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The recent announcement that US online trading broker Robinhood Markets plans to list provides us with some insight into the behaviour of retail investors in the world’s largest capital market. Robinhood’s motto, to “democratise finance for all” has spearheaded the trend towards zero-commission trading in the US, and it has accumulated 18-million clients since 2013.
The US is a unique market due to the high propensity of the population to invest in equities. Over time the holding periods of US stocks plummeted from about three years in the 1980s to now just a matter of weeks. US retail investors have also steadily increased their share of total traded market activity to close to 20% — double what it was a decade ago.
However, the Covid-19 crisis provided an unexpected boost to online share trading, with Robinhood doubling its client numbers over the past year. As markets pulled back sharply and a large portion of humanity was confined to their homes, swathes of customers turned to investing online. In the US, a number of factors have contributed to a spike in online trading.
The work-from-home trend and the generous income support schemes provided by the US government have left a good number of the American population with more disposable income than before the Covid-19 crisis. Some have even suggested that the lack of live sports events has meant many people were lacking a source of entertainment. Nonetheless, a record number of online accounts were opened by first-time market participants.
It was also fortuitous that as markets started to fall sharply in February 2020 in response to news of the global pandemic, new online market participants were able to scoop up stocks at huge valuation discounts as the US Federal Reserve was about to aggressively flood the market with liquidity. Companies like Robinhood also provided existing customers will incentives by offering “free shares” for referrals. The data also shows that the majority of Robinhood investors tend to buy stocks trading under $5, with fractional share trading also facilitating smaller trades.
FNB Online Share Trading has experienced a similar trend, with a record number of new clients signing up on our platform. Self-directed clients were most active in March 2020 as the Covid-19-induced sell-off intensified, and peaked in April 2020 as bargain hunting intensified. Trading activity in SA was initially focused on heavily sold-off blue chip stocks, with newcomers focusing their attention on Sasol, which plummeted from more than R300 to close to R20 a share as the oil price collapsed.
However, what started as a positive trend in the US then morphed into something more unexpected. As the US retail investors began to congregate in online bulletin boards, the phenomenon of meme stocks took hold. Retail investors collectively started to invest in out-of-favour stocks like struggling video-game retailer GameStop, and forced hedge funds — which were short, betting the stock would fail — to close their positions at a substantial loss. In addition, Robinhood benefited financially by facilitating cryptocurrency trading, with dogecoin accounting for a third of crypto trading revenues.
Globally, online share trading platforms have embraced technology to build better engagement with their clients. For instance, the average age of new Robinhood clients is 31, while with FNB it is 35. One of the more worrying aspects from the Robinhood filings are the number of pending lawsuits against the US company. Robinhood has already settled with the regulator on claims that it failed to do proper due diligence in opening derivative accounts for first-time investors. With over 50 class action suits looming and investigations ranging from possible money laundering to cybersecurity breaches, this has highlighted that it is more important to build a strong control environment than to focus on triggering confetti each time a client makes a trade.
As more investors get tempted to invest online, we believe investor education and money management will differentiate the short-term opportunists from the long-term players. We therefore think clients should reduce single-company risk by choosing a basket of stocks — or consider low-cost exchange traded funds — to ensure they are well diversified for the long term.
• Razack is head of FNB Share Investing and Rassou chief investment officer at Ashburton Investment and FNB Wealth & Investments.
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Published by Arena Holdings and distributed with the Financial Mail on the last Thursday of every month except December and January.