The world of retail investing is in the crosshairs of technology-driven ‘disruptors’.

The most prominent is US-based Robinhood, launched in 2013 and backed by Silicon Valley venture capital heavyweights. It had raised a total of US$5.6bn in funding by February 2021 as a private company, according to Crunchbase, and a further US$1.9bn from its initial public offering.

Robinhood’s customer base had grown to 18 million app users by March 2021, according to its website, around half that of market leaders Fidelity and Charles Schwab, which had 36 and 32 million brokerage accounts respectively at that time.

In the UK, Trading 212, launched in 2016, had grown its client base to 1.5 million by August 2021, only just short of the 1.6 million active clients of the UK’s largest incumbent, Hargreaves Lansdown.

While client numbers are impressive, much of the growth of these platforms comes from younger, inexperienced investors. Robinhood CEO Vladimir Tenev, in a statement given in February 2021 to the US House of Representatives Committee on Financial Services, said the median investor age on Robinhood is 31, with about half of customers identifying as first-time investors. Its average account size is around US$5,000 (the median is just US$240).

In contrast, Charles Schwab reports an average customer age of 52 in its July 2020 Summer business update and an average retail account size of US$140,000 in its 2021 Winter business update. Trading 212’s declared assets under administration (AUA) of £3bn translates to an average account size of just £2,000, compared to the £136bn AUA and £82,000 average account size of Hargreaves Lansdown, according to its year-end results at 30 June 2021.

But such rapid expansion in this segment of the market can have consequences. Novice investors have lost huge sums, financial markets have been shaken, and a 20-year-old options trader using Robinhood took his own life after seeing a US$730,000 negative balance on his account. So, are these platforms really the future of retail investing? Or further accidents waiting to happen?

Noble ideals: democratisation and education

A common theme across the platforms investigated – Robinhood and Public.com (operating in the US), Trading 212 (in the UK and continental Europe), and eToro (in the UK, Europe, Australia and the US) – focuses on ‘democratising’ investing. Stephen Sikes, chief operating officer of Public, says 90% of its one million plus clients are first-time investors, 40% are women and 45% are people of colour.

These mostly new investors are presented with a range of financial products. Robinhood, Trading 212, and eToro cater to both long-term investors and short-term traders with individual stocks, exchange-traded funds (ETFs), cryptocurrencies (Robinhood and eToro), and even options (Robinhood) and contracts-for-difference (CFDs, offered by Trading 212 and eToro) – products that allow traders to take long or short positions using financial leverage.
Part of the challenge of attracting first-time investors is reducing financial barriers to entry

Public positions itself differently, with Stephen saying it targets longer-term investors and only offers individual stocks and ETFs.

Part of the challenge of attracting first-time investors is reducing financial barriers to entry. Robinhood and Public have no minimum deposit requirements. Trading 212’s is just £1 and eToro’s US$200. None charge commissions on trades.

Revenue models vary between the platforms. Robinhood uses a ‘payment for order flow’ (PFOF – see box below) model which is akin to receiving a commission from a ‘market maker’ – a company executing trades on exchanges on behalf of brokers such as Robinhood – paid for out of the difference the market maker pays for a stock and the actual price paid by the platform end-user.

Public declared itself ‘PFOF free’ in February 2021. It generates revenue by allowing users to pay an optional ‘tip’ to cover the costs of execution, from interest on cash balances and from ‘lending’ securities to institutions (such as for short selling).

PFOF is not permitted in the UK and EU. It is considered a conflict of interest, according to a December 2017 ‘Dear CEO’ letter issued by the FCA. Trading 212 and eToro make money from buy-sell spreads, interest income and fees on positions that remain open overnight.

None of these platforms offer financial advice. They are do-it-yourself (DIY) investment platforms. But all have a heavy emphasis on education, with prominent ‘learn’ or ‘education’ tabs on their websites or apps, which consist mostly of short, jargon-free material.

Public has a library of educational explanations, with each containing a sub-heading ‘TL;DR’. This stands for ‘too long, didn’t read’ and is used in this context as online slang for a summary. For example, its material on ‘What is a stock split?’ consists of a six-bullet TL;DR, followed by a thousand-word deeper dive.

Whether all this is sufficient to educate an inexperienced cohort of investors is debatable.

Dan Moczulski, UK regional manager at eToro, emphasises the importance of access to a free demo account as part of its educational offering. He says that it “enables users to invest with a risk-free virtual balance while they learn the platform and refine their strategy”. eToro has over 20 million registered users (with five million added in 2020) and 1.2 million funded accounts, according to a March 2021 press release.

Enter gamification

Mike Lee, EY global wealth and asset management leader, wrote in a 2018 article, ‘How gamification could take investor experiences to a new level’, that the potential of gamification lies in simplifying the often dauntingly complex world of finance and investing, educating people and incentivising good financial behaviour.

Mike spoke to The Review about making learning ‘fun’ to aid understanding. Gamification of investment, for example, could require a new client to pass through ‘levels’ of a game before being allowed to trade, as opposed to ‘taking a test’ as Mike calls it – the modus operandi of some platforms today. Mike says, “If you make something boring people will tend to forget it, but a well-designed ‘game’ can be fun, and people will retain the knowledge. They’ll be learning when they don’t even know it.”

An example Mike offers of incentivising good financial behaviour might be a platform providing people with a virtual reality simulation of the dream home they are saving up for when they reach investing milestones. But, says Mike, “I haven’t seen anyone do this yet.”

And the examples of gamification techniques in investing found by The Review have tended to focus on encouraging clients to sign up and to trade more – see below for examples.

Consequences

In this reshaped DIY investing world, the convergence of pursuing extremely rapid growth, fuelled by techniques such as gamification and platform revenue models with strong links to trading volumes (PFOF), has proved to be a toxic mix in some circumstances – with Robinhood at the forefront of these controversies.

In December 2020, regulators in Massachusetts filed to commence an adjudicatory proceeding against Robinhood and recommended action against the company, including the revocation of its broker-dealer license and compensation payments to clients for losses. The allegations included:

• Using gamification to encourage and entice continuous and repetitive use of its trading application. For example, it said the use of animated ‘confetti’ which is ‘sprinkled’ across the screen after users execute trades instilled “a sense of celebration and accomplishment as a result of simply buying or selling securities”.
• Failure to follow its own written supervisory procedures regarding the approval of options trading, saying that 68% of Massachusetts customers approved for options trading identified as having no or limited investment experience.

Robinhood has refuted the claims and is fighting the action, as stated in its blog of 15 April 2021, ‘Statement on Massachusetts Securities Division complaint’. Then, in January 2021, Robinhood found itself at the centre of another controversy related to trading in the company GameStop. The events were so profound they led to the establishment of a hearing of the US House of Representatives Committee on Financial Services, Game stopped? Who wins and loses when short sellers, social media and retail investors collide.

During the first week of February 2021, the GameStop stock price plunged 81%GameStop, a predominantly ‘bricks and mortar’ US retailer of computer games and equipment, was seen to be in terminal decline by some hedge funds that had accumulated large short positions in the company. In January 2021 several retail investors, many using the Robinhood investment platform and communicating on the social media platform Reddit, found out about the large short positions and decided to buy the stock to drive the price up. Motivations were not purely financial, some traders simply wanted to exact harm on the hedge funds.

With the stock price rising 530% over three days, according to Tenev’s statement, one of the funds that shorted the stock, Melvin Capital, lost 53% of its investments during January. During the first week of February 2021, the GameStop stock price plunged 81%. According to the Committee memorandum, this left “some retail investors, potentially, facing hundreds of thousands in losses. Those who lost money during this volatility include novice investors.”

The Committee’s concerns extended further than just the financial losses of retail investors. At the height of the volatility, Robinhood temporarily restricted new trades in GameStop and some other stocks. The Committee memo highlights that there was speculation that “Robinhood’s decision to restrict trading resulted from a business relationship between Robinhood, Citadel [a market maker executing trades on behalf of Robinhood but also an investor in Melvin Capital], and Melvin Capital”. The inference was that Robinhood was acting to protect the financial interests of these institutions over those of its retail investors.

Tenev disputed this in his statement to the US House of Representatives Committee on Financial Services, saying that the reason restrictions were placed on trading was to meet clearinghouse deposit requirements.

Brokerage firms such as Robinhood are required to post collateral with a clearinghouse, the size of which is related to trading volumes on the platform. This is to cover counterparty risk between the time of a trade on a platform and the time the trade is processed by the clearinghouse and cash transferred between buyers and sellers – in the US, this is two days, known as ‘T+2’ settlement. Tenev says in his statement that, between 25 and 28 January 2021, Robinhood’s collateral obligation jumped from US$124m to US$3bn. Robinhood had to raise additional capital of its own to meet these requirements – it raised an additional US$3.4bn from investors – but was essentially forced to temporarily restrict trading in some securities to prevent further increases in requirements.

Aftermath

US regulators are grappling with their immediate next steps. The Committee’s memorandum states: “[The GameStop event] raises important questions about the efficacy of anti-market manipulation laws and whether technology and social media have outpaced regulation in a manner that leaves investors and the markets exposed to unnecessary risks.”

The FCA has now launched a ‘digital disruption campaign’ to prevent investment harm. It uses online advertising to disrupt investors’ journeys and drive them to a ‘high return investments’ webpage – which asks consumers to consider factors such as their level of comfort with the level of risk of an investment and if they should get financial advice.

Many expect further market impact. In the JP Morgan e-Trading 2021 survey, 33% of institutional and professional traders say mobile trading applications will be the most influential factor shaping the future of trading in the next 12 months.

Financial planners and advisers

These platforms will almost certainly impact the financial planner and adviser community, in some perhaps surprisingly positive ways. Stephen Sikes of Public says he and most advisers he interacts with recognise the need for both DIY and adviser-led investing models in different areas of the market. He says: “While we are certainly seeing a generational bias towards self-directed investing there will still be a massive number of people who want advisers. We are getting more people exposed to financial markets earlier but over time, as the younger generations grow their wealth, a proportion of them will undoubtedly migrate to an advised service.”

Mike Lee thinks that if these platforms are successful in their educational role, it will be a positive for advisers. “As an adviser, I would want financially savvy clients so they can make informed decisions.”

The ultimate impact of the rise of these new platforms is yet to be seen. But there will almost certainly be further impact – on regulatory action, financial markets, not to mention the wider advice and wealth management community.