IT WOULD BE hard for a firm that describes itself as “democratising investing” to go public in any other way. When Robinhood lists on the Nasdaq on July 29th institutional investors will, as is usual, be able to buy and trade shares on the exchange. Less conventionally, the retail-trading platform will also sell a third of the shares in itself to its customers.
Your correspondent felt a frisson of excitement as she participated in an IPO for the first time, bidding for a single share in Robinhood. The slick graphics explained how IPO shares are allocated, and reassured punters that—unlike at other brokers—order size, assets and the age of the account would play no part in whether a bid was accepted or not. Before most firms go public they do a roadshow, which typically involves investment bankers compiling slick slideshows, donning their sharpest suits and fanning out to meeting rooms in big cities to canvass support from pension funds, asset managers and other big institutional investors. Robinhood instead made its 40-minute pitch online to anyone who wanted to listen, on the Saturday afternoon ahead of its debut.
The anti-establishment approach is all too fitting. No other company’s rise has been as inextricably linked to the current retail-investing craze, fuelled by online forums and lockdown-induced spare time. Robinhood, which is expected to fetch a valuation of $35bn, has seen its user base explode during the pandemic (see chart 1). Its prospects are likely to follow wherever the retail mania, the subject of much regulatory hand-wringing, goes next.
For decades retail investors were overlooked and underserved. The rich might have dabbled in trading stocks directly, but most workers earned defined-benefit pensions, which kicked any portfolio-management decisions to pension-fund managers. The transition to self-directed 401K retirement plans, registered investment advisers and retail brokers was at first accompanied by wide trading spreads and meaty fees.
Then the adoption of new technologies—such as computerised trading and wicked-fast marketmaking algorithms—helped erode spreads. In 2013 Baiju Bhatt and Vlad Tenev, Robinhood’s founders and former employees of marketmakers, saw that it might be possible for a retail broker to make money by offering consumers commission-free stock trading. It could instead earn revenues through “payment for order flow”, the practice by which a high-frequency marketmaker offers a broker a better execution price than the prevailing price for a stock on an exchange, and pays out a little of the spread it earns to the broker through a profit-sharing arrangement.
For a time the big retail brokers ignored the plucky upstart and continued to charge commissions and fees. But by 2019 the writing was on the wall. A quick, brutal price war broke out. Charles Schwab, followed by E*Trade, TD Ameritrade and eventually the biggest broker of all, Fidelity, succumbed, scrapping their commissions and trading fees.
Lower costs for investors are a laudable thing. At Robinhood’s roadshow Mr Tenev claimed that his firm helped people buy shares in firms they love and got them excited about investing. By the broker’s reckoning, half of all brokerage accounts opened in America since 2015 have been set up through its platform. But Robinhood has also been at the centre of unease about the retail revolution, which peaked during the speculative frenzy in GameStop, a struggling video-game retailer, earlier this year. The company’s share price spiked from $17 in January to more than $450 two weeks later. So much of the trading volume came from retail investors, and so much of it was directed through Robinhood, that the broker was forced to suspend trading in GameStop because it lacked the capital to cover the lag between its customers’ trades and their settlement. Some disgruntled investors even protested outside Robinhood’s headquarters (see picture).
The queasiness over Robinhood’s success stems from two sources. For a start, when the price of something falls, people tend to do more of it. According to data in the firm’s IPO filing, around half of its customers check their investments in their app every day. But plenty of research papers find that the more people trade, the worse their returns. Another concern is that Robinhood exposes its users to risky products. Its profit margins are slimmest for the vanilla stuff, like stock trading, but rise as its customers dabble in riskier, more complicated markets, such as trading derivatives or buying cryptocurrencies. Although options and cryptocurrencies make up about 17% of the $80bn in assets that Robinhood oversees, about half of its transaction revenues come from these categories (see chart 2).
These concerns have led lawmakers to question whether retail investors stand to make any gains from Robinhood. Summoned to Congress after the GameStop affair, Mr Tenev claimed that its customers had earned more than $35bn in profits by buying stocks and investments, compared with what they had deposited with the broker. But Jim Himes, a congressman from Connecticut and a former banker, skewered him. “$35bn is a meaningless number unless you convert it to a rate of return so that I can compare it to Treasuries, so I can compare it to the S&P 500.” Mr Tenev deflected, claiming the right comparison was the lower bar of “not investing at all” because many of Robinhood’s customers were new to trading.
Whether the firm’s empowerment of retail investors has been desirable or not is more than a philosophical matter. It is also the key question that any investor, institutional or retail, will have to wrestle with ahead of its debut. This is largely because it is where the risks and rewards for potential shareholders lie.
The upside seems to lie in the retail frenzy continuing. It was common (including in the pages of The Economist) to expect that the GameStop episode could be the undoing of Robinhood; that its original adopters might feel betrayed by the firm’s suspension of trading in GameStop and junk the app. But the company’s prospectus reveals that the adage “all publicity is good publicity” still holds. In the first quarter of 2021 alone some 5.5m funded trading accounts were opened on Robinhood.
Much of the broker’s 300-page prospectus, however, discusses the big risks to its business. These include the possible introduction of a financial-transaction tax, which might scupper Robinhood’s ability to offer free trading and deter customers from trading every day. It also includes the possibility that payment for order flow, which accounts for 80% of Robinhood’s revenues, might be restricted or banned by regulators. Gary Gensler, the head of the Securities and Exchange Commission, has said his agency is looking closely into whether the current market structure creates conflicts of interest; the financial-services committee of the House of Representatives, which hosted the GameStop hearing, has drafted a bill that would ban payment for order flow. Given all this, and the sheer unpredictability of the retail mania, your correspondent feels comfortable with her bid for just a single share.