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Discount Brokerage Weekly Roundup – October 19, 2018

This fall, the colours of the leaves in Canada were distinctly green as legalization of recreational cannabis officially took effect. There was lots of excitement in the months and weeks leading up to this major milestone. For DIY investors, that has translated into lots of volatility and trading which online brokerages are always happy to receive.

Even though Canada was clearly in the spotlight across the globe this past week, for this edition of the roundup, we shine a spotlight on the US online brokerage space yet again. Earnings for major US brokerages were reported as well as what management at these brokerages had to say about some very weighty issues, so continue reading to get more details on what those reports mean for online investors on both sides of the border. As usual, we have the tweets from DIY investors and a pair of interesting forum posts to share.

Mind on My Money, Money on My Mind

Like all good students of any market, it pays to do your homework. So, when it comes to tracking movement in the online brokerage space, the publicly-traded US online brokerages provide ample reading – especially at this time of year when they publish their quarterly earnings results. Unlike many quarterly earnings calls and discussions in the past, however, there was definitely one event/issue on the minds of analysts and online brokerages alike: zero-commission trading.

While Robinhood was or is perhaps best known for their “zero-commission” trading model, it was the announcement last fiscal quarter by J.P. Morgan that they too will enter the commission free trading game that sent shockwaves through the online brokerage space.

This week it was the shockwave of that announcement and the maneuvering the industry has done in response that appeared in earnings calls (and calls with management) at Interactive Brokers, E*Trade Financial and Charles Schwab.

For many online brokerages, the launch of Robinhood in 2015 and their no-cost trade model certainly raised the notion that trading commissions could go to zero a lot faster than anyone had ever anticipated. Still, Robinhood faced many hurdles and incumbent online brokerages were content with monitoring the situation and reacting accordingly. Fast forward to 2018 and as Robinhood has crossed above six million accounts, which put them at least for a time ahead of E*Trade Financial.

Because there is so much back-story to each of these organizations, it is tricky to distill the path that each has taken to respond to zero-commission trading but the short version is that they will really only entertain a zero-commission model if there is no other choice, and right now, it appears that there are still many options on the table. That said, price reductions for equity commission trading are already on the minds and the financial models of both Schwab and E*Trade. Interactive Brokers, at least for the moment, is content with their pricing structure standing firm for some time.

Just for posterity, it’s important to mention that Q3 of 2018 for publicly traded US online brokerages was a massively profitable one. The number of accounts at Interactive Brokers is at its highest point, DARTS are incredibly strong and the pretax operating margin of 66% is enviably efficient. E*Trade is doing so well that they announced they will be distributing a dividend for the first time and on top having performed a $1B share buyback program in 2018, are also planning to do another in 2019. Schwab saw a net income for the quarter jump of 49% year over year to $923 million, with 1.2 million new accounts opened year to date.

The take away: the major players in the US online brokerage space are extremely well capitalized, have very large war chests, and are highly motivated to defend their market position.

So, how are US online brokerages preparing for a world of declining commission prices? For starters, diversification of service delivery is one key strategy.

If online brokerages aren’t reliant on direct online investing commissions alone then commission revenues have less of an impact. For Schwab, there are digital and in-person advisor services that are generating material revenues. At Interactive Brokers, they are looking to offer more traditional banking-style features like paying high interest on cash balances, direct deposit and a Mastercard tied to an individual’s portfolio account. And, at E*Trade, their corporate services division is bearing significant fruit and enabling them to differentiate relative to their peers.

Diversification for online brokerages also means encouraging or facilitating online investors’ use of higher margin (i.e. more profitable) products, in particular options. In both Interactive Brokers’ and E*Trade’s calls options were specifically cited as a product that, because investors weren’t trading as much, impacted revenues. For Canadian DIY investors, this is especially important because, like the US, options trading in Canada is highly profitable for the Canadian online brokerages, so there is likely going to be more emphasis on enabling and/or training individuals to be able to trade options.

Another strategy to defend against zero commission trading is to go on offence. In this regard, online brokerages have a number of interesting levers to pull.

For example, both Interactive Brokers and Schwab stated that advertising campaigns are going to be key. In fact, founder and CEO of Interactive Brokers, Thomas Peterffy will be looking to have the narrative around commission-free trading to be a net negative for consumers stating:

“So, this is a serious issue for us now that JPMorgan joined Robin Hood offering free trades. We have to take this very seriously as I said. So, we are currently working on commercial to explain to people why that is bad for them, but the fact is that if you look at our [track record] for example, we regularly gain customers, two, three, four customers a day from Robin Hood and I’ve never seen a customer who went from us to Robin Hood.”

Of course, there’s also the use of incentive offers and promotions to try and win over new customers or court them to switch. Not all brokerages are crazy about the use of promos, however, as noted by Walth Bettinger from Charles Schwab who stated:

“That’s always been an area of competition…where incentives are offered to new clients around possible cash or free trades. It’s certainly not something that we necessarily like because it’s not an ideal way to build a long-term relationship with a client. Unfortunately, I would say, in some ways, promotions like that work. And so therefore, as long as they are commonly utilized in the industry, it’s difficult to take a hard stand that we’re not going to have similar types of promotional offers. But they are inconsistent with our long-term approach of building trust-based relationships with clients.”

It’s important to note that despite their traction and growth, firms like Robinhood still have many challenges to overcome.

This week, for example, the co-founder of Robinhood Vlad Tenev appeared on stage at a technology conference hosted by Bloomberg, and struggled with the explanation as to why Robinhood sells its clients order flow. Although there was a response posted on their company blog, the communication around selling order flow is a bumpy topic.

Ironically, also this past week, Robinhood found itself in the spotlight for selling client orders to large market making firms in order to benefit from trade rebates. As such, even though they are doing well, Robinhood cannot really afford to fail or take too many missteps.

For Canadian DIY investors, this offers a very interesting perspective on the various kinds of scenarios that could play out here in Canada once a Wealthsimple Trade goes live or if another commission-free trading player were to enter the market.  Either way, it’s reasonably certain online brokerages in Canada are having the conversation about what can be done and how to avoid taking commission costs to zero. As is playing out in the US, however, Canadian online investors are also likely to see advertising from Canadian brokerages ramp up as well as promotional offers start to get richer. While it will sound good on the surface, DIY investors are soon going to have many more options to choose from so it looks like there will also be a lot more homework for discerning shoppers to have to do.

Discount Brokerage Tweets of the Week

From the Forums

Gateway Trade

The general advice from financial professionals is to never try and time the market. That didn’t stop this curious investor from turning to Personal Finance Canada forum to debate if it would be worth moving out of mutual funds into a lower cost ETF’s at the end of a market cycle. Find out what the forum had to add here.

Puff Piece

For DIY investors it’s important to think about the bigger picture when it comes to personal financial planning. This investor turned to the forums after years of “living recklessly and frivolously” when it came to saving, and now wants to utilize his upcoming funds wisely. Read some interesting advice and opinions in this Personal Finance Canada thread.

Into the Close

That’s a wrap – or roll – on this edition of the roundup. While there may be no shortage of sports drama or political intrigue this weekend, there might be a shortage of weed. Howsoever you choose to relax this weekend, just don’t forget to bring the Doritos!






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