This week’s Future of Fintech is on the future of retail investing, covering r/WallStreetBets, the changing nature of investing, and more.
Guests for this week include:
- Leif Abraham, Co-CEO of Public
- Howard Lindzon, General Partner at Social Leverage
- Aditi Maliwal, Partner at Upfront Ventures
- David McDonough, Founder of Commonstock
- Alex Rampell, General Partner at Andreessen Horowitz
- Yoshi Yokokawa, Co-Founder & CEO at Alpaca
- Julie Young, Investor & finance writer
Highlights from Future of Fintech: Retail Investing
This interview has been lightly edited for length and clarity.
Why Public made the decision to not receive revenue from order flow:
LEIF (Public CEO): There were two main drivers. One, Payment for Order Flow (or PFOF, the practice of market makers paying brokers to execute customer orders) has a bad rep. People don't feel comfortable with that being the business model behind the investing that they're using.
The other side is the incentives that drive our business. Whatever nice intentions you have personally, what will always drive your business in the future is the incentives of your business model. How you make money defines how you design your product, how you act as a business, the culture you've built internally. We wanted to make sure we're not building a business that predominantly drives revenue from payment for order flow. Because that will put us into a position where, from a pure product design perspective, we will be incentivized to make people trade as much as possible and sell things like options, which make much more money on payment for order flow than our regular securities.
Since 90% of people on Public are first-time investors, we have a responsibility to ensure that when people have the first investing experience, they're not getting burned.
Why PFOF is effective:
HOWARD (Social Leverage GP): The VCs have been completely late to this trend. They've completely missed the do-it-yourself investing trend. The decentralized world picked up on it with Binance and Coinbase and Robinhood and eToro before Robinhood. These are truly innovative companies because they designed the UI and embraced the old business model. And have tried to work on new business models that we're all copying and trying to figure out. But payment for order flow just is a good thing. There is no business model around free trading that I've seen that's an alternative to PFOF unless VCs are going to fund these things indefinitely.
ALEX (Andreessen Horowitz GP): I had been on the board of the biggest market maker in the US, Knight Capital. Market makers do well during times of extreme volatility because extreme volatility means very, very high bid-ask spreads. When you're trading the spread all day long and you've got balanced order flow (which you get from retail) you can make a ton of money when the VIX (Chicago Board Options Exchange Volatility Index) is not suggesting high volatility, which it was for years. The level of volatility over the last couple of years has been very high, but there was a period of peace for a while, and market makers were not making that much money.
Almost all of the hot takes are massively misinformed: "You're the product. You're not the customer." Stock lending; t is one way that you can make money. You can get paid for order flow, or you can also just allocate it back to price improvement. The takes are wrong. There's a great post by Patrick McKenzie, a Stripe engineer, who goes into all the ways retail brokerages make money and how PFOF works.
There are maker rebates and taker fees. That's how most exchanges make money: on the spread between the maker rebate and the taker fee. If you post lots of orders to an exchange like NYSE Arca, which is roughly 15% of all volume in the U.S, you're getting paid at an NYSE maker rebate. That's a payment that the broker keeps, not the customer. The only brokerages that have done something fundamentally different are Interactive Brokers, where a lot of power traders go because they share the stock lending fee with you. If you have very volatile security with a high stock borrow rate, you should put all of your stock in Interactive Brokers, not Robinhood or Public. They're going to share the stock lending revenue with you.
Interactive Brokers has a fundamentally different business model than most other retail brokers. And it’s loaning money. It's loaning out your securities. It's charging some kind of rebate from the market makers that process orders that are earning high spreads from or price improving for retail, but also earning a decent living. Therefore retail brokers get a kickback on that. The only thing that potentially should change in terms of the PFOF debate is you've got every retail broker that publishes their 606 filings, you have to show who paid you for order flow. It's not super clear in terms of how much price improvement vs. PFOF is happening.
HOWARD: People were being led off a cliff one way or the other. We were being told to index our money and Vanguard's narrative took over, "Oh, fees are bad." At some level fees are bad, but at some level you were trading on Betty and Jim putting their retirement money into Vanguard, buying Wells Fargo or FactSet or Equifax. They were buying just as evil a company as everybody in the media complaining about the new villains.
We were creating all this bad behavior because the narrative was, “People are stupid, you can't beat the market.” The narrative was winning. And that narrative created Wealthfront and Betterment, which were just UI improvements on a product that everybody had randomly decided was good and passive. That was a lie too because those are not passive. S&P 500 is a quant product; it drops. Whatever their timing is, market cap companies that drop a certain amount of market cap for higher market cap companies. So that's a quant model. MAST is a low fee passive model.
People were being lied to. The best thing that we can have is a choice, which we're getting now. I'd rather have a world where people learn the language of the market. Handing your money off to Vanguard to index is not learning the language. And that's fine. People should be allowed to invest.
There had been no advancement until Robinhood changed the UI. What we should be talking about is the next wave of investing, which is fractional or influencer-based, as we're seeing with SPACs and infinite choice, where you can fractionalize trading cards or NFTs. We're finally creating some new things to invest in, which is dangerous and speculative, but also leads to discovery.
Social networks as the next application layer in retail investing:
DAVID (Commonstock CEO): Anything that is targeting new investors needs to be transparent about how powerful and beneficial that is to regular investors vs. insinuating or implying anything otherwise. It is such a good thing for the vast majority of investors to remove those barriers. Robinhood and Plaid have ushered in this massive new wave of capital markets participation by removing all of the costs and empowering people to build platforms on top of any financial institution.
We at Commonstock now get to build a platform because this is mainstream. The focus is amplifying the knowledge of the best investors. Commonstock is broker agnostic. We don't really have a dog in the fight of which brokerage people should use. Our goal is, with all of this increased participation, to focus and harness that energy for constructive outcomes by letting people put their money where their mouth is and link their existing brokerage accounts, to share their portfolio.
HOWARD: I actually don't want to see people's portfolios, just like I don't want to be investing in the same portfolio as everybody else. And I thought the S&P 500, we got lucky because we were headed over a different cliff if everybody was pushing the same button and selling on the same day in the S&P 500. So we're lucky it happened in GameStop. I want ideas and this is why I get so mad watching Twitter ignore the verticals: sports and finance. Real-time matters when it comes to sports and finance.
The real innovation is what Twitter brought in: "Just tell me your ideas. I don't care what you look like. I don't care about your weight, your color, your education. I want to know what you're thinking about that idea." Because everybody, as Steve Martin said in The Jerk, has a special purpose and has their 10,000 hours in something. I just want to hear more opinions and I can get those from free streaming products like StockTwits and Twitter. We've over-innovated around portfolios and under-innovated in deep analysis and a much cleaner way for people to make decisions on their own.
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Validating and verifying whose investing advice you’re listening to on social networks:
DAVID: My thesis is that for the next 20 years, we've got this explosion of people sharing and creating content. We need to curate the best ideas and verify what people are doing. Looking at someone's portfolio doesn't necessarily mean copying that. Being able to validate, "Oh, this person was in Tesla early and Zoom early. Maybe they know what they're talking about, so I can trust their insights and their investment memos," is what Commonstock does.
LEIF: There's a difference between trading and investing. Most communities, historically, have been focused on trading. It's a more short-term, statistical analysis of stocks and markets. Now you have this breed of people coming to the stock markets who are predominantly first-time investors. It's their first time when they open the Public app or Robinhood. Social networks are then a way to scale education around the stock market. That education is driven, not just by people who are deep in finance, but also by people who are closer to pop culture, who have certain domain expertise because they work in the field. If you're interested in the future of fitness, you might want to talk to a Peloton instructor. It's not just driven by people who you would normally find on CNBC. That lends itself more to investing than necessarily the trading component. These two are being interchanged often. I think what you find on the Wall Street desk is much more trading, more short-term, versus investing for the long-term. It's much more about owning companies and trading stocks. Those two are different and lend themselves to different cultures or communities as well.
JULIE (Investor, Finance Writer): Throughout the course of a year, I'll make a maximum of five new investments. The rest of the time, I'm just contributing to existing positions. As someone on FinTwit, a lot of people ask, "Can you sign up for one of these services? Can you show us your portfolio?" I encounter that same friction that you're talking about Leif. I've spoken very publicly about the companies that I believe in and why. My opinions rarely change since I'm just holding for a long time.
ALEX: There are many ways of bringing people into the market. I think what's unfortunate about GameStop is that so much of the focus is on, "Oh, there are people that are acting irresponsibly." More people investing in assets when the Fed prints money is a good thing. We don't want people to hold onto cash. We want people to invest in assets. We need to give them tools for different ways of doing this. There's the Robinhood, Commonstock, Public tool.
There will be a lot of people that still find this daunting, "Well, I think I'm still waiting for this negative selection bias thing to catch on, which is I want a broad-based index, but Peter Lynch in reverse. I want to pick the things that I don't like, or maybe overweight the things that I do like just a little bit more.” And that's an easier process than spending 10 hours a week.
I remember when I was a kid, I used to look at all the fractional quotes in the Wall Street Journal every morning. It was so cool to see what my stock was trading at. There just aren't that many people that want to do that. There are tools for people to enter the market more easily.
Building for the next generation of retail online:
DAVID: Commonstock was built around long-form investment memos, where people can analyze a company. Our goal is to democratize and amplify equity research. The brokers have done an incredible job democratizing access to capital markets. What I would love to do is democratize access to quality investment knowledge. And that's what Seeking Alpha and a ton of platforms, TradingView, Motley Fool have built over the past decade.
I think there's a large market for that, but I think there's space for someone to build a Bloomberg terminal-like experience for a new generation of investors. The layer that sits on top of every brokerage with communication on the news. That's my view for the future and how people interact.
YOSHI (Alpaca CEO): Embedded finance could go even farther than Motley Fool or even Public and Commonstock. There's a lot of very local de-segmentation. For example, what Robinhood focused on was a millennial generation in an English-speaking country. So how about focusing on different countries, cultures, sexual orientations, or races? There are so many customer segments. It's not only investing segmentation, it's not only trading segmentation. We don't know what's going to be happening in three to five to 10 years.
DAVID: And even asset classes too, like NFTs, where I bet everything becomes an investable asset in the next five or 10 years. There's a new generation that will invest in sports cars digitally. How cool is that? Rally and Otis are two insanely cool companies where you can invest in a Lamborghini and own a part of that.
LEIF: One anecdote we hear all the time from users is, "Before I joined Public, I thought the stock market wasn't for me." To truly democratize the stock market, you have to change its culture and make it more approachable, not just accessible. A lot of the conversation around democratization has been around, make all the tools available for everyone, make them free, make them pretty and easy to use on a mobile phone.
People go from being scared about the stock market to joining something like Public and recognizing it's not rocket science. It's just a massive confidence driver. If you want to bring the next 100 million people into the stock market that are not participating right now, the true focus should be to make the stock market more approachable.
ADITI (Upfront Ventures Partner): People want to go through this with other people they feel comfortable doing it with: smaller groups, people that they're already doing it with. I'm on a bunch of group texts with my female friends who are investing for the first time and they don't necessarily want to do it in a public forum. They're like, "Hey, what should we buy?". There is something around that trust that we have in a smaller group that is a big driver for first-time investors too, not just expecting an expert to tell me what to do.
YOSHI: Why don't we have an app that focuses on that? Why don't we have apps that focus on certain minority groups? They all have a personalized approach to investing and becoming more involved in capital or stock markets. That's how I think about the future: micro-segmentation of how the financial services will touch each group of people entering the market.
APEX Clearing announcing a $4.7b SPAC:
YOSHI: We used to be their customer. What I see is democratization. Robinhood made stock trading more approachable. Our turn as Alpaca is to make building and broker apps approachable. What has to happen is what Twilio did in the communication sector. There hasn't been a similar service.
DAVID: I'm excited about Apex's public scenario because it will bring a lot of sunlight into the PFOF situation. If they're the ones providing the pipes for so much of the market, hopefully, more transparency there will clear the air that this is not bad.
YOSHI: We always have to be careful about the separation of trade clearing and trade execution. Apex clearing comes from trade clearing, which has nothing to do with the PFOF. They work with Citadel and all those market makers to do the execution. They're not the market maker, they're the clearing firm.
IMMAD (Mercury CEO): So from my understanding, Robinhood stopped using Apex when they got to enough scale. Is that an issue with Apex, that at scale people stop using them?
SHEEL (Better Tomorrow Ventures Partner): It’s the same risk you have in any company.
LEIF: At the end of the day, it's purely a business model question on the margins you want to have on those backend brokerage revenue streams.
Why self-clearing is particularly hard:
YOSHI: There's a big task building, the custody operation. That includes capital requirement calculation, being able to be approved for the software that you're using, and being responsible for the requirement capital from the clearinghouse. There's a bunch of that responsibility that comes with clearing yourself.
Should retail investors take part in SPACs?
HOWARD: SPACs have been around. There was this path to going public that was just becoming accepted. Kudos to all the people who have said, "Wait a minute, there are not enough public companies. People will invest." We're at this weird moment in time where you have social networks that allow you to bet on people. I have a SPAC myself right now, but people want to bet on the person. This is just the opposite right now.
When this is all over, we'll have SPACs, direct listings, and then Goldman Sachs and Morgan Stanley taking companies public. We're overshooting from a period where we didn't have enough public companies and there were only two ways to go public. We should be cheering people for taking risks with SPACs. Buying a SPAC at a 20% premium versus trading GameStop is still a better idea in my opinion.
With so many SPACs, will it be hard to find well-priced, reasonable private companies to buy?
HOWARD: Let's remember if there's a 10% pullback in the NASDAQ over the next two weeks, or COVID flares up again, post-vaccine, VC money will go in a completely new direction. And there'll be 100 unicorns that we didn't think about three months ago.
So I got two years, we're not rushing to do something, but yes, it is more crowded than it was. I'm going on it from a macro view that there are probably 1,000 potential $1 to $3 billion public companies in the cloud and global mobile social space. I'm not scared about being SPAC 200, or whatever the number is, in a world where, over the next two years, there could be 2,000 public companies.
If the Fed raises rates tomorrow and we have some kind of event, I win too because I've already raised my capital. I don't think people should try and time the market. The same thing goes with starting a company and with raising a SPAC. SPACs are just another expression of the market not having enough public companies that potentially could fit in the NASDAQ 100.
JULIE: I’m wary of anyone taking 2020 and then extrapolating conclusions about the future of major asset classes or investor behavior. People were searching for yield this year, and even the big institutions couldn't look at fixed income.
ADITI: I do agree with Howard on this. Opening up the public markets and creating new paths to liquidity is incredible from a retail investor's perspective. I wouldn't necessarily encourage the first-time retail investor to invest in every single SPAC, unless you're trying to create an index fund of SPACs, then go for it. But the second thing is people are looking to anchor behind the leader of the SPAC. Whether it's Howard or whoever it may be.
As a first-time investor or someone who's starting to make decisions in the public markets, that's something that I’d spend a lot of time thinking about: who is behind this and how influential will they be in the journey of taking this company to the public markets?
HOWARD: If I do a bad job with SPAC one, there will be no SPAC two. We're putting our reputation on the line, which is what it's supposed to be. We finally have a choice back in the market. And I like that everybody doesn't own the same 500 stocks and that FAANG rules the world. There are enough smart people on the internet where you can go for free and ask a few questions as a retail investor and just avoid 90% of the scams. It doesn't mean you're not going to go do a YOLO on GameStop, but people are going to get their fix one way or the other. There are enough good-intentioned SPACs. And the pipes to get public were so poorly managed that this is why we have SPACs. The best thing to do is to help educate people and keep these conversations going.
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The Mercury Team