Alan Grujic, Founder and CEO, All of Us Financial
At the start of October, Charles Schwab, a broker with a nearly 50-year history, announced it was introducing fee-free trading. This legacy player was almost certainly responding to seismic market changes brought about by challenger brokers, most notably Robinhood, who have long offered fee-free trading.
If transaction fees were the golden egg sustaining the brokerage industry, Robinhood was the farmer who broke it. Canny observers will note that it was only a matter of time until the rest of the industry followed suit, with legacy players either reducing or eliminating the fees they charged per trade. It is, after all, hard to compete with free.
This leads to critically important questions: If the entire industry pivots to fee-free trading, how will brokerages make money? And, crucially, can brokerages make money without undermining the interests of their customers, many of whom have embraced the stock market for the first time in their lives?
From Mobiles to Markets
On its surface, no-fee trading sounds exciting, but the truth is these fees never needed to be charged in the first place.
Think of telco operators back in the 90s, who all tripped over themselves to offer free long-distance calling when in reality it didn’t cost more money to place a long-distance call than a local call. Technical advancements made it impossible to charge long-distance, and once the first operator sought out a competitive advantage, they all followed. In a similar way, the time for extraneous fees in investing has ended. However, the real financial boon to brokerage firms isn’t just in trading fees, it’s in the amount of money they earn on each individual customer, figures they’ve never been willing to share.
For much of their history, brokerages charged investors crushingly-high fees. Each buys or sell order came with a commission attached, which could cost $10 or more. In addition, small “mom and pop” investors often paid annual maintenance fees, either as a percentage of their portfolio or as a flat sum. Collectively, these charges disproportionately diluted any potential profits, thereby deterring many low-net-worth individuals from investing in the stock market.
And like long-distance calling, these fees were wholly unnecessary. Few knew that the cost to place a trade was negligible compared to the sum levied by the brokerages. And it wasn’t long until a new generation of startups figured this out and launched their own commission-free trading platforms.
This happened in 2013, with the launch of Robinhood. This platform, which boasts 6 million users, is today worth an estimated $7.6 billion. That figure will inevitably grow as the company expands. It’s currently in the early stages of European expansion, with a UK launch expected later this year. Across the Atlantic, Freetrade offers a similar service. In April this year, the app-based broker raised £1 million (roughly $1.2 million) in 77 seconds via Crowdcube, a popular equity crowdfunding platform.
The enthusiasm for these platforms highlights two unassailable truths. Firstly, there’s a large appetite among retail investors for services that cheaply facilitate stock trading. Secondly, and even more to the point, many of the fees charged by legacy brokers were simply unjustifiable. Collectively, challenger brokerages’ entry into the market has had a disruptive effect, forcing legacy players to lower their commissions drastically or cull them altogether.
A Brave New Market
So, how will brokers make money when they can no longer charge on a per-trade basis?
There are a few answers to that. The most obvious is that many challenger brokers act like ultra-low-cost airlines, where they make money from ancillary services rather than the core product itself. This “freemium” model is extremely popular. Freetrade, for example, batches trades together and executes them at 4PM daily. If you want your order to go through immediately to capitalize on a particular price in the market, you’ll need to pay roughly $1.25.
Likewise, Robinhood offers commission-free trading but charges a fee for trades made on margin. Users with a minimum balance of $2,000 can borrow twice their capital to trade with. They’re charged a flat fee depending on the amount they borrow.
Other revenue streams, however, are perhaps less savory. In October 2018, it emerged that half of Robinhood’s revenue came from third parties wishing to influence the way it executes orders. This controversial practice is called “payment for order flow,” or PFOF, and was pioneered by the disgraced financier Bernie Madoff.
Critics of PFOF argue that it incentivizes brokerages to execute orders with whatever market maker will make them the most money, rather than what is in the best interest of the client. Although it’s illegal in many jurisdictions (the UK banned it in 2012), it remains an accepted practice within the US financial services sector.
Of course, there are always two sides to every story. Proponents of PFOF say it’s an essential component for monetizing fee-free trading. They state that without it, platforms like Robinhood simply wouldn’t exist. Payment for order flow, it’s argued, is the mechanism that stops us from reverting to the dark era of $10 commissions on trades.
Yet another way brokerages are making money is by lending out hard to borrow stocks to those who have sold shares they don’t own, a practice called short selling. Short-sellers borrow stock they have sold so that they can deliver it to the buyer, thereby betting its price will fall. When they buy back their shares at a lower price than they sold them, they are able to return their borrowed shares to their lender, and profit from the price difference. –Brokerages lend out customer shares but don’t share the money they make doing this with their customers, who own those holdings in the first place.
Transparency is Key
For what it’s worth, the SEC mandates that platforms using PFOF inform their customers on a quarterly and annual basis, after a trade is executed, and via their terms of service (which, let’s be honest, few people bother to read anyway). But is that enough? No, it’s not.
Brokerages need to provide the most honest, fair and transparent information available for investors today, ensuring that people know how their money is being put to use. As it stands, this industry is sorely lacking a purpose-driven brand that genuinely puts its customer’s interests over their own. When you peel back the curtain it reveals that investment firms and platforms make excessive amounts of money on their customers – money that each investor could be earning more of on their own. The truth is that free trading isn’t really free. The individual investor might not be explicitly asked to pay fees, but trust me when I say the brokerage firms are still making money off each and every trade, and making it seem like they are not is intentionally misleading to the consumer.
With an industry notorious for its bad actors, radical transparency can allow challenger brokerages to develop their brand, and crucially, instill trust with their customers. It will allow investors to see whether their brokers truly have their best interests at heart, or whether they would be better served to move their portfolio elsewhere.
Consumers today have a different value system for companies they engage with, and that extends to investments as well. New generations are digital and social-media natives, expecting to tap into the benefits of both in everything they do. Consumers also place a much higher premium on trust and transparency with brands and never is this more evident than with those to whom they entrust their money.
It was Benjamin Franklin who once famously said: “An investment in knowledge pays the best interest.” Complete transparency is possible and should be required and embraced by investors.
Cryptocurrencies: the new gold?
By Gerald Moser, Chief Market Strategist, Barclays Private Bank
Time to add to a portfolio?
There has been a lot of talk about bitcoin, and cryptocurrencies in general, being a “digital” gold. Similar to gold, there is a finite amount, it is not backed by any sovereign and no single-entity controls its production. But for bitcoin to be considered in a portfolio and to become an investable asset, similar to gold, the asset would need to improve the risk/return profile of that portfolio. This seems a tall order.
While it is nigh on impossible to forecast an expected return for bitcoin, its volatility makes the asset almost “uninvestable” from a portfolio perspective. With spikes in volatility that are multiples of that typically experienced by risk assets such as equities or oil, many would probably throw the cryptocurrency out of any portfolio in a typical mean-variance optimisation.
And while bitcoin’s correlation measures are relatively supportive, it seems to falter when diversification is most needed, such as during sharp downturns in financial markets. Looking at weekly return correlations since 2016 shows that bitcoin is not strongly correlated with any assets (see below). It is however only second to US high yield in its correlation with equities. US Treasuries, gold and US investment grade were better diversifiers than bitcoin when it comes to equities.
Furthermore, looking at global equity corrections since 2015 (see below), it is noticeable that bitcoin has performed even worse than equities over the last three corrections. And while gold and fixed income provided some relief during those corrections, bitcoin compounded the loss that investors would have incurred from equities exposure.
The fact that cryptocurrencies also fluctuate alongside equities suggests that investment in bitcoin is more akin to a bubble phenomenon rather than a rational, long-term investment decision. The performance of the cryptocurrency has been mostly driven by retail investors joining a seemingly unsustainable rally rather than institutional money investing on a long-term basis.
Several studies around market structure have shown that emerging markets with high retail/low institutional participation are more unstable and more likely subject to financial bubbles than mature markets with institutional participation. And while more leading financial houses seem to be taking an interest in cryptocurrencies, the market’s behaviour suggests that the level of institutional involvement is still limited. Another issue is around its concentration: about 2% of bitcoin accounts control 95% of all bitcoins.
In summary, difficulty to forecast return, lack of diversification and high volatility makes it hard to consider bitcoin as a standalone asset in a diversified portfolio for long-term investors.
An inflation hedge?
Another point widely quoted in favour of cryptocurrencies is that they provide an inflation hedge. This might be a valid point, if inflation stems from fiat currency debasement. As mentioned above, a currency’s worth comes from the trust economic agents have in it. If unsustainable amounts of debt and large money creation shatter belief in sovereign-backed currencies through spiralling inflation, cryptocurrencies could be seen as an alternative.
Regardless of its price, bitcoin’s production is set on a precise schedule and cannot be changed. If oil or copper prices go up, there is an incentive to produce more. This is not the case for cryptocurrencies. In a very specific and highly hypothetical scenario of all fiat currency collapsing, this could be positive. But other real assets such as precious metals, inflation-linked bonds or real estate usually provide a hedge against inflation.
Bitcoin’s technology should theoretically make it extremely secure. As there is no intermediary, each transaction is reviewed by a large number of participants which can all certify the transaction. However, there have been frauds and thefts from exchanges. Another point to consider is the risk of “losing” bitcoins. According to the cryptocurrency data firm Chainanalysis, around 20% of the existing 18.5m bitcoins are lost or stranded in wallets, with no mean of being recovered. As there is no intermediary, there is no backup for a lost bitcoin.
From a sustainability point of view, adding cryptocurrencies to a portfolio will make it less green. Mining and exchanging them is highly energy intensive. According to estimates published by Alex de Vries, data scientist at the Dutch Central Bank, the bitcoin mining network possibly consumed as much in 2018 as the electricity consumed by a country like Switzerland. This translates to an average carbon footprint per transaction in the range of 230-360kg of CO2. In comparison, the average carbon footprint of a VISA transaction is 0.4g of CO2.
Beyond energy use, the mining process generates a large amount of electronic waste (e-waste). As mining requires a growing amount of computational power, the study estimates that mining equipment becomes obsolete every 18 months. The study suggests that the bitcoin industry generates an annual amount of e-waste similar to a country like Luxembourg.
Cryptocurrencies are here to stay
Innovation in digital assets continues rapidly and will likely drive increased participation, both from retail and institutional investors. The underlying blockchain technology behind bitcoin was meant to disrupt a few different industries. While results have not lived up to the initial hype, more sectors are investigating the use of the technology.
And with Facebook announcing a stablecoin, or a cryptocurrency pegged to a basket of different fiat currencies, central banks have accelerated the movement towards central bank digital currencies. Those could improve payment systems resilience and facilitate cross-border payments.
Energy stocks drag down FTSE 100, IG Group slides
By Shivani Kumaresan
(Reuters) – London’s FTSE 100 slipped on Thursday, weighed down by falls in energy stocks as oil prices slid after a surprise increase in U.S. crude inventories, while IG Group tumbled on plans to buy U.S. trading platform tastytrade for $1 billion.
The blue-chip FTSE 100 index lost 0.4%, while the domestically focussed mid-cap FTSE 250 index also slid 0.4%.
Energy majors BP and Royal Dutch Shell fell 3.2% and 2.5%, respectively, and were the biggest drags on the FTSE-100 index. [O/R]
“What is holding back the UK is a lack of tech stocks to capture the ‘rotation’ back into tech seen since Netflix results,” said Chris Beauchamp, chief market analyst at IG.
“Stock markets overall are much quieter today, looking so far in vain for a new catalyst for further upside.”
The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy and led to mass layoffs.
British Prime Minister Boris Johnson said it was too early to say when the national coronavirus lockdown in England would end, as daily deaths from COVID-19 reach new highs and hospitals become increasingly stretched.
IG Group tumbled 8.5% after announcing plans to buy tastytrade, venturing into North America after a stellar year for the new breed of retail investment brokerages.
Ibstock jumped 7.3% to the top of the FTSE 250 after the company said fourth-quarter activity benefited from better-than-expected demand for new houses and repairs.
Pets at Home Group Plc rose 2.2% after reporting an 18% jump in third-quarter revenue, boosted by higher demand for its accessories and veterinary services as more people adopted pets during lockdowns.
(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V and Mark Potter)
Wall Street bounce, upbeat earnings lift European stocks
By Amal S and Sruthi Shankar
(Reuters) – European stocks rose on Wednesday after Dutch chip equipment maker ASML and Swiss luxury group Richemont gave encouraging earnings updates, while investors hoped for a large U.S. stimulus plan as Joe Biden was sworn in as president.
The pan-European STOXX 600 index closed 0.7% higher, getting an extra boost as Wall Street marked record highs.
All eyes were on Biden’s inauguration as the 46th U.S. President, with traders betting on a bigger pandemic relief plan and higher infrastructure spending under the new administration to boost the pandemic-stricken economy.
Tech stocks rallied to a two-decade peak in Europe after ASML Holding NV rose 3.0% to all-time highs on better-than-expected quarterly sales and a strong order intake for 2021.
Meanwhile, Richemont rose 2.8%, after posting a 5% increase in quarterly sales as Chinese splashed out on Cartier, its flagship jewellery brand.
Britain’s Burberry jumped 3.9% after it stuck to its full-year goals, saying higher full-price sales would boost annual margins, while Asian demand remained strong.
The pair boosted European luxury goods makers that are heavily reliant on China, with LVMH and Kering gaining between 1% and 3%.
“Any sign that retail spending is picking up in China is going to be a boost to the Western markets and those heavily exposed to it,” said Connor Campbell, financial analyst at SpreadEx.
The European Central Bank is set to meet on Thursday. While no policy changes are expected, the bank could face more questions about an increasingly challenging outlook only a month after it unleashed fresh stimulus to bolster the euro zone economy.
“With the new round of easing measures fully in place and no new forecasts to be presented tomorrow, it should be a fairly uneventful day for the euro,” ING analysts said in a note.
Italy’s FTSE MIB gained 0.9% and lenders rose 1.6% after Prime Minister Giuseppe Conte won a confidence vote in the upper house Senate and averted a government collapse.
Conte narrowly secured the vote on Tuesday, allowing him to remain in office after a junior partner quit his coalition last week in the midst of the COVID-19 pandemic.
Daimler AG jumped 4.2% after its Mercedes-Benz brand unveiled a new electric compact SUV, the EQA, as part of plans to take on rival Tesla Inc.
Germany’s Hugo Boss added 4.4% after Mike Ashley-led Frasers said it boosted its stake in the company.
(Reporting by Sruthi Shankar and Amal S in Bengaluru; Editing by Shailesh Kuber and Arun Koyyur and Kirsten Donovan)
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