Is Robinhood Violating the Fiduciary Conduct Standard in Massachusetts?

 

A complaint against Robinhood has been filed by the state of Massachusetts. The action is based on a new state law that it began to enforce in September. This filing comes in the same week that the self-directed brokerage firm settled a suit with the SEC by paying $65 million. The new action is based on regulations unique to broker-dealers conducting business in Massachusetts, it charges the online broker with “gamification” of its platform.

Back in March, the Massachusetts Securities Division adopted amendments to one of their codes in response to the U.S. Circuit Court which threw out the Department of Labor’s fiduciary rule two years prior. The DOL regulation sought to curb conflicts of interest in financial advice by holding broker-dealers to the highest standard of doing what is in the clients’ best interest, rather than the lesser suitability standard they had been operating under. The amendment to the state’s existing code included language that held the broker-dealer community to a similar standard as wealth managers when providing investment advice.

What’s in the Amended Code?

The regulations cited in the action became effective on March 6, 2020, while enforcement of the regulation began on September 1, 2020. According to the Secretary of State for the Commonwealth of Massachusetts website, the regulations make a broker-dealer or agent subject to a fiduciary duty to clients when providing investment advice, recommending investment strategy, moving assets to an account, or the purchase, sale, or exchange of securities. Commissions are allowed under the current law; however, it requires that a broker-dealer or agent make recommendations and provide investment advice without regard to the financial or any other interest of anyone other than the customer. The fiduciary conduct standard also requires that the broker-dealer or agent must take all reasonably practicable efforts to avoid conflicts of interest and reduce conflicts that cannot reasonably be avoided.

Unsolicited trades, defined as one in which the client initiates the transaction without the idea having first come from the investment professional, have not been subject to the fiduciary conduct standard. The standard applies in connection with recommendations or advice provided by a broker-dealer. Activities of a broker-dealer in connection with unsolicited trades are subject to both state and federal conduct rules.

What’s in the Complaint?

Robinhood has 486,000 brokerage accounts in Massachusetts with total assets of $1.6 billion. The complaint alleges that Robinhood exposed Massachusetts investors to “unnecessary trading risks” by “falling far short of the fiduciary standard” The 24-page complaint from the Office of the Secretary, William Galvin, focuses on the tactics that Robinhood uses to keep investors engaged. The implication is that the self-directed broker-dealer encourages users on the platform through what it calls “gamification.” Examples cited within the complaint include one Robinhood customer with no investment experience that made more than 12,700 trades in just over six months.

Referring to Robinhood’s business practices, Galvin said, “They know that their investors are primarily younger. It’s because they think there are more unsophisticated investors among them — we heard from some of them”. He charged, “They’ve exploited the current situation with the pandemic. They contributed to the frothiness of the market, bringing people in who don’t know much about it. They’re not responsible fiduciaries.”

A Robinhood spokeswoman disputed the allegation, “Those who dismiss new and younger investors, who come from increasingly diverse backgrounds, as unsophisticated or unserious perpetuate the myth that investing is only for the wealthy,” she said. “History is littered with startups criticized by the establishment that are now strong, longstanding businesses.”

Robinhood plans to defend itself.

What it Could Mean for Robinhood?

There are two main charges in the Massachusetts complaint against the broker. First is that Robinhood encourages risky trading. The second is that they ignore their own options-approval rules by allowing margin accounts for users of their app with little or no market experience. Proving that they encourage risky trading because of the alleged gamification of the platform may be difficult. The marketing of most retail platforms includes some method of added appeal related to the target demographic. The challenge is in the difficulty of proving that Robinhood encouraged speculation. The second main charge seems to depend on more clear-cut evidence. The complaint alleges about 68% of Massachusetts Robinhood account owners that are approved for margin trading have been identified as having limited or no investment experience. Since margin accounts provide Robinhood with additional order flow and the ability to extend credit for which Robinhood does earn daily interest, they may be in violation. Their own rules on extending credit demonstrate they believe clients should have a minimum level of experience. If it’s accurate that the broker’s questionnaire records indicate 68% of Massachusetts Robinhood margin account owners did not have this experience when they first had margin made available to them, Robinhood’s conduct does not meet the state’s code and Secretary Galvin’s complaint is valid.

On December 8, 2020 Robinhood selected Goldman Sachs to lead preparations for an initial public offering (IPO) which could be valued at more than $20 billion. The Massachusetts complaint, or any fines stemming from it, are not expected to have a material impact on the companies plans or valuation.

 

Suggested Reading:

The Federal Reserve and MIT are Experimenting with Digital Currencies

Investing and trading Skills

College Scholarships for Esports Gamers

 

Do You Know a Student Who Could Use $7,500 for College?

Tell them about the College Challenge!

 

Sources:

Robinhood is Expected to be a Top IPO – Regulatory Actions Show Hurdles

After Courts Kill a Federal Fiduciary Rule, Massachusetts Launches Its Own

Massachusetts Fiduciary Conduct Standard for Broker-Dealers and Agents

Ahead of an IPO Robinhood Agrees to Pay $65MM to Settle Charges

SEC Charges Robinhood for Misleading Investors

Robinhood Accused of Gamification in Massachusetts

Massachusetts Regulators File Complaint Against Robinhood

The Fiduciary Rule Is Dead. What’s an Investor to Do Now?

 

 

Small-Cap Stocks Have Been Performing at a Multiple of the Large-Cap Sector

 

In October, Channelchek published an article titled, “Which Stocks do Better After a Presidential Election?” The article looked back over 40 years and demonstrated that there has been a consistent outperformance of small cap stocks and explained some of the reasons smaller stocks could outperform large caps again.

It has been two months and we see that small cap stocks had a great month over the past 30 days. During the 30-day period ending December 10, the small cap Russell 2000 (RUT) index had gained 10.69%, compared to the S&P 500 (^SPX) increase of only 2.67%, and Dow Industrials (INDU) with a 2.05% increase.

This chart shows the Russell Small Cap Index(red) had a fivefold increase relative to the Dow 30 (yellow), and more than threefold compared with the S&P 500 Index (green).

Source: Channelchek Advanced Market Data

Performance Drag:

Based on these performance numbers, someone who invested for 30 days in a fund mimicking the RUT would have earned an additional 8% over the same investment in an ^SPX fund. If the same investor had placed money in an actively managed mutual fund designed to beat the small cap index, they likely would have been much more disappointed.

The small cap fund sector has been experiencing a lot of inflows during the last quarter of 2020. This is why it’s rising; this is how momentum builds. For the portfolio manager in an actively managed fund, this creates a few problems. The first is that the new money coming into the fund has to be invested or left in cash. During a fast upward moving market, cash detracts from performance. Alternatively, suppose the portfolio manager instead decides to invest the inflows. In that case, they will be investing at a time when stocks have already run-up, purchasing them at less than optimal times. They may be forced into decisions they would not have made with a more level and predictable account size. This sector had already had a good run up into November; an active fund manager putting money to work after the run-up is at a disadvantage versus the stocks represented in the index.

There’s another disadvantage a mutual fund portfolio manager, compared to an indexed ETF or even an individual investor may have as a rising market meets fund inflows. During the month of November, $5 billion in net new money was put to work in index-tracking, broad-based small-cap exchange-traded funds (ETF). This represented about 4% of the ETF’s total assets. Active managers usually don’t have as broad of a base of holdings instead as an index fund. More common is they take a higher percentage of their positions in the larger, more liquid names in the sector. When inflows to broad-based index funds accelerate, the smaller companies in the small cap universe often get lifted disproportionately, active funds participate less in these gains. On average, small cap actively managed funds returned about two percentage points less than the benchmarks during November.

Looking Forward

Market participants have been expecting a strengthening in small and micro cap stocks for a couple of years. They had been underperforming and expected to revert to their mean average relative performance. The events of 2020 surrounding the pandemic drove a lot of investible cash to large tech companies leaving small cap stocks to have to wait a bit longer for their move.

The recent move in small stocks across the board remains strong. Profit-taking among the large cap sectors are fueling a rotation into the small sector as many still perceive it as undervalued.  Investors also recognize that continued low materials prices should help many companies keep costs of operating below their pre-2020 levels while expectations of a post-COVID world should bolster profitability.

 

Suggested Reading:

Which Stocks do Well After a Presidential Election

Small-cap Stocks are Looking Better for Investors

The Advantage of Micro Cap Equities for Investors

 

Sources:

Why the Small-Cap Rally is Just Getting Started

Small-Cap Stocks Soared Last Month

 

Upcoming Events

 

 

The Disappearing Broker-Dealer Equity Analyst – Why it Hurts Investors

 

Stock research or equity analysis is an irreplaceable resource for investors to determine the fair stock price of a company.  The value of in-depth research is understood by large institutional investors such as mutual funds, pensions, and insurance companies, this is why they hire in-house stock analysts. Portfolio managers at these firms immerse themselves in information from a variety of trusted sources, they then get guidance from their own staff of highly compensated stock and industry analysts.

Covered Companies Continues to Shrink

The number of covered names analyzed by bulge bracket investment banks has been shrinking in recent years.  Company analysis and research are now primarily reserved for the most lucrative corporate customers with several high-profit banking relationships. This has been causing private investment advisors along with self-directed investors that had relied on the research of the followed companies to look for other in-depth institutional caliber research to review. The reduction in coverage of smaller worthwhile companies left many with either fewer firms covering them or completely orphaned. For a company, coverage by several firms is ideal – astute Investors and advisors weigh consistency among research analysts in their stock selection.

Ongoing consolidation within the broker dealer industry of firms including TD Ameritrade, Eaton Vance, E*Trade, Charles Schwab, Morgan Stanley and others is further shrinking the research available to investors. This is because  many of the firms folding into each other had overlapping covered equites. This follows years where these same broker dealers were reducing their research coverage.

The absence of one or more research firms regularly reporting on once covered companies is putting money managers in a position with fewer names to choose from. This is especially true of those professionals that make prudent use of Investment Policy Statements.

Investment Policy Statement (IPS)

Prudent investment management on behalf of others dictates an Investment Policy Statement. The Chartered Financial Analyst Institute (CFA) defines the role of the IPS as:

“The investment policy statement (IPS) serves as a strategic guide to the planning and implementation of an investment program. When implemented successfully, the IPS anticipates issues related to governance of the investment program, planning for appropriate asset allocation, implementing an investment program with internal and/or external managers, monitoring the results, risk management, and appropriate reporting.”

Two common elements of most IPS are the Limits on Investments and Relative
Constraints section. Within these sections it is not uncommon for the IPS to have wording which includes analyst rating at or above their mid-rating.  Or, in other cases it may require the average of at least three analyst ratings above or at the mid-point. Other language may allow investing down to the lowest rating but limit the total portfolio percentage in this category. If a company isn’t rated it may not be allowed in consideration. There are of course other possibilities that eliminate a stock from being purchased in order to comply with what was agreed upon with the client or trust agreement. The reduction in coverage of companies by firms, and fewer firms covering those companies, eliminates many that otherwise would be a fit. That they can’t be considered is not good for the investor or the company.  

Alternatives

Other research is filling the information gap made even wider by Wall Street. Independent research firms and boutique research-oriented investment banks are providing research on the stocks that have been left hanging by Wall Street. This means that independent research firms are becoming a primary source of information on a high percentage of publicly traded stocks. Some of this is subscription-based from investors. Another model which is gaining more prominence and acceptance is fee-based research where the cost of high caliber research is covered by the company itself. This model, often referred to as company-sponsored research is beginning to fill what would be a widening gap with broker dealer consolidations. It provides investors adhering to an IPS that would otherwise be required to exclude uncovered stocks the ability to consider them. The research also provides investors with details on company projections they would not have otherwise had for use in making decisions at no cost to the investor.  Public companies securing this service have additional benefit since, unlike subscription-based, the research is available to all. 

Company Sponsored vs. Promotional

It’s important to differentiate between unbiased fee-based research and research that is promotional. Objective fee-based research is similar to the role of your doctor. You pay a doctor not to tell you that you are well, but to give you his or her educated and truthful opinion of your condition.

Professional fee-based research is an objective analysis and opinion of a company’s investment potential. This is not to be confused with promotional write-ups. These write-ups are short on analysis, long on hype, and often written by marketers, not investment professionals.

Look for these characteristics to determine a research firm’s legitimacy:

• They provide analytical, not promotional services
• They are paid contractually in cash, (not any form of equity)  
• They provide full and clear disclosure of the relationship between the company and the researcher

Some company-sponsored research firms have taken additional steps including requiring FINRA registrations  of its analysts to demonstrate a high level of understanding, promote ethical behavior, and subject the analyst and the firm to punishment including loss of career, if some guidelines are not adhered to. This additional step punctuates the ethics, diligence and authenticity under which the evaluations were conducted.

Companies That Would Benefit from Research:

• Its shares may be undervalued because investors are not familiar with the company
• It has fewer than two respected firms covering the name which may take it out of consideration by professionals
• It believes that its story, financials, and management can withstand objective analysis

Take-Away

The visibility, credibility, and investability of a company hinge on investors recognizing and understanding the company. It also has to meet the criteria of the IPS of those firms it would like to attract. The company should also try to avoid tarnishing its reputation by not associating itself with hype masquerading as research.  Similarly, a research firm may have its own criteria for selecting which stocks they want to analyze.  Investors should make certain they are looking at high caliber research and not hyped marketing.  The need left by large broker dealers, both by reducing covered companies, and also by merging with  firms where there was a duplicate coverage situation  is being filled by company-sponsored research firms. Their value is becoming better understood as the best solution to the problems left by the large Wall Street houses.

Suggested Reading:

Is Company Sponsored Research the Future for Small-Cap Stock Investors?

Small Cap Stocks Can Increase Your Portfolio Diversification

Large and Small Cap Return Probabilities

 

Do You Know a Student  Interested in Equity Research?

They Could Win Up To $7,500 !

Tell them about the College Challenge!

 

Sources:

Elements of an Investment Policy for Institutional Investors

Elements of an Investment Policy for Individual Investors

 

The Advantages of Micro Cap Equities for Investors

 

A micro cap stock is a publicly-traded company with, by most definitions, a total U.S. dollar value of outstanding shares valued between $50 million and $300 million. Micro cap companies have greater market capitalization than nano caps and less than small cap companies. The price of the stock itself does not indicate a company’s capitalization; for example, a company with shares trading at $2.50 and 25 million shares outstanding is larger than a company trading at $10 with 10 million outstanding shares.

The Small Firm Effect

A theory called “the small firm effect,” backed by empirical evidence, suggests there is a risk premium placed on smaller firms. The theory holds that the effect of this risk premium, perhaps coupled with larger management stakes in these small firms, on the group, allows smaller companies to outperform larger corporations over time.

The phenomenon has also been explained by the ability of smaller companies to have a sharper focus and the ability to be more nimble after seeing an opportunity or upcoming trends. While equity shares issued by smaller companies often experience more volatility, the small firm effect states that the opportunity to appreciate company shares may be superior versus those that are considered less risky and trade with less volatility.

Smaller firms are necessarily more streamlined and efficient. Their business model often dictates reducing waste and “dead-wood” employees.  This could put the smaller firms at a more competitive advantage when competing with larger firms within their space. A leaner, perhaps more simplistic model can also add to the company’s success in that decision making can be quicker with fewer people involved. A perceived opportunity in the marketplace can be capitalized on with little wasted motion, meetings, and memos. This translates to an increased ability to be first and be best. This allows capturing market share early and the momentum to hold onto and grow that market share even when the larger players step in to compete.

Investor Benefits

Small firms have been shown to have a positive impact on the potential returns of investors. While smaller companies lack the capital assets and distribution channels of large, deep-pocketed, and more established businesses, the ability to make decisions quickly on what might be a short-term event can add earnings to the bottom line. The earnings are a much more significant percentage of total revenue compared to larger firms. The effect over time is the shares of stock issued by smaller firms could rise as the increase in earnings are understood and known. The companies’ valuation would respond accordingly, as more deem them worthy of consideration for purchase as an investment. While investors have more volatility, the possible returns can often balance that risk and make allocations in select small cap stocks a good strategy for investors.

Many of the stocks that meet the definition of micro cap are not widely reported on and may even be lacking equity research coverage from reputable organizations. This lack of opportunity and being known can depress equity valuations as investors are less likely to take on assets they don’t clearly understand. Or understand on a surface level while trusting the expertise and regular reports of an industry analyst covering the company.

Take-Away

While the small firm effect is a theory that has been backed up with decades of both data and anecdotal reports, there are differences in thought on how to best measure it. The different measurements return different results. One large difficulty in quantifying data is the time frame. Suppose one looks at measurements on a year-to-year basis of companies that meet small capitalization criteria. In that case, each year may be excluding the greatest winners as they grow out of the definition. The same drawback to accuracy is on the downside, a study would also be eliminating those that dropped below the $50-$300 million set of companies.

The past year has brought tremendous focus on the performance of the most highly capitalized public companies. All of them were once micro cap and considered risky. These mega cap giants will all likely be dethroned one day by innovations coming about by companies that are barely on investors radar right now.

 

Suggested Reading:

Are Nano Cap Stocks Beneficial to Your Portfolio?

Financial Markets Lifted Household Wealth to Record Levels

Which Stocks Do Well After a Presidential Election

 

Do You Know a Student  Who Could Use $7,500 for College?

Tell them about the College Challenge!

Sources:

Correlation and Micro Cap Equities

Micro Cap Stocks, Investopedia

The Micro Cap Advantage

 

Noble Capital Markets Invites Students to Compete in Second Annual College Challenge – An Equity Research Contest Awarding Up to $7,500 to Winning Student(s)

 

Boca Raton, Fl. December 1, 2020, Noble Capital Markets Inc. today announced the launch of its second annual  College Challenge. The equity research report contest is designed to encourage college students to explore the field of equity research and analysis. The prize package includes cash for both winning student(s) and the winner’s school, a paid internship with Noble Capital Markets, an award ceremony at the virtual NobleCon Investor Conference (NobleCon17), and more.

Participants are to prepare a “Wall Street-style” equity research report on one of the more than 6,000 public small and microcap companies found on channelchek.com. Channelchek is an investor resource featuring news and commentaries, equity research, live and recorded management discussions, company and stock market data, plus exclusive reports on select industries.

The student(s) that register for this year’s College Challenge will be competing for up to $7,500 paid to them; their college will receive an additional $5,000. The student(s) will also be offered a paid internship with Noble Capital Markets. The award ceremony will be online at the 17^th annual Noble Capital Markets investor conference; a video of the award presentation ceremony will be featured on the NASDAQ Tower in New York City’s Times Square.  

Each year NobleCon draws executive teams from public small and microcap companies presenting their company’s investment opportunity to attendees who are both institutional and self-directed investors. NobleCon17 will occur on January 19, 20, and 21, 2021 (more information available at NobleCon17).

The College Challenge has been made possible with the support of the following sponsors: Channelchek, Tribune Publishing, Salem Media Group, Kelly Services, NASDAQ, The College Investor, and E.W. Scripps, known for its National Spelling Bee.

Mike Kupinski, Noble’s Director of Research, was active in providing guidance and judging last year’s College Challenge; he stated, “It’s exciting to be involved in this competition again. Last year the students clearly took the competition seriously with reports that were well written, with thorough analysis. The winners, Stephen Zurlo and Casey Szarkowski from the University of Tennessee are examples of the high level of talent present within the college community today.” Looking toward this year’s College Challenge, Kupinski said, “I hope that the competition will incent more students to be inspired to seek careers in equity research, as well as the financial industry.”

Register Here: https://www.channelchekcollegechallenge.com/home#home

 

Contest Guidelines:

The Challenge is open to students without restrictions relating to age or academic specialization who are registered at an institute of higher learning anywhere in the United States. Entries will be judged by senior equity analysts at Noble Capital Markets.

A complete list of rules are available at College Challenge Rules.  There will be two informational session webinars for those interested in competing. The registration links for the sessions are below. Students are encouraged but not required to attend these sessions.

December 3, 2020, 2:30pm EST

College Challenge Information Meeting with Mike Kupinski, Director of Research Noble Capital Markets

https://attendee.gotowebinar.com/register/9109245340248312848

December 8, 2020, 3:00pm EST

Tips for Completing your College Challenge Entry with Mike Kupinski, Director of Research Noble Capital Markets

https://attendee.gotowebinar.com/register/7121098519299164688

About Noble Capital Markets, Inc. Noble Capital Markets (“Noble”) is a research-driven boutique investment bank that has supported small & microcap companies since 1984. As a FINRA and SEC licensed broker dealer Noble provides institutional-quality equity research, merchant and investment banking, wealth management, and order execution services. In 2005, Noble established NobleCon, an investor conference that has grown substantially over the last decade. Noble launched Channelchek – a new investment community dedicated exclusively to small and micro-cap companies and their industries in 2018. Channelchek is tailored to meet the needs of self-directed investors and financial professionals. Channelchek is the first service to offer institutional-quality research to the public, for FREE at every level without a subscription. More than 6,000 public emerging growth companies are listed on the site, with growing content including research, webcasts, podcasts, and balanced news.

Contact:

Email: mkupinski@noblefcm.com

About NobleCon17: https://www.nobleconference.com/seventeen

 

Channelchek Again Kicks off the Giving Season Helping Students With a Research Contest – What You Should Know

 

A lot in 2020 has been canceled or postponed because of the pandemic; travel, weddings, even Mardis Gras celebrations in New Orleans. But the spirit of helping others has not been postponed, and thankfully not canceled. As we approach the year-end holiday season, Thanksgiving  into the New Year 2021, the idea of helping others has not been put-off and is more important than ever.

This time of year is the helping and giving season. If you aren’t a college student but know of one that would be thankful you shared this with them, I encourage you to use the sharing tool above to tag or address them on social media or email. A student, particularly one with a business or finance concentration, may be particularly interested and grateful. If you have a relationship with a college, ask them to share the College Challenge to help their students and possibly bring a cash prize to the school itself.

2021 will arrive whether a ball drops to a cheering crowd in Times Square or not. The College Contest is determined to again help students, colleges, and the very noble profession of equity analysis.  We look forward to awarding a stand-out student and their school. The past 12 months have made looking out for others and helping when we’re able more fashionable than ever before. All of the Channelchek sponsors are proud of our contributions.

Everyone at Channelchek wishes you a productive start to the holiday season. Links to the College Challenge and Zoom Meetings are found below.

 

Paul Hoffman

Managing Editor, Channelchek

 

Learn More:

Information and rules for Channelchek’s College Challenge

Register now for the College Challenge

Information about NobleCon17

 

Informational Meetings for the College Challenge:

 

 

 

Channelchek Premium access at no cost

 

Winners and Losers as Interest Rates Shift Investor Focus

 

Treasury bonds sold-off pushing yields higher over the past week. The tech sector and other interest rate sensitive stocks felt downward pressure as individual investors and fund managers may have begun cutting their exposure. Experience tells us that when rates rise, particularly suddenly, tech stocks suffer. Technology shares have been prone to getting ahead of themselves since the 1990s. Last week saw selling in tech in part because of the precarious interest rate scenario.

A Quick Look Back

At the beginning of 2020 there was an 80bp spread between 1-month US Treasuries and the 30-year Treasury Bond. As of close of business last Friday the spread sat at 155bp. Although the entire yield curve has shifted lower, industries that make money on the spread between short deposit rates and longer lending rates benefit from the  wider spread and the amount of economic activity rather than the absolute level. This could include securities brokers where customers have large, uninvested balances, credit card companies, banks, and other finance companies.  

US Treasuries at Open of 2020 and November 2020  Daily Closing Yields

Source: www.treasury.gov

Activity This Past Week

Hope for a stronger economy ahead caused yields to rise after a release from Pfizer and BioNTech announcing a vaccine that achieved 90% efficacy against COVID-19. The 10-year US Treasury, responded by hitting .97% which is a seven-month high and later closed out the week at .89%.  According to data from the US Treasury all maturities past 1-year also posted a similar upward movement. This spooked some sectors as market participants considered the impact of higher rates on various industries that don’t do well as financing costs increase or bonds become an attractive alternative.

Yields are still 70-140bp below their start of the year and well below their 5-year average. Forward looking stock market participants last week lightened positions in  shares that ran up during the rally that pushed the S&P 500 up 58% from its March low.  

What May Lie Ahead

Expectations are that an economy that has been partially sedated to minimize spreading of a novel virus may resume more rapid growth moving forward. Higher economic activity would continue an already strong recovery trend as releases showing massive improvement in GDP and employment have beat expectations. A continuation of positive reports would reduce the need for the Fed to maintain rates at the low levels the FOMC now targets.  Higher overall rates could reduce profits for tech companies with high debt loads and industries where customers depend on financing such as the real estate and automotive industries. The popular list of companies that roared as people stayed home, (Zoom, Facebook, Peleton, Amazon, and others) are unlikely to achieve those levels of enthusiasm in a world less threatened by COVID-19.

. 

 

Suggested Reading:

How Will Remote Working Change After the Pandemic

Which Stocks Do Well After a Presidential Election

Many
Investors are Keeping Their Powder Dry

 

Do You Know a College Student?

Tell them about the College Challenge!

Sources:

https://robinhood.com/us/en/support/articles/earning-interest/

https://www.pfizer.com/news/press-release/press-release-detail/pfizer-and-biontech-announce-vaccine-candidate-against

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/TextView.aspx?data=yieldYear&year=2020

 

SEC May Limit Individual Investors Knowing What Some Money Managers are Doing

 

In mid-July, the Securities & Exchange Commission proposed to amend Form 13F to update the reporting threshold for institutional money managers. Adopted in 1978, Form 13F requires money managers who manage in excess of $100 million to submit a list of their long equity holdings each quarter within 45 days of the end of the quarter. The purpose of the original rule was to provide the SEC with data from larger money managers about their investment activities and holdings so that their influence and impact could be considered in maintaining fair and orderly securities markets. The $100 million reporting threshold has not been adjusted in over 40 years.

Big Changes in SEC Proposal

The SEC proposal would lift the threshold to $3.5 billion, reflecting proportionately the same market value of U.S. equities that $100 million represented in 1978. The new threshold would retain disclosure of over 90% of the dollar value of the holdings data currently reported while eliminating the 13F filing requirement for nearly 90% of the filers that are smaller money managers, or some 4,500 investment managers, overseeing $2.3 trillion in assets, according to the National Investor Relations Institute. The SEC estimates the elimination of 13F filing requirements for smaller money managers could cut direct compliance costs some $15,000 to $30,000 annually per manager or $68.1 million to $136 million annually in aggregate.

Opposition Almost 100:1

What’s not to like about reducing “paperwork” while saving investors money? Sounds good, right? Well, in the first few days following the Proposal, 179 comment letters had been filed with the SEC in response to the Proposal – and 177 of those letters are opposed to it. Comments continue to trickle in, with the most recent from October 16^th, and each of the last ten were opposed to the proposed rule changes, although some expressed interest in some type of change to the existing rules, just not the one’s the SEC has proposed. An article in the Harvard Law School Forum for Corporate Governance commented, “It is difficult to see how eliminating the limited transparency into ownership by activist and other hedge funds, and instead of increasing the percentage of 13(f) information provided by “price-taking” index funds rather than smaller active funds that set prices, will further” the goals of data gathering and increasing investor confidence in the integrity of the securities markets.

Why the seeming outpouring of opposition to the SEC proposal? According to the CFA Institute, “The resulting loss of holdings information would harm market participants such as, among others, investors, issuers, researchers, and the affected institutional investment managers themselves.” The CFA goes on to say, “We also believe the Proposal would run counter to other statutory objectives, such as the need to build investor confidence, enable issuers to identify their beneficial owners, afford an understanding of the effect of institutional investor activities on individual securities, and serve as a single centralized repository of certain holdings data. And finally, we believe the economic analysis falls short in establishing a baseline of current practices and assessing the costs and benefits of the proposed rulemaking in a thorough and impartial manner.”

Small Investors Have a Beef

An especially galling aspect to small and individual investors is the significant reduction in the ability to “follow the smart money.” A Forbes article noted that “Goldman Sachs estimates that the number of funds tracked, that would continue filing 13Fs, would plunge from 815 to just 65 if the filing threshold increased to $3.5 billion, which highlights only how much less transparency there would be if the proposal were implemented.” And in an article for Columbia Law School, Eduardo Gallardo pointed out that some of the most prolific activist funds would no longer have to file 13Fs, including Jana Partners, Starboard Value, Greenlight Capital, along with many others. In fact, of FactSet’s SharkWatch 50 list of the top activist funds, just ten would still have to file 13Fs. While following the “smart money” isn’t a panacea, many investors track these investors to get additional insights not only into individual stocks but industries and the overall stock market.

Where There is Agreement

Despite the opposition to the SEC proposals, many stakeholders and market observers agree that the rules and regulations need modernizing. Such potential changes include shortening the reporting window so that shares held updates are available as soon as two business days following the quarter end, rather than 45 days, and to change the reporting period from quarterly to monthly to match the short?sale reporting period. A number of proposals also have commented on increasing the reporting threshold, though none as high as the SEC proposal.

 

Suggested Reading:

Financial Markets Lifted Household Wealth to Record Levels

JOLTS Report Suggests More Risk Taking

U.S. Debt as a Percentage of GDP is Skyrocketing

 

Each event in our popular Virtual Road Shows Series has a maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

 

Sources:

https://secsearch.sec.gov/search?utf8=%E2%9C%93&affiliate=secsearch&sort_by=&query=Pictures+13F

https://clsbluesky.law.columbia.edu/author/eduardo-gallardo/

https://www.forbes.com/sites/jacobwolinsky/2020/09/16/sec-13f-proposal-bad-for-investors-and-companies/#114477594b25

 

Cyber-Piracy Risk and Protecting Online Brokerage Accounts

 

The increasing popularity of online and smartphone trading has increased opportunities for a few unwanted players. Unfortunately, some of these players are hackers, thieves, and other conmen. Just as the rise of email opened the door for the wealthy “Nigerian Princes” to reach out across the ocean and solicit financial help, technology and interconnectivity open the doors to new scams and other avenues for criminals to gain information on you with bad intent.

Brokerage Community

The enhanced ability to work remotely, which was more broadly adopted and rushed into place by the challenges of 2020, has since caused an increase in opportunities to hack information from unsuspecting computer and smartphone users. The online brokerage community has been a recent victim. This past week, one popular trading app reported that it had a “limited number” of customer accounts targeted by cybercriminals. Although many of these 2000 odd accounts had been looted and skimmed, the broker made clear that their systems themselves were not hacked. The fintech criminals were able to compromise users’ personal email accounts outside of the trading app; they then used those emails to gain access to customer’s login, the company said.

Recourse

Investment brokerages rely on providing, information, reliability, and execution. However, none of these will keep them in business without an outstanding reputation. Broker’s need to maintain this reputation, for this reason they may be inclined to help investors whose accounts, through no fault of the broker, have been looted. This type of theft is not covered by FDIC insurance as it would be (within limits) at most depository institutions. The SIPC signage you see at many brokerage firms provides coverage only for cash and securities in the trading account. This insurance coverage comes into play primarily if the broker is in financial trouble, and customer assets are missing. It does not provide protection against other theft. And, the SIPC is not a regulatory body of any kind.  The recent cases referred to above, involved individuals own electronic devices being hacked.

The brokerage community is not automatically responsible for your online weaknesses. That is generally up to you. The growth in popularity of online trading has exposed weaknesses on many fronts. In order to have some level of comfort, it is best to research how individual brokers have historically handled cases of their customers’ login being hacked. It’s also good practice to see how easy it is to reach their customer service number. If money is wired out of your account without authorization, it may be possible for the broker to reverse the transfer. But not if they are unreachable. If you have an account, you may decide to find that number now and put it in your phone’s directory rather than try to find it on their site when speed is important.

Individual brokerages have their own policies. If cybersecurity is a large concern of yours, you may want to prioritize working with a company that guarantees they will take responsibility. Even if it means they are lacking in other services and conveniences offered by others.

 

The Charles Schwab website explains its policy on cybercrime.

 

Protection

No one is scam proof, but there are precautions you can take and red flags you should recognize. Some of the more basic precautions include not divulging your personal information to any non-authorized person. If you are called by someone asking for information, call them back using the website’s direct number. If an email or website looks odd, question it. Look at the URL, dig deeper to ensure the site is legitimate.

 

The Interactive Brokers website has a notice posted on how to avoid phishing scams.

 

You shouldn’t use unknown or unprotected WiFi when logging into your account. Check your balances frequently, even if you haven’t transacted in a while. Also, brokers are required to issue confirmations of transactions and account statements at scheduled intervals. Open them, and be sure to review the statements closely. Look to see if there are any unauthorized activity in your account. Make sure your cash balance reconciles with your known activity. Make certain your contact and address information have not been changed. As an additional layer of caution, take the time to change your password as frequently as practical.

Any questions should be directed to the brokerage firm in writing. You may first call to be expeditious but then follow-up with documentation of the call, including who you spoke with and all details of what was discussed.

Below are helpful resources on where to turn for help should you believe you are a victim of cybercriminals: 

• The United States Securities and Exchange Commission
• The Financial Industry Regulatory Authority
• Your State Securities Regulator
• North American Securities Administrators Association
• National Fraud Information Center
• Investor Protection Trust
• Alliance for Investor Education
• FBI/Secret Service Internet Fraud
• Federal Trade Commission
• U.S. Commodity Futures Trading Commission

 

Suggested Reading:

A Feather in the Cap of Robinhood Traders

Why do Small-Caps Outperform After a Major Election

Investment Barriers Once Seen as Insurmountable are Falling Fast

 

Each event in our popular Virtual Road Shows Series has a maximum capacity of 100 investors online. To take part, listen to, and perhaps get your questions answered, see which virtual investor meetings intrigue you here.

 

Sources:

Facts Statistics Identity Theft and Cybercrime

Robinhood Accounts Hacked

SIPC About Page

Schwabsafe Guaranty

Photo: howtostartablogonline.net

 

Will Sidelined Investors’ Patience End Soon?

 

COVID. A Gyrating stock market. Economic uncertainty. A Presidential Election. These and other factors have combined to push funds held in money markets by retail and institutional investors to all-time highs. According to the Federal Reserve Bank of St Louis Economic Research, at the end of September, retail investors held $1.09 trillion in money market funds, down slightly from the all-time high of $1.15 trillion at the end of May this year and well above the $600 billion-$800 billion range typically held over the past decade. Institutional investors held $3.0 trillion in money market funds at the end of September, down slightly from the $3.2 trillion peak earlier this year and well above the historic $1.6 trillion-$2.0 trillion range over the past decade.

Combined, there are some $1.5-$2.0 trillion of above-average funds being held in money markets today. Put another way, a potential $1.5-$2.0 trillion of Dry Powder. The Dry Powder amounts to 4.2%-5.6% of the entire market capitalization of all publicly-traded companies in the U.S. A not insignificant sum if it were to be re-invested in the stock market.

While moving to the sidelines in uncertain times is the historical norm, how long can this behavior last? The FDIC reports the average money market rate at 0.08% APY. Bank Rate reports the best (our emphasis) 1-year CD rate at 0.75%, 2-year at 1.00%, and 5-year at 1.35%. But the U.S. Labor Department reported the annual inflation rate for the 12 months ended September 2020 was 1.4%. And the Federal Reserve Bank of Philadelphia reports the estimated long-term annual inflation rate at 2.05%. Obviously, on a real basis, holding funds in such investments reduces one’s inflation-adjusted net worth. And this is exacerbated for institutional investors who typically are being paid to invest money, not have it sit on the sidelines.

What about other investment alternatives? MacroTrends reports the current 10-year treasury yield at 0.67%, the lowest rate over the last 60 years. At some point, one would expect treasury yields to begin to rise, which would result in prices of such bonds to decline. Gold at $1,899 per oz is not too far off its 100-year inflation-adjusted high of $2,268 hit in 1980. And while debate rages about the usefulness of gold as a hedge, gold does not pay a dividend and can oftentimes incur carrying costs. And even property values are hitting all-time highs. The St. Louis Fed reports the S&P/Case Shiller U.S. National Home Price Index is at an all-time high of 221, up substantially from the previous high of 184 hit in the summer of 2006.

One potential use of the Dry Powder could be to trim household debt. Household debt hit a record high of $14.3 trillion earlier this year, some $1.6 trillion higher than the previous record during the Great Recession. Housing debt makes up the bulk of overall household debt. Revolving, credit card type of debt has dropped dramatically during the COVID crisis, while auto loans and student loan debt continue to rise. But, if the additional debt incurred was in response to lower rates, at a current 2.89% 30-year mortgage rates are at their lowest levels since at least 1971, according to Freddie Mac, consumers may not be inclined to use Dry Powder to repay such loans.

Given the alternatives, the 7% average annual return of the stock market over time may look appealing to investors seeking places to invest their Dry Powder.

 

Suggested Reading:

Why
Do Small-Cap Stocks Outperform After Elections?

The
Role of Microcap in Tech Future Should Not Be Forgotten

Financial Markets Lifted Household Wealth to Record Levels

 

Subscribe to Channelchek’s YouTube Channel

Each event in our popular Virtual Road Shows Series has a maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

 

 

Splits, Ticks, and Stock Value

 

During August, when Tesla and Apple had both scheduled stock splits, there was a great deal of online discussion around how the value of these two companies would be impacted. It also opened an opportunity for smaller self-directed investors who want more diversification than they could accomplish with share prices between $500 and $2,000 to wave in a few shares. These investors could be more prudent with their exposure to the companies that have been relentless highflyers – favorites that had been out of reach.

Stock splits, at a minimum, serve to place ownership in more hands of more investors. Broad diversity of ownership is desirable for management and boards who prefer to have their ownership less concentrated; it allows them more autonomy to manage. But, what does it do for the stock price for buyers? On the surface, a stock split doesn’t change the fundamentals of the equity in the hands of the public; does it impact shareholder value? Are trading desks enriched or hurt?

Splits Help Stocks Trade Higher

A company stock split changes how their stocks trade. A lower per-share price expands the pool of interested investors; more demand puts upward pressure on price and improves returns. Increased valuations may then feed increased interest driving the performance even higher. As explained by Poe Fratt, Senior Equity Analyst at Noble Capital Markets, “Investors often regard stock splits as positive even though the market capitalization and valuation of the company don’t change. The perception that stock splits are positive probably emanates from the fact that a stock split generally follows a period of strong stock price performance.” Mr. Fratt continued, “While the valuation doesn’t change, there is a belief that a stock price in the $25-$100/share range enhances trading liquidity and makes the stock more attractive to retail investors.” With retail investors now making up more than 25% of stockholders, the inclusion of the “little guy” puts upward pressure on performance.

On average, it shows up in the stock price over the next 12 months. Large-cap stocks outperform the market after a split by 5% during that year. Companies of all sizes outperform after announcing a split by 2.5%. Academic research confirms that liquidity improvements following stock splits reduced average companies’ cost of equity capital by 17.3% or 2.4 percentage-points per-annum. The benefit, on average, is a material boost to both issuers and investors.

 

On average, split stocks do outperform the market as soon as the split is announced and even more over the next 12 months.

 

Trading for Investors Becomes Less Expensive

The cost of transacting in a name is increased by:

• Spread– The percentage difference between bids and offers.
• Liquidity– The average daily value traded, which limits how much value can be easily transacted in a day.
• Volatility– The risks of losses for market makers providing liquidity, low volatility helps to keep spreads tighter.

 

The Costs of Trading in a name mostly improve.

 

Looking at these metrics for stock-splits from 2012-Q1 2020, they show that on average:

• Spreads- improved by 22%, with 89% of stocks seeing better spreads.
• Liquidity- Value traded increased by 18%, with 70% of stocks seeing better liquidity.
• Intraday Volatility- reduced by 3%, with 66% of stocks seeing lower volatility.

 

These changes all contribute to lower trading costs. A decline in costs increases returns, which then improve valuations.

Tradability and Stock Price

All publicly-traded stocks in the U.S. transact under a very similar set of rules. The rules impact different per-share prices differently.  Two rules that impact ease of trading that have recently been softened by technology still have an effect on the overall cost of getting in and out of a position. They are tick sizes and round lots. Low dollar-priced stocks have ticks that make spreads wider on a percent of share price levels. That increases lengths of time waiting to trade and cost to trade. Simply put, their spreads are necessarily wider. Higher dollar-priced stocks have too many ticks and a larger cost round lot. The higher the number of ticks the easier to jump queues. Their spreads are wide because trading is difficult. The high priced round lot makes it expensive to post bids and offers cheaply. There is a sweet spot. Someplace in between is a price level where the tick more closely represents an ideal tradeoff for immediacy of transacting. The “in-between” stocks trade with the lowest spread costs.

 

 

Wide spreads deter professional portfolio managers that are measured against benchmarks where slippage is not factored in. A wide spread could deter these investors from larger positions. That reduces interest, and the lower demand weighs on price.

The One-Cent Tick Issue

The smallest increment of U.S. currency is $0.01 or one cent. For example, you can bid $5.01 or $5.02, but not in between. This is part of the problem with tick size versus stock price. The one-cent-tick represents a very different cost for a $5 stock (20bps) than a $500 stock (0.2bps).

For low priced stocks, these spreads can be “expensive” for investors to cross. There needs to be confidence that the potential for an increase is high. This slows down the trading queue and liquidity of the shares.

The one-cent tick also distorts trading in higher-priced stocks. High priced stocks have more tick gradations and more odd-lots, even if the market depth is the same.

 

 

The example above compares a $1,000 and a $100 stock with identical liquidity profiles. The top chart shows that ticks on a $1,000 stock are worth just 0.001%. Even the most liquid companies in the U.S. markets have a spread closer to 0.01%. More increments reduce the cost of new buyers jumping in front of (pennying) buyers already in line. This impacts the initial bidder who may miss being filled. At the same time, it doesn’t really improve the price for those selling.

Round Lot Issues

Using the top chart above, once again, we can see an issue with the convention of trading stocks in increments of 100 (round lot). Historically trading in round lots was designed to reduce paperwork on settlement and to ensure that benchmark spread prices reflected a meaningful trade value. Because of this almost outdated convention, odd lots aren’t treated the same way as round lots. The prices quoted to the public are round lot prices. They set the official spread that institutional investors use to calculate trading costs, and they are “protected,” which means traders cannot skip over them to trade elsewhere (including off-exchange).

Round lots can widen spreads. The chart above shows the value of a round lot increases as prices increase. According to Nasdaq research (the V-shape above) is the same regardless of tick size. However, when the stock in the upper chart is split 10:1, the 50-share ($50,000) odd lots become round lots, this instantly adds size to the official quote and cuts the spread for the $100 stock in the lower chart in half. So, with larger increments and smaller round lots, an investor looking to outbid those in the queue now has a more difficult time with the tighter spread.

Regulators are Aware of the High Price Issues

Investors have weighed in about issues trading high priced stocks and are looking to alleviate some of the issues. The SIP committee, responsible the consolidated tape, has proposed adding odd lots to the tape. That fixes the round lot issue but may create a best execution issue if very few shares are indicating the benchmark price. The SEC has proposed changing round lot sizes. This partially helps issues in the round lot quagmire, but while trying to avoid the best execution measurement issues, it removes some investor protections by allowing trade throughs. In Europe, regulators have eliminated round lots and also changed tick sizes.

Stocks are Pricier Than Before

From 1930 until as recently as 2007 nominal prices of common stocks have remained constant at around $30-$40 per share as a result of firms splitting their stocks. Stock splits were so normal that prices held in a consistent range. Before 2007 it was rare for the S&P500 to have more than a few stocks over $100. Now there are more than 100 (approx. a quarter of the index).

 

Number of Stock Splits by S&P 500 Companies

 

It would be easier for traders if stocks traded more uniformly with roughly the same prices. Instead, fewer stock splits have allowed higher stock prices since the financial collapse of 2008. This is a relatively new characteristic of the market.

Some of the blame is placed on Reg NMS which were trading rules instituted in 2007 to help make markets more readily electronic and interconnected. The rule included decimalization (not fractions), which cleared the way for low one-cent ticks. Now, a significant number of stocks have reached well past the level where they are constrained by a one-cent tick. The result is a larger proportion of trading is happening away from listed prices. Price discovery may also be dampened by the lack of visibility widening spreads.

Take-Away

Stock splits fundamentally improve tradability and that boosts share price. Tradability and its connection to trading costs help clear the way for these better valuations. The market’s positive reaction to a stock split announcement confirms that traders know costs matter to longer-term price. It also, according to Mark Reichmann, Senior Equity Analyst at Noble Capital Markets “… signals to the market that management is confident in its operations.”

Statistics demonstrate that many IPOs get priced around $20 to $40 per share. This shows that bankers taking companies public intentionally choose an effective stock price level. But the sweet-spot, where ticks are neither too wide or too narrow, is different for every company. Regulators are beginning to address investor concerns as stock splits have become far less common over the past dozen years. Some of the issues of higher prices are helped by the new trend of brokers offering fractional shares. This ability compounds many other issues–but that’s a topic for another article.

Paul Hoffman

Managing Editor, Channelchek

 

Suggested Reading:

Why do Small-Cap Stocks Outperform After a Major Election

Investment Barriers Once
Seen as Insurmountable are Falling Fast

Trading Technology Continues to Level the Playing Field for Investors

 

Each event in our popular Virtual Road Shows Series has maximum capacity of 100 investors online. To take part, listen to and perhaps get your questions answered, see which virtual investor meeting intrigues you here.

 

Sources:

Stock Split Calendar

Three Charts That Show a Dramatic Drop in Stock Splits

Three Compelling Reasons for Companies to Split Stocks

PSU.EDU Academic Research

Why Intelligent Ticks Make Sense

Looking for the perfect Stock Price

Volume and Implications for Access

The Nominal Price Puzzle