This week, Steve Johnson and Gareth Brown get together to discuss the impact of the app Robinhood on the stock market and how its attracted a real following amongst new and young investors. Steve and Gareth also chat about why this year, and recent market volatility, has been positive for Forager.
Hi everyone and welcome. It’s Steve Johnson here, Chief Investment Officer at Forager Funds. I missed last week’s video, sorry, I’m in trouble with the marketing team but I completely forgot about it. I’m joined this week by, Gareth Brown who works with us on the International Fund. Hi Gareth. How are you?
Hi Steve, hi everyone.
I wanted to touch today on a topic that’s been all over my Twitter feed and starting to turn up in all of the newspapers as well, that’s Robinhood and it’s impact on the stock market. Can you just give us a quick explanation about what people are talking about?
So Robinhood is an app that’s been around for five years now, but it’s really grown in popularity the last little while. It’s an app that allows you to trade stocks, currencies, crypto currencies, all sorts of stuff, commission free.
So you can go and buy your 10 shares of whatever and not pay a commission. It’s been growing extremely rapidly. They’ve got 13 million users, I believe they’ve had growth of more than 3 million users over the course of this calendar year alone and it’s becoming a real force in the market.
There’s a whole bunch of idiots on YouTube, recording videos of themselves day trading using their Robinhood accounts and it’s becoming a real subculture and something that’s somehow reminiscent of things that were going on 20 years ago in the tech boom.
I think because it is free because it’s an app it’s very millennial in the way that people use the product and because of Twitter and YouTube and all of these people, at least telling the world that they’re making fortunes and trading for free, it’s attracted a real following amongst new young investors and a lot of criticism of some of the older investors, Warren buffet in particular, I think has been a prime target of some of these people.
When you say 20 years ago, I think there’s a lot of trading going on of stock prices that are just going up without any reference whatsoever to the underlying value of what’s being traded. It is very reminiscent in that regard of the tech bubble. And you’re seeing these stories about people getting very rich, particularly out of this last meltdown. I think there’s a lot of concern about some of the marketing and ability for people to lose money in that space. But it is, you already touched on this, affecting the real market and some of the hunting ground that we like to look in, such as small cap stocks and businesses that are underappreciated, we are seeing them effected by this phenomenon.
So we’re profiting from that. Some of the stocks that we own are skyrocketing, we’ve been doing our best to harvest gains as we can. And that is a concern that it’s sort of impacting some of the hunting grounds for us. So I’m sure you’ve gone to a currency booth when you’re in Trafalgar square or somewhere else overseas and thought I might just change a few dollars and get some local currency. If you’ve ever noticed it they’ve got them extremely wide spreads, they’re making these huge margins on you, but they’ve got this big sign sitting there saying no commission. This is like a modern version of that. Robin hood is commission free. It is not free. So the ways they make money that I’m aware of, any cash balance that you have, they harvest the interest from so they take your money.
They lend it out to counterparties and keep the interest. They take your long position stocks, they lend them out to short sellers. They take the fee from that as well. Now, those two things, you might want to think of them as a source of return free risk. Things can happen when your money’s lent out or when your stock is lent out and you’re not getting any compensation for it.
So that’s a concern and it’s a quite a binary concern. But I think that’s the really entry level Robinhood-ing. The chief bit here is that they trade through these dark pools and they trade through alternative brokerage systems. So rather than going on exchanges, they’ll tell you it’s because they get cheaper execution and there may be some truth to that, but they also get rebates. So your audit float is being sent to people like Citadel Securities, Virtu, other high frequency trading firms. And they are front running you very regularly, and that’s why they pay the rebates back to Robin hood.
Some people would argue you can do trade with a traditional broker, pay a commission and still get skimmed by the algorithms and the front end more. So what’s worse about this?
That’s true and that is the best defence. I think it’s worth noting here that the founders have said that exact same defence in their blog, which is legitimate. Understand the founders of the firm come from the high-frequency world. They started off by trying to build a high frequency trading firm and then they started building systems for other firms. So it may be that they’re doing some good in the world, but they are actually from that world of high frequency trading. I have a feeling that their average Robinhood account holder is a bigger sucker for that kind of stuff than most brokerage account holders especially when you’re trying to day trade in and out of things, you’re going to get skimmed very regularly and it’s going to be quite a meaningful cost over time.
Yeah and we live in a world where these phenomenon happen faster than they’ve ever happened and on a more global scale than they’ve ever happened before.
This one is, certainly in terms of my reading, come from almost nowhere and become very mainstream very quickly. We’re seeing that vary across different industries in different spaces because of the internet as an enabler of these things globally, but you touched earlier on it impacting some of our stocks. How do you actually think about it in terms of our own portfolio? I don’t think anyone out there at the moment is going to be complaining about the returns we’re posting for the year, because they’ve been very good, but even with me, there’s some stocks here that I’d really like to own for a very long time and getting all of that gain in a short period of time, we’re almost forced to sell some of these stocks and it’s not necessarily ideal for us.
Why don’t you talk about Spotify? We bought Spotify. We think everything’s falling into place. We’re seeing some pieces of the puzzle, definitely falling into place, but we’re still waiting for all the evidence that suggests the stocks were twice what we paid for. It started moving in that direction very hard based on, what was it that Harvey said the other day to you?
Well, they’ve signed up a Kim Kardashian podcast and the latest one yesterday was a partnership with DC comics to produce podcasts as well. The share price was up 50% since we purchased it. It’s probably up $5 or $6 billion in market cap over the past week on the basis of these couple of podcasts. We sold a little bit more of the stock last night and Harvey said to me this morning, I really want to own this stock, long-term, I’d be happy continuing to hold it.
If this price movers on the basis of the margin thesis that we have playing out, but we don’t really have any more evidence that that is going to play out. What we’ve got as a Kim Kardashian podcast and the share price up 50%. So I think it makes it really hard for us because there is still all of that uncertainty about how profitable this business is going to be. It is very hard for us to hold that in the same proportion that we could hold it at 50% down.
As long as we find places to recycle into, that’s fine but that’s the question, as the market gets frothy, it’s harder and harder to do that.
I think maybe there’s some positives and negatives to this sort of back to day trading type world. So one we’re benefiting on some of the stocks we own getting caught up in that silliness and maybe getting fuller and fairer prices quicker than we might otherwise. On the negative side, it damages the immediate opportunity set. But I think longer term if you think about the market, to be the smart money that out earns the market, there needs to be a pool of dumb money that under owns the market or else the whole thing doesn’t work. For 20 years I’ve sat there and lamented, I’ve gotten better as an investor, but the world’s gotten harder and harder.
Part of the reason being is that all the dentists of the world that used to own trading accounts and punt on crazy stuff, they’ve started getting smarter. They started buying index funds and ETFs, and so the dumb money is moved out of the pool. This is like a glimmer of hope for us that there’s a bigger pool of dumb money than a thought and a bigger pool than there was 12 months ago. There’s got to be opportunities coming from that.
I think that’s true and I think that’s true of the past 12 months. I know that it is stressful and I know it’s been gut wrenching going through what we’ve been through over the past six months as this coronavirus thing has hit, but we need volatility. Our whole investment strategy is taking advantage of volatility. I think as a client of ours, you should really look at that and say, well, this has been a great year for us as an investment team, because it has enabled us to put some of those advantages that we have to work and you don’t want it to go away.
I know people want prices to go up and they want to feel rich, but for us to actually add value, we need that volatility and this is just another element. There’s obviously been some far bigger elements to that volatility over the past year, but I think this type of activity is also going to create volatility on the upside and the downside and that is long-term helpful. I’ll be in trouble for running over time here again. They tell me that Twitter and YouTube needs has short attention span so we need to keep this short, but that’s been very interesting Gareth. Thanks for your time and we’ll see you again soon.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.