“If you really look closely, most overnight successes took a long time.” – Steve Jobs
“Speak in extremes. It’ll save you time.” – David Bowie
“Less than 10 bucks a month…”
This statement – or, some algorithmically-sanitized equivalent – is the next destination to which we’re headed in the retail brokerage saga, where in our last episode, all the major players in the space appear to sacrifice hundreds of millions of dollars of commission revenue in order to copy (and therefore, prevent) the insurgent, Robinhood, and a few roboadvisors from disrupting their incumbency with zero-commission trading (as showcased in our subtly-titled post, “Schwab and Others Confirm Status as Casinos, Purveyors of Financial Opioids“).
So, that development seemed like a good opportunity to refresh some data, make some new pictures, and tell a story based on those pictures. Of course, normally among the foremost fixations on our Feed has been on who is paying and receiving on the basis of order flow, and how much. Most recently, Alphacution has detailed its work on the PFOF theme in the posts like, “Saved by Zero? Virtu’s 30 Quarters of Payments for Order Flow,” and “Robinhood: Payments For Order Flow 2018, Up 227%.”
And, while it’s an important thread within the larger themes of retail brokerage, wealth management, market structure and others, it turns out not to be the big story here. Yes, in the case of TD Ameritrade (which earned $492 million in order routing revenue over the 4 quarters ending September 2019 – and the biggest chunk of any other player), PFOF is important on an absolute basis, but only represents an average of 8.2% of total net revenue over the past year. For Schwab, on the other hand, order flow revenue averages only 1.2% of total net revenue over the past 4 quarters. The chart, below, illustrates this relationship over the reported history that such a practice has been in place with these two firms.
Now, we do want to keep an eye on PFOF as it hovers near all-time highs across all the measures we track. It may be the case that evolving factors around retail brokerage, order flow and market structure could cause the next set of disclosures to establish new all-time highs, which would be indicative of an increasingly competitive ecosystem for certain types of flows. And, then again, there is an argument to be made that order flow payments and revenue have peaked. We shall soon see…
Anyway, here’s what we think is part of a (much) bigger consolidation story that is tied to a re-bundling of brokerage and wealth management services that are best achieved through asset accumulation. The chart below illustrates the 31-quarter migration of account growth between Schwab and TD Ameritrade that results in the more than 24 million accounts that are likely to sit under the combined firms.
With the exception of the Scottrade acquisition by TD Ameritrade that closed in September 2017, these are very smooth lines which suggests that there is an evolutionary aspect to account growth tied to that of the underlying demographics, and conversely, that (because these services, especially when bundled, are quite sticky) there is little or no evidence of strategies used to noticeably change this pace – and not even the hyperbolic antics on the CNBC financial entertainment channel and others like it (where folks are told by my friends Dr. J and Pete Najarian and others where to place their stops).
Still, all accounts – and the investors behind them – are not the same. Certainly, there are potential age brackets. And, independent of that, there are likely to be activity brackets. Some investors want to play more of a role in the management of their savings than others.
The next two charts begin to tell that part of the story: Though the prior chart showed equivalent account accumulation between Schwab and TD Ameritrade (around 12 million accounts each), their asset accumulations are quite divergent. In the chart below, Alphacution presents average client assets per period for Schwab, TD Ameritrade, and the combined “Charles Ameritrade” over the past 31 quarters ending September 2019. Here, we can see Schwab is contributing nearly 3x the assets to what may become a $5 trillion asset base in the combined company.
This is a big difference in assets given that both firms where founded in the 1970’s; 1971 in the case of Schwab and 1975 in the case of the predecessors of TD Ameritrade. In that case, differences in assets may be explained by strategy, with a simple bifurcation between active and passive. In the chart below, Alphacution presents average account value between Schwab and TD Ameritrade for the 31-quarter period ending September 30, 2019.
Here, we see Schwab’s average account value at nearly 3x that of TD Ameritrade (as indicated by the total client asset figures). Moreover, we can literally see the Schwab time series doing a fine job of imitating the trajectory of a broad equity market index – perhaps as a result of largely passive investment strategies (?) – while the TD Ameritrade time series performs its own impersonation of an active strategy as executed by an amateur up against some of the most finely-equipped professionals of all time; in other words, achieving little to no growth over the past five years – and, in other other words, is exactly the kind of “emotional” flows (along with that of Robinhood and likely E*Trade clients, too) that professional quant traders (and their stop-sniffing algos) really like to prey on…
This brings us to our closing points, which have already been implied above, but which become more evident with the chart below. Here, Alphacution is presenting the annualized average trades per account for Schwab and TD Ameritrade over our 31-quarter sample period ending September 2019. And, it is here that we can see more evidence of the (average) difference between the Schwab client and the TD Ameritrade client: The former is less active than the latter. Furthermore, average trade activity doesn’t change all that much over time, with the exception of asymmetric flares of volatility (which is exactly where we see spikes in both time series).
In other words, average trading activity appears not to be influenced by much other than demographics and volatility, which further implies that the main way to grow this type of business is to accumulate assets and attach a pricing model to the services surrounding those assets…
So, now that trading can be done for zero commissions, are these firms simply going to forego hundreds of millions in commission revenue? Absolutely not. With elimination of cost redundancies, there is a better argument to be made that revenues and profitability can continue to be managed upwards in a combined “Charles Ameritrade.”
Chances are – a few free trades per month, increasing PFOF competition, bundling of brokerage and wealth management services and lots of other gimmicks and thresholds notwithstanding – the latest commission levels will be replicated with various subscription mechanisms that could be done, on average, for less than 10 bucks a month…
Until next time…
