After GameStop, what’s next for investment apps?

Downloads of retail investor apps have spiked during Covid-19, highlighting the vulnerabilities of users and the stock market.

By Samir Jeraj

When he turned 18, at the end of 2019, Adam Mlamali started investing in the stock market. “I was looking at ways I could generate more income,” he says, but he also wanted to put money into “companies and causes” he believes in.

Mlamali works in finance and is comfortable with investing. He follows the financial and business news for leads, and at the start of this year was one of the many stock market dabblers who noticed an unusual trend in shares in the US video games chain GameStop.

The firm has been around since the 1980s, but became a global household name in early 2021 when it found itself at the centre of a battle on Wall Street. Long in decline as in-store purchases lost out to online shopping, GameStop became the target of investors seeking to “short” its shares, essentially betting the company would fail.

The ensuing debacle engulfed the global news cycle. An army of small “retail” investors like Mlamali – many of them co-ordinating through the social media site Reddit – bought shares of GameStop using fee-free investment apps, the most popular being Robinhood. Collectively, they managed to push the price of GameStop shares up from around $25 on 11 January to $350 on 27 January. This meant the short sellers suffered significant financial losses.

Mlamali considered investing in GameStop, but opted instead to buy shares in AMC Entertainment, a US cinema chain that had also become the target of short sellers. “I saw less of a risk with AMC compared to GameStop only because I figured movie theatres weren’t going anywhere in the short term,” he says. The gamble paid off. On 27 January, the AMC share price increased by nearly 300 per cent.

These events generated huge interest in investment apps, though their use had already spiked in the earlier days of the pandemic – by a reported 88 per cent in the first half of 2020. During the heady January days of the GameStop moment, downloads of Robinhood registered a 747 per cent increase in the US alone, while in the UK downloads of Freetrade and eToro went up by 287 per cent and 197 per cent respectively in that same period.

Robinhood may have been the weapon of choice in the fight for GameStop, but it soon came under fire for its practices and business model. While the app enabled the trades of its users, the actual buying and selling were done by another company called Citadel Management, to whom Robinhood sold its users’ information (known as the “order flow”). Robinhood had to briefly suspend trade in GameStop shares on 28 January because the amount of money it needed to process payments had jumped to $3bn. The fallout continues, with investigations conducted by financial regulators and the US Congress.

Long before the dramatic events of this year, investment apps were attracting millions of users. “It’s nothing new here. They have just had attention drawn to them because of the GameStop story,” says professor Alex Preda of King’s College London. The Robinhood app itself is already six years old, and just one of many that have emerged since the 2000s.

The idea of “discount brokerage” with very low fees has been around since the 1970s, Preda adds. With the rise of retail investors in the 1990s, some discount brokerages bought or started to use software. Social media has taken it a step further, enabling real-time contact between investors and allowing people to see how individual traders are performing against each other. “This leads to classifying traders into trade leaders and followers,” says Preda. As a result, investing platforms that integrate social media have higher rates of “herding” among users, with people collectively moving towards buying particular shares. Users also tend to stay in the market for longer.

One of the major criticisms of such apps is that they do not provide guidance to potential investors. In Mlamali’s experience, there is “little to no information available on the company you’re investing in” if you are just using an app. For him, it is important to look at the financial statements, company fundamentals, and what management is doing before buying shares.

“What we saw in the first few months of 2021 was really extraordinary,” says Alex Campbell from Freetrade, a UK-based investment app that launched in 2018. The app has around 600,000 registered users, up from 50,000 at the start of 2020. While it does offer fee-free investment, its business model is different to Robinhood, for both regulatory and “ethical” reasons, says Campbell. The company operates a subscription premium model akin to Spotify, where people can pay a monthly amount to speculate in stocks and shares.

“It’s really straightforward. The costs are low, so people are able to start investing with less money and to gradually build up over time,” Campbell says. As such, the company has a vested interest in maintaining the loyalty of its customers and delivering for them over time, rather than earning money from selling their data and order flow (which is explicitly banned by the regulator in the UK, and currently a grey area in EU law).

Campbell believes the sudden spike in interest off the back of GameStop places a “duty of care” on investment platforms and apps. “You’ve got new customers who are coming to the markets and have varying degrees of knowledge and expertise,” he says. That means providing “all the materials” to customers about the risks and the practice of investing.

However, that does not mean Campbell thinks “retail” brokers, who mainly serve individuals rather than companies or institutions, should offer higher risk investments such as derivatives or leverage (borrowing to invest). “The guiding principle is always treating your customer fairly,” he explains.

The GameStop affair showed the enormous impact investment apps can have on the stock market. There appears to be room to grow, with retail investors making up around 20 to 25 per cent of stock market activity in the UK and US compared to 30 per cent in places such as Hong Kong. The question is whether these platforms should only be providing the means to make trades, or whether they should be educating users to make better-informed decisions.

This article first appeared in the latest edition of Spotlight on fintech. Click here to download the full edition