Fintech Spotlight: Is Social Investing Failing? Only If No One Makes Money

Social investing companies emerged as a topic of discussion recently. Perhaps the question should be whether they offer value to

Is social failing in fintech? This has been a current topic of discussion spurred on by a recent article in Tech Crunch titled ‘Why Has “Social” Failed in Fintech‘. Penned by guest contributor Shane Leonard of Stockflare, the premise of the article is that integrating social, whether for trading or investing hasn’t been a winning solution for fintech firms.

In terms of what is social, Leonard characterized it to companies where their main business model centers around the creation of communities of traders and investors that interact together. To make his point, Leonard explained that two notable fintech darlings that cater to investors and traders; Robinhood and Wealthfront, had only found success after pivoting away from using social-based models. In addition, according to Leonard, other firms such as StockTwits and eToro have been able to become marginally successful businesses, but have yet to become household names.

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Critical Responses

With a polarizing opinion on social investing, it was no surprise that the Tech Crunch post drew its share of critical responses. Among them, Howard Lindzon, Founder of StockTwits, replied with a post of his own. In his opinion, the social investing sector is no different from any other, with the vast majority of startups failing. However, among players in the field include winners that are growing their communities. Lindzon also noted that regulation is a barrier, with him stating that “no other industry that has tried to become more social has faced more regulatory and incumbent pushback.”

In relation to regulation, it is worth noting that many of the social features that may work in one jurisdiction cannot in others. For example, while social/copy trading has become popular in the retail forex market, where unit sizes of trading lots are similar among different currencies, it is harder to duplicate with stocks that have different prices. One solution is through derivatives like CFDs that can be created to fit any unit size. However, in the US, regulations prohibit offering CFDs to retail investors.

Does Social Make Money for Investors?

One aspect that was surprisingly not included in the discussion on the topic of social investing was whether it even provides a value to consumers. Perhaps this is due to a lack of data collected on the topic. But, the question of the value proposition for end-user customers should be the real factor behind whether ‘Social has failed fintech’?

Among existing data, within the online forex and CFD industry which excludes the US market, brokers have been receptive to social trading. For brokers, social and copy trading features provide an alternative for their clients. Rather than having to pick winning assets, they can follow or copy the trades of traders with positive track records. This simplified approach decreases the need for brokers to educate their customers in learning how to trade, thereby increasing conversion rates and long-term values of clients.

Retail traders are poor at picking trades and are bad at copying traders

However, inside sources that have developed social trading platforms or worked at brokers offering copy trading, have commented in the past to Finance Magnates that although brokers benefit from such offerings, customer performance doesn’t. As one developer explained to Finance Magnates during last month’s iFX Expo, “Retail traders are poor at picking trades and are bad at copying traders.”

Explanations for this are that the same risk management shortfalls that retail traders have when buying CFDs and forex pairs, exist in copying traders, such as lack of diversification and following hot trades but exiting positions too early. In addition, a developer who moves from developing social trading products to investing games as a form of education, noted that retail customers are copying traders that have limited experience themselves.

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Among firms that have been able to both create large social communities and create trading products adapted to social and copy trading is eToro. However, the jury is still out whether their customer performance is any better than other online forex and CFD brokers. In the past, eToro published data revealing that customers copying others perform better than self-traders. However, the firm has yet to publish client percentages of profitable accounts and requests from Finance Magnates to eToro about this information in the past hasn’t been answered.

Investing Isn’t Easy, the Story of kaChing/Wealthfront

Perhaps the story that most depicts the barriers of difficulty in the social space is Wealthfront, which in its previous life had been kaChing. Similar to the mission of the current Wealthfront, operating as kaChing, the firm believed that the mutual fund and financial advisory sector wasn’t transparent. The result is that investors were unable to truly track their manager’s performance as holdings are only revealed on an end of quarter basis. As a solution, kaChing created a community of investors where leaders reveal their positions as they occur to provide real-time insights to members of the community. Leaders were experienced traders that were vetted by kaChing, with novice members of the community also having the ability to graduate to become leaders.

In 2010, kaChing rebranded as Wealthfront. However, before evolving to its current robo-advisory model, in 2010 Wealthfront expanded its social platform to include professional money managers that were broadcasting their holdings in real-time. This allowed the platform to meet its mission of bringing transparency to the professional money manager sector.

In 2011, Wealthfront ditched the social investing model in favor of robo-advisory

Ultimately, in 2011, Wealthfront ditched the social investing model in favor of robo-advisory. Users no longer would follow trading leaders and use their ideas to invest themselves. Instead, Wealthfront became a security advisor itself and would invest client funds in ETFs using modern portfolio theory.

One of the takeaways, is that Wealthfront evolved from being a platform that required active participation of its users to passive investing. This breakthrough is at the heart of Wealthfront’s current pitch to customers; where they advocate that passive investing beats actively managed funds over the long-term. As a result, Wealthfront promotes a simpler investing approach that also provides better returns than competing actively managed advisory solutions.

Wealthfront’s pivot can be viewed as the firm only being able to reach its potential after finalizing on a model that provided maximum value to its users. In their example, this ultimately was reached by offering simplicity over active participation which is required for any social community to succeed.

As an Education Device

The bottom line, is that although social finance services can provide transparency and value to users, it may not be the best value for investors. Specifically, performances can suffer if social traders don’t use sensible risk management in controlling their portfolios as well as copy trade leaders that underperform. In addition, even for social investors that are lucky enough to be members in profitable communities, they may not have the ability and time to actively follow recommendations to succeed.

One area where social trading offers value to investors is as a form of education. Members of communities like StockTwits or websites with active commenters such as ForexLive provide a venue for users to ask questions and learn about trading. Unlike simply watching commentators on CNBC, these social sites provide an opportunity to both listen as well as participate. For new traders, this is an important facet to furthering their education. But, just because access to education and intelligent trading conversation is available within social investing networks, members still need to put in the time and effort to actively handle their accounts. As such, this endeavor may not be for everyone.

Fintech Spotlight is a new column on Finance Magnates devoted to reviewing innovative financial technology companies and sector trends.

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