over a decade, most recently as Chief Financial Officer (2009 to 2011) and Executive Vice President of Corporate Strategy and Data Products (2000 to 2009). During this period, she led several key acquisitions that expanded the scale and scope of Nasdaq, e.g., INET, OMX, and the Philadelphia and Boston Exchanges.
The Nasdaq was the first electronic stock exchange when it opened its virtual doors in 1971. Today, while it is still a leading stock exchange, where some of the most famous global companies are listed and traded, Nasdaq is also a global technology company that serves the capital markets and other industries with data, analytics, software, and services. As of December 2021, Nasdaq was the second largest stock exchange in the world by market capitalization of listed companies. Nasdaq’s tech-heavy portfolio of the biggest global brands—including Apple, Amazon, Microsoft, and Google—drove impressive performance over the 10-year time frame through March 2021: 444.12% for the Nasdaq Composite Index and 552.24%, for the Nasdaq 100 Index.
Nasdaq’s transformation into a leading global exchange and technology solutions company with operations across six continents has been credited to Friedman’s strategic and operational expertise as well as her vision of the role that capital markets play in the 21st century. For example, in addition to pursuing growth opportunities—such as diversifying Nasdaq into data research services and SaaS (software as a service)—Friedman has leveraged Nasdaq as an “engine for capitalism” that makes investing more accessible by bringing companies back to the public market. To advance corporate diversity, which she considers a key driver of equitable capitalism, she led Nasdaq’s successful proposal to the SEC to require companies listed on its exchange to publish board diversity data. Among other awards, she has been named to Barron’s list of the 100 Most Influential Women in U.S. Finance.
Given Friedman’s long and successful tenure at Nasdaq and her history-making career in the capital markets, I spoke with her about the future of stock exchanges and the impact of new technology and investing trends, including the steady gains that passive investing has been making against traditional active investing models.
Active vs. Passive Investing
We began our conversation with Friedman’s perspective on the debate over active vs. passive investing, which has been going on since 1975, when Vanguard founder Jack Bogle created the first index fund as an alternative to active strategies that require high-priced portfolio management teams focused on beating stock market returns and taking advantage of short-term price fluctuations. Since then, index investing, which seeks to replicate the performance of a financial market index (like the S&P 500), has been the most common form of passive investing, a term for any buy-and-hold investment strategy that avoids the cost of an active human team by trying to match—not beat—the performance of the market. (ETFs and robo-advisors are also examples of passive investing strategies.)
Now that the consensus in the investment community is that the steady growth of passive against active investment vehicles in the U.S. market will continue for the foreseeable future, we discussed how this trend will shape the future of the exchange.
“I believe that there will—there has to be—a balance between active and passive,” Friedman said. Although Nasdaq “likes the passive world” and has “about $200 billion of assets under management tied to index products that (they have) created,” she cautioned that “if every single dollar coming into the market is a passive seller and there’s no individual thought going into making investment decisions,” that could lead to “a herd mentality” that would create “a huge opportunity” for arbitrage (the simultaneous purchase and sale of the same asset in different markets to profit from tiny price differences). This could make active investors come into the market, which could lead to “total (market) dislocation,” i.e., large, widespread asset mispricing that happens when financial markets operate under stressful conditions.
However, with investment research firms reporting that few (if any) active mutual funds perform better than passive index funds (especially over the long term), Friedman said that the biggest passive vs. active issue “over the next 10 to 20 years” is that “active managers (will have to) rethink what value they provide and how much they can charge for that (value).”
Friedman touched on another important consideration in the active vs. passive debate, i.e., two different measurements of historical performance: alpha and beta. Alpha, which active investors try to keep high, is a measure of a portfolio manager’s “edge,” i.e., their ability to outperform a market index. Beta, which passive investors try to keep low, is a measure of an asset’s risk against systematic market risk, i.e., risk that is inherent in the market as a whole (not just a particular company or industry), including the impact of all economic, geopolitical, and financial factors.
“When the market is primarily going in one direction (toward passive investing),” Friedman said that “it becomes increasingly difficult for active investors (who are compelled to seek alpha) to differentiate themselves from the beta of the market.”
Migrating Capital Markets to the Cloud: Artificial Intelligence, Alternative Data, Machine Learning
Although there could be “(a market) cycle that will allow (active investors) to differentiate themselves positively (from) a passive fund,” Friedman said that active investors could also find “new ways to differentiate themselves through alternative data and…artificial intelligence”—two examples of active investment tools that are not open to passive investors.
For example, under Friedman’s leadership in 2021, Nasdaq announced a multi-year partnership with Amazon Web Services (AWS)—the cloud services provider that controlled 33% of the entire market in 2021—to build the next generation of cloud-enabled infrastructure for the world’s capital markets. Co-designed Nasdaq-AWS platforms will deploy two technologies that Friedman predicts will have a huge range of applications in the financial industry—and both are based on algorithms, i.e., series of instructions that tell computers how to accomplish specific tasks. The first, artificial intelligence (AI), is a set of algorithms to enable computers to mimic human intelligence and cope with complexity; the second, machine learning (ML), is a set of algorithms to enable computers to learn from previous outcomes, make predictions, and complete tasks without being programmed.
As Nasdaq migrates capital markets to the cloud, the AWS infrastructure will provide AI and ML to power high-frequency trading (HFT) systems that deliver an enormous competitive edge by leveraging complex algorithms to analyze multiple markets simultaneously and execute large numbers of orders within seconds. Not only will AI and ML allow Nasdaq to deliver real-time, mission-critical data to the investment community, but these algorithms will also enable the use of extremely large (and previously unusable) data sets to create structured data and build applications.
Friedman’s other suggestion for active investors seeking to differentiate themselves is alternative data, which (in finance) means data from a wide range of non-traditional sources that investment firms can analyze to find a market edge. The sources can be anything from metrics on web traffic, app usage, and social media to satellite imagery on mall traffic, GPS data from cellular networks, and corporate aviation intelligence. For example, in 2018, shortly after Friedman’s promotion to CEO, Nasdaq acquired Quandl, an alternative data company that tracks private jets—including an Occidental Petroleum corporate jet that landed in Omaha, the headquarters of legendary investor Warren Buffett, in April 2019. In this scenario, active investors, anticipating that a major energy deal was about to happen, could act swiftly to take advantage before the Occidental share price soared skyward.
Frictionless Trading and Market Efficiency: Artificial Intelligence, Blockchain, Quantum Computing
As our conversation turned to how the rapid evolution of technology across capital markets will impact the way exchanges operate over the next 10 to 20 years, Friedman said that the essential role of exchanges as “central hub(s) where buyers and sellers come together will continue to be very much alive and well.” Without exchanges acting as intermediaries, “a buyer of a company and a seller of a company” would not be able “to buy and sell at a price they are looking for at a time that they’re looking for.”
On the other hand, Friedman said that technology will certainly have a significant—and positive—impact on the way exchanges operate in (at least) two core areas that are currently not optimal: frictionless trading and market efficiency.
“The (current) level of friction”—the total direct and indirect costs associated with the execution of financial transactions—has been “a very hard nut to crack“ for all stakeholders, including “the broker dealers, all the intermediaries, and the investors, particularly institutional investors.” She anticipates that, within 10 to 20 years, the entire trade settlement process—from the date that an order is executed in the market to the date that the trade is finalized—will be “much more streamlined…across asset classes“—and that it will be driven by blockchain or a similar big-data analytics technology.
Friedman’s second example of a currently suboptimal area that will be expedited by technology is the slow progress from market inefficiency to perfect market efficiency: a hypothetical market condition in which share prices reflect all available, relevant information, so there are no undervalued or overvalued securities and no way to “beat” the market. Her predictions as the most likely technologies to solve market inefficiency are artificial intelligence (AI) and quantum computing. Looking ahead over the next 10 to 20 years, AI is already being deployed, and prototypes of quantum computers, which use the properties of quantum physics to store data and perform computations, can already calculate “158 million times faster than the world’s fastest supercomputer.”
As the “march towards (even more) actionable…artificial intelligence” continues, Friedman said that the entire investment community will be able to “synthesize…mountains of data,” draw much better conclusions, and make much better decisions. “If you (could) then pile on top of AI…the potential of quantum computing” to analyze “thousands of outcomes in seconds,” all investors would have all the necessary data to determine the right price to buy or sell every company and asset class—and capital markets across the globe could theoretically become perfectly efficient.
Regulatory Technology: Deep Learning AI
Another crucial area for Friedman as she charts Nasdaq’s future is RegTech (regulatory technology) to manage all monitoring, reporting, and compliance processes within the financial industry.
In fact, Friedman considers RegTech the most important artificial intelligence technology that Nasdaq has already deployed, i.e., the market monitoring products that “root out bad behavior, market manipulation, (and) insider trading—all the bad things that make markets unfair.” For example, in 2019, Nasdaq launched an artificial intelligence platform to boost their market surveillance functionality with new technologies to expand the range of malicious activity their systems can detect. The platform includes: deep learning (to identify extremely complex patterns and hidden relationships in massive amounts of data); transfer learning (to create new models from old models, e.g., to detect new forms of financial crime in new markets); and human-in-the-loop learning (to allow analysts to share their expertise with the machine efficiently).
Nasdaq’s AI technology is “such a critical part of (the) roadmap” to ensure that “all the right defenses (are) in place” to eliminate bad behavior that the company launched their market surveillance technology beyond their own market to other markets and the broker dealer platform—a total of “50 other exchanges, 12 regulators, and about 160 broker dealers.”
Blockchain and the Stock Market
When asked what Nasdaq was doing with blockchain, a distributed ledger technology (DLT) for maintaining secure, decentralized records of transactions that can be shared (distributed) but not edited, Friedman replied that “the public equity market is not going to be the first place that blockchain disrupts the world.” However, she added that Nasdaq is “using blockchain for proxy voting” and making investments in companies that are focused on “stable points” of the blockchain structure. Those areas are where blockchain will have “the most impact (on markets) over the next five years.”
Digital Currency in the Nasdaq of the Future
Although “the jury is still out” on whether digital currency will ever become “an actual fiat” that is widely used for goods and services, Friedman said that a currency like Bitcoin “is (certainly) not used…for that purpose (right now).”
Of all the cryptocurrencies, Friedman sees one class as having the fastest track to adoption: stablecoin, which offers the price stability of fiat by pegging the market value to a reserve asset, such as the U.S. dollar or the price of a commodity, like gold. Unlike other cryptocurrencies, this price stability means that the minting of stablecoin is “just digitizing a currency in a way that takes friction out of the system and allow(s)…the transfer of money in a faster, more efficient way.”
Will IPOs Still Matter?
As she considered the future of IPOs and the significance of going public on the Nasdaq, Friedman said that the real question is whether there will be “a convergence between the private markets and the public markets” within the next 20 years. While she believes that a public-private market convergence is inevitable, “right now the private markets are really only available to the wealthy”—such as “accredited investors or qualified purchasers.”
The Technology Underpinning Capital Markets
Under Friedman’s leadership, Nasdaq, the company that pioneered the digitization of the trading process, has remained committed to digital innovation that promotes transparency and drives access to the financial information that powers capital markets.
For example, now that “consuming and managing datasets in the cloud is…the norm,” Friedman led Nasdaq’s 2021 launch of Nasdaq Data Link, a cloud-based platform that provides “all segments of the investing public with a comprehensive suite of core financial, fund, and alternative data…to generate alpha, manage risk, and gain transparency into public and private markets.”
In the era of low-cost products and falling prices for trade execution, Friedman said that Nasdaq’s most important function over the next two decades will be “to provide the technology underpinning the data and insights (that) allow…capital markets around the world to flourish.”