Is the SG broker model Broken => A TDA analysis
Brokers going broke? Well, that's just the market's way of saying, 'Hey, even experts need a margin call on their humility - Anonymous
Is the SG broker model Broken => An TDA analysis
As news of TD Ameritrade announced their exit of their retail brokerage business, this generate considerable amount of buzz in the retail investor space and influencers. Although I am working in the prime brokerage (Integrated custody for institutionals) role and not directly affected by this news (Execution broker for retail), this sparked my interest in researching more about this event. I decided to distill my knowledge in a post to cement my insights and learnings and hope that this article will become useful for investors whom wants to know the <Why> and not just the <How> on how the SG brokerage space operates.
SG Broker Industry - a history
The traditional stock brokerage industry in Singapore is charaterised by remisers in Singapore, whom help their clients to execute trades, arrange financing, or resolve their trade issues / complex strategies with a human touch. Remisers are basically traders whom trade using their own capital, and source for their own relationships / clients to assist them in managing their trades / accounts. In exchange, they will earn fees from their trading volume / performance.
Brokerages then used to host trade fairs / competitions at Universities to incentivise finance students to get their feet wet and ignite the dream to be the next Grorge Soros. This acts as a recruitment drive for prospective talents whom seek to break into the industry, as well as find students whom can become prospective future clients. When I was a fresh graduate back in 2016 and started researching on brokers to use, the cost of executing a trade can cost up to SGD25 for a fully postpaid trade (Philips Capital) , and a phone-call based trade can cost up to SGD40 at banks like Citi. Perhaps recognising early that I have no special talent in examining candlesticks / TA indicators and reading market sentiment, or having quicker hands and analysis than algo-driven hedge funds, I decided to go for the long term investing route and focused on vanilla low cost custodian and brokers instead (MayBank KimEng, SCB etc).
Moving onward 7 years later, the broker industry has been disrupted beyond recognition. Pre-funded accounts are the norm and not the exception (Fees of SGD 10 or lower) in the traditional broker dealers and banks, while there is an ongoing price war and prevalence of (zero commission brokers) in the retail brokerage space. The broker space is also increasingly commoditised and focused on features and costs and less on relationships, and retail traders can easily jump from one platform to another with very low switching costs, or enticed by the next promotion by Webull / Moomoo / Tiger Brokers.
How does a retail broker make money
Interest rate Float
Prefunded accounts are an innovative way for brokers to allow clients to trade at a lower commission. As the accounts are already prefunded prior to trading, they have a low risk of default and excess funds can be utilised by the bank to earn interest rate / improved liquidity for the accounts they hold.
Commissions based model => Fees Based Model
Platform fees, Financing Fees, Custody Fees, margin fees, stock borrowing and landing fees,
As the industry is engaging in brutal price competition, the commission based business is transiting to a fees based business, whereby the strategies of these brokers is to focus on rapid account opening and on-boarding to increase their fees they can charge from their clients. Some brokers even incentivize new signups to deposit fresh funds and auto-crediting them stock based rewards, so they can run (UAT) on those accounts to ensure the entire client on-boarding process runs smoothly. By giving clients the ownership of a stock, it will spark the client to have an economic incentive to research more on the trading process and get their feet wet, and be less likely to close the account without taking any action.
Bid Offer spread (from FX, underlying stocks, and derivatives / options)
Driven by trading volume, these broker-dealers / execution brokers focus on Earning from the difference between the bid offer spread of the underlying product. Large cap stocks in liquid markets like the US (MSFT, APPL) will have very competitive spreads compared to small cap stocks. Derivatives / Options / FX also might have wider spreads. If the matching algo of those brokers dealers are capable and efficient, they will be able to match inventory within the Broker warehouse of stocks / locate internal and external counter-parties, earn the spread from partaking in this market making risk, while remaining market neutral.
Why did TDA kick the bucket (My own understanding)
Fees from Payment for Order Flow
Payment For Order Flow is a model utilised by TDA / Robin Hood, whereby instead of routing the trades to the exchange, their trading feed and orders are routed to alternative avenues like hedge funds for their own execution / strategies. Because Retail traders are perceived to be market neutral / less knowledgeable and are trading in smaller shapes, Hedge Funds can act as the counter-party for their market marking / prop strategies and lower their risk of execution or earn sizable profits from it. This controversial business model is under tight scrutiny in the US after the Robin Hood / Citadel Debacle.
TDA is the only retail broker in SG (To my understanding) that utilises this practice, which is sensitive to regulatory changes in different jurisdictions. The underlying hedge funds willingness and ability to pay for this execution method will directly affect the retail broker business.
Fixed Cost feeds not justified by low retail volume
Within the broker dealer space, there are huge fixed fees such as system maintenance and enhancement fees, manpower fees (from traders and CTOs to client servicing / ops professionals), licensing fees, expenses for client education to unsophisticated investors, and client money lockup requirements by regulators. All these can only be justified if TDA can command operational leverage and huge market share (in compared to its fixed cost). As the SG retail TAM (account size) is very small and contested by many brokers operating in a zero commission meta, a business decision could have been made to off-board the low margin retail business, pivoting to the (Accreditation Investor space), and create disincentives (like account maintenance fees, specific timelines) to facilitate the client off boarding process.
In the Accredited Investor space (Justified by large trading lots, larger account sizes, lower disclosure costs, larger portfolios making clients resistant to jump between brokers). Per TDA disclosure, the AI money will be managed directly from the US entity. The use of an US legal entity and license meant that there will be savings in the TDA business from the client money asset lockup requirements and collateral needs (Legal Entity Simplification) , as well as a much leaner ops / client servicing / trading team which can service their existing US clients as well as SG clients. Instead of optimising for top-line revenue by servicing multiple clients which has lower margin and commoditised services, TDA is focusing less on revenue gain (account quantity) and more on cost control to improve profitability. For more sophisticated investors whom wish to trade via the (agency broker flow) instead of a (broker dealer flow), TDA could also gain more differentiated higher margin services to their clients.
Questions
There is a lot of considerable hype on the procedures on how to migrate their assets from TDA to alternative brokers. But there are not enough people asking the real questions
1) Even if you migrate your assets to brokers like Moomoo / Tiger, if the business landscape is not sustainable, you will need to go through the entire process in a few years time. This will be risky if there are bouts of market volatility and your assets are stuck during asset migration and you cannot execute those trades timely.
2) There are a lot of new brokers that I have not do any due diligence on, in terms of their execution track record, of their financial health.
For personal finance channels that are incentivized to propagate their sponsored brokers, there is an inherent conflict of interest in the advice they are peddling. Although there are some channels which are credible and I trust over most others, I believe the nature of a broker and custodian is to provide stability in execution when the markets goes wild, and not add to the excitement when you least need it. It might be prudent to divide majority of your assets to a broker-dealer with a stable trade record of execution and demonstrated intent to be in SG market for the long haul, while the short term money be allocated to the newer brokers.
3) Automation and not humans are the future state of retail brokerage business. For fresh graduates looking to be the next <Wolf of wall street>, the direction is to take a tech driven role or pivot to the high SES market for business relationships. I expect there will be further consolidation at the custodian / broker end in SG retail market and this is just the start of a bigger snowball.
Portfolio Decisions for the Month of September
As I hit some of my financial goals, I made a decision to halt additional allocation to my stock portfolio for the time being, and focus on capital recycling within my portfolio. Excess cash should be allocated to short term SSB / longer term FixedD in the higher interest rate environment, or any other instrument that has a reasonable rate of return.
I averaged down on a mid size position on Yum CN at HKD 50 on 26 Sept 2023. I believe that the HK/CN market is not trading based on fundamentals with the hot money flows outward from China / HK over the Evergrande debt crisis / perceived unpopular sentiment towards China, and there is a reasonable margin of safety. As a bottom up investor investing in the complex environment in China, I will favor a simple understandable free cash flow generating business that is lightly levered with a reasonable growth rate, at an unregulated rate of return.
Yum China is a conglomerate that has the globally famous fried chicken which charges a premium in china. The underlying chicken products has no taste memory and can be prepared in multiple ways, and scalable among the different taste buds between northern and southern china. Yum Cn continually comes up with innovative and differentiated diversified product types among its diff brands (Pizza hut, innovative non fried chicken products, coffee chains). Its service score among its customers and Joey Yut’s ratings from her employees are great, and it has good control over its supply chain from the owner operated stores in China, control over the chicken farms in China, and ownership of Meituan stock in Yum Cn to ensure QC in delivery for home delivery packages are met. With its supply chain and fixed cost in line, it is scaling its branches as restaurants cum distribution centers (mid tier price segment) among the T3 and 4 cities in China and enjoying operational leverage in its branch business and app order count, characterized by improving margins and revenue across the business. The Ever-grande crisis resulting in low rental prices among the different cities, allowing YUM Cn to scale across China at a low cost and improved operating margin. Perhaps most importantly, regardless of whether the China economy does great or poorly, people still eat their comfort food and fried / grilled chicken products, and this is not expected to change over the next 5-10 years.
I initiated a mid conviction position on AirBnb after reviewing some presentation materials in the Berkshire investor group I was in, reviewing their notes, and running down the content based on my internal checklist. Brian Cheskey seem like a competent capital allocator and product manager based on his regular use of AirBnb for his travel trips, and his shrewd actions on efficient and humane retrenching (cutting loss on non core business) while navigating AirBNB through one of the most tying moments for travel bookings post IPO.
The travel and experiences business is traditionally fragmented and focused on the hotel bookings piece while the experiences are separated. Instead of price competition in the traditional hotels bookings industry. AirBnb now focuses on more on long form business renting (based on WFH trends) and newfanzled experiential travel experiences (broadcasted on instagram / TikTok). AirBnb is now pivoting towards the higher margin market whom trusts the AirBnb (travel and experiences megaapp) brand name and perceived quality standards. This solves a major pain point for busy office workers and travellers, whereby they do not need to relearn new platforms while searching for local commutes, integrate unique accomedation as part of their instagrammable travel experiences on social media, as well as possibly book attractions and packages from the integrated experiences app that Cheskey is pivoting towards.
AirBnb is nonetheless operating in a regulated industry (abiding by rental taxation and regulations in diff countries), and prone to larger political risk / huge volatility based on the consumer sentiment about its services and impact on the locals (like higher housing prices). From another perspective, Once AirBnb takes the first mover in the regulated global travel market, there are very few apps that can potentially scale to such a mega-app status on a global scale due to the barriers of entry. The WFH Long-form booking and experiential travel plan demonstrated Brian insight on created differentiated market segments from an commoditised industry, which require exceptional insight and marketing ability (which cheskey has demknstrated). I look forward to periodically monitor the app and company for updates.
Conclusion
After suffering from poor health for quite a while, I finally mustered up sufficient energy to get my personal life back on track, and pen my thoughts. This year was a trialing period for me on many fronts. But I am blessed that I have made new friends that helped / supported me along the way, and guided me on things I should be focusing on. Until then, I will be focusing on myself and getting better, both physically and spirituality until my next post!