The rise of retail investment has made headlines lately, particularly in the U.S. as a result of COVID-19 fiscal stimulus packages that went to individual Americans. This retail rally has reached the UK, too, but the FT reported that Britain's stock market has been given the 'cold shoulder' by retail investors.
Image from Robinhood.
This retail investment trend captures some key themes going on in the market at the moment. Mainly, new tech providing access to industries for people at home that would be otherwise inaccessible. This in turn sparks ideas of democratisation and decentralisation of certain markets – but we will cover this in detail when we explore blockchain and crypto in another blog. So, then, let’s take a look at retail investing. As always, with reference to Bloomberg and the Financial Times as our primary sources.
A quick note, this is going to be US-focused as most of these trading apps companies are US-based. Don't worry - pieces on big data anti-trust in the UK and on the outlook for our UK post-COVID-19 economy are currently underway.
What is retail investment, and why the sudden popularity?
A retail investor is essentially a non-professional investor. In general, a retail investor can buy securities, mutual funds or exchange traded funds either through a traditional brokerage firm, an online broker or other types of investment accounts. Traditionally, because retail investors have little bargaining power, brokers can charge higher fees on each individual trade, as well as charge marketing, commission and other fees. Expensive. Regulation, advice and security in trading is expensive, though. So, in come the tech disruptors. Robinhood, for example, offers immediate smartphone access to trading stocks and options and offers zero commissions on trades - but, note, traders research stocks and manage portfolios on their own.
Wait, zero commission? How do they make money, then?
Typically, revenue can be draw in other ways like investing or loaning out the money they hold for clients, or by loaning customers cash to buy stocks, or offering securities for short selling and hoping to profit on the decline. Thanks to Bloomberg for this explanation.
Note also, these apps do not provide the same service as a commissioned broker. With so much data to manage on zero fees, for example, Robinhood data encryption and password protection has been lacking, as has its customer service. Robinhood also suffered some system outages in March due to overwhelming trading volumes and volatility. There have been a few cyber security issues, too, like account hacking and data breaches. Robinhood is now working on this, with Bloomberg reporting on a recent hiring spree of support staff. Essentially, though, if users want quick and effortless access to trading stocks and options but with few checks or protections, then retail investing is a way to do that.
But why did retail investing take off in 2020?
Let’s boil it down to two reasons: people are stuck at home; COVID-19 volatility allows traders to ride significant trends.
We are working from home, or furloughed, with access to unlimited resources on the internet and maybe have extra cash from government stimulus. How can there be extra cash in an economic crisis? Well, Bloomberg puts the issue quite nicely: “Relentless support of global central banks has also buoyed equity markets despite the worst economic fundamentals in living memory.” Finally, sports betting is off because COVID-19 ended matches initially – a quick aside, though, check out this innovative business that allows consumers to bet on player performance in the media (not just the field).
So, retail investment apps have their time in the sun. They ‘gamify’ trading through dashboard interfaces – allowing traders to manager their own portfolios – and charging zero commission on access to markets. This is likely why retail investment apps are so popular among millennials and first-time investors “whose time horizon until retirement is 40-plus years” (Bloomberg). For example, about 80% of Robinhood's assets under management come from millennial users.
Are retail investment trading apps like Robinhood shaping capital markets?
These outages and data hacks suffered by Robinhood left some room for competitors like E*trade, Ally Invest, Webull, and Charles Schwab. There are quite a few retail investment brokers trying to ride the surge in users. So, are all of these trading apps making a difference to the market? Well, in the short term at least, yes.
Bloomberg explains how this change has been possible quite nicely: "Perhaps [retail investors'] impressive performance comes down to their ability to react to headlines, or a penchant for risk-taking after coming out prosperous from a harrowing first quarter. Or maybe it’s a self-fulfilling prophecy. [Facilities like Robintrack - a stock popularity monitor - mean] one investor sees another piling into certain stocks, and then pours in too. Whatever it is, their picks are working."
Bloomberg reported in July that retail investors were outperforming some funds for buying low and selling high. There were trends in buying stocks in companies that filed for bankruptcy, and even petroleum stocks, that institutional investors would classify as too much risk. Tesla caught a wave of retail investor attention, too. There has been notable social media influence on stocks traded, especially with Robinhood who even trended on TikTok. Note, though, that risk doesn't mean always mean a chance of high profitability, it can mean that investing in that stock is reckless. Markets were impacted, though - some bankruptcy stocks rallied, as well as Tesla stocks. It is a matter of time, now, to see if this recovery is for the long run through COVID-19 and further.
More recently, it has been reported that these higher stock prices are likely to remain elevated. However, if this is with general disregard to the fundamental pillars of investing, then can these elevations be trusted? This kind of retail investing is probably causing market inefficiencies if stock prices are inflated or kept afloat for no good reason other than blind investment. Yet, perhaps because government stimulus may find itself injected directly back into capital markets through trading apps, then how do we value whether this rally is being achieved efficiently or not? For example, some reports of the heaviest investment are in pharma and biotech companies, and as far reaching as Hong Kong. It could be that in a time of great uncertainty, a surplus of investment could benefit capital markets and industries may be able to put to good use any equity, regardless of its origin. The price to pay for this risk and any downside to this great rally, of course, falls on the likely unprotected retail investor users of these apps.
As Bloomberg puts it: “Professional investors have watched with a combination of amusement and envy as retail investors mostly rejected the tenets of fundamental investing and bought companies at staggering valuations.” If retail investors are randomly ‘gaming’ the stock market, they probably aren't performing proper risk balancing of their portfolios. Retail investors have certainly cemented their spot right now, but it is just a matter of whether that interest will stay there. Will investors move onto professional investing once markets correct and COVID-19 volatility cools down; will they close their accounts; or will they find a new area to game? Let's see what happens in the next few months.
As stocks rally globally, we are reminded of a classic fundamental pillar of investing – one that might not be quite so obliterated by lucky mass investors as they achieved with bankruptcy stocks in June – "the market that keeps going up must inevitably, to some degree, come down".
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