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"Fuller & Thaler Asset Management's Raife Giovinazzo on Robinhood IPO"

Dr. Raife Giovinazzo, CFA, a Fuller & Thaler Asset Management Portfolio Manager, discusses Robinhood IPO and retail trading. Dr. Giovinazzo's conversation with Dani Burger and Alix Steel on Bloomberg Markets. (Source: Bloomberg)

Dani Burger Thank you so much for joining us. In your notes before the show, when it comes to the IPO of Robinhood, you say we will skip. I know you have a lot of reasons for why you would skip, but what do you think is the best argument to not buy into this IPO?

Raife Giovinazzo Well let me say this, the number one reason I would say is our investment philosophy is to buy when the insiders are buying and to sell when the insiders are selling. If think about an IPO it is the company and the insiders selling. So that is the number one driver for us. That is very true if you join after the sort of one-day pop that is common, not always, but is common. There might be some arguments for having participated in the original offering, but once it starts trading, the odds are, the long-term research suggests participating in these IPO's in general, trying to trade against the company executives is a bad idea.

Alix Steel What is different this time is how much is going to be allocated to retail. So who are the insiders now?

Raife Giovinazzo What I mean by that is the executives and the company are selling. I’ll tell you in our strategy as investment managers is when we see companies buying back shares, we have tended to buy along with them. we've had a lot of long-term success doing that and an IPO, again, is the opposite. Now, it is nice on some level (to your point) that a lot of the retail investors are participating and getting to join in on this initial IPO to Robinhood's credit, they are democratizing the one-day pop, we’ll see if that’s the case and they do have a one day pop. But if there is good for them, that they are sharing that. But post one-day pop, on average, IPO's tend to underperform. So in that sense, that is why we are little skeptical about trading against the executives of the company.

Dani Burger OK, Raife let me take you into the future than. If we move beyond the IPO and its traded some, would you buy Robinhood at that point? Can you get interested in this company?

Raife Giovinazzo Well, we are always open to new ideas, and we don't remain anchored on an initial impression, but our initial concerns right now are twofold about the fundamentals. One is obviously, there has been a tremendous surge in retail trading. We think there's a lot of reasons to believe that may be peaking right now. Individual trading has gone up for a lot of temporaries, I’m happy to go into that if you are interested. The second concern is that about 2/3 of the business of Robinhood I would characterize as more like a casino than brokerage. We all know them for trading stocks, and that is a legitimate business, and good for them for having improve the interface and engagement with customers, but about 2/3 of their revenue comes from trading options and cryptocurrency. It’s not as well understood in the general market. But, those are areas where those are zero-sum games. You are not buying a piece of a company; you are buying something that is a little bit unclear. We are skeptical about the regulatory risks long-term of combining these two types of businesses.

Alix Steel Raife, you mentioned reasons why you don't think it is going to last. I’m going to assume it is because people are going to go back to work, they won't get the extra unemployment benefit checks. That hasn't happened yet, though. I look just to Monday we saw $1.7 billions come into Chinese ETF's that were beaten down. I just wonder what gives you the confidence that this juice is going to run out of steam?

Raife Giovinazzo Those are part of it, that as people return to work, they have less time to fiddle around perhaps on an app, trading stocks. But, you know, to Robinhood's credit, you can do it on your phone pretty easy. I'm sure you can go to the bathroom and do it there as well. But longer-term the other factors that matter from a behavioral perspective, psychological perspective, is right now we’ve had a huge run up in the past year. Everyone feels like a genius trading stocks. You buy anything in it go up, and it goes up, you think, wow I really know what I’m doing. It is very different in a more normal market. If the market isn't doubling and almost every stock is winning, that is going to change. Right now people are also suffering from what is called a house money effect. Which is when you're gambling with winnings in a casino, you are willing to take more risks. to the degree that people had success buying stocks in the past year, they have all gone up, they may feel like they've got money to lose, they will trade more. We think that is going to disappear.

Dani Burger We are seeing Robinhood now indicated to open at $39.50. The IPO priced at $38. That is slightly lower than $40 before. But, Raife, I have to play devils advocate a little bit. If you look over WallStreetBets, the mantra is diamond hands, you don’t sell. You don't sell to the extent that you brag when you have losses. Has there been a behavioral shift in the way that a lot of retail investors invest in stocks?

Raife Giovinazzo I think some of them I'm sure have. I think one positive thing about this interest in the stock market is it will get more people to invest, and stocks in general, are tremendous investments. If you look over the history, they are a wonderful way of building long-term wealth. But the thing is a stock is not a number on a screen. This is not a video game. A stock is a piece of a company. What is missing, unfortunately, with a lot of the discussions on WallStreetBets and elsewhere, is a focus on the numbers. Is it going up Or is it going down? As opposed to analysis of the underlying business, what’s happening. And there is some of that as well on WallStreetBets and elsewhere, but we need more of that, more focus on does this valuation make sense, is this a solid business, and less if it has gone up 200% or 1000%, I want to join along. So, that is what would be my concern about the long-term trend of can this interest to sustained by fundamentals, not just big price improvement.

Alix Steel Ok, Raife, you mentioned regulatory issues before. Which is the biggest regulatory overhang? It is probably payment for order flow, right? That is how they make most of their money. How does that evolve?

Raife Giovinazzo The payment for order flow is fascinating. I think there's two differences. You know frankly, paying for order flow, which again is “I am so happy to trade against the Robinhood customers, I am willing to pay Robinhood for that privilege”. If that is a tiny amount, that is fine, sort of like the fact that advertisers are paying to appear on Bloomberg TV or elsewhere. That is not a real cost to investors. Where it really matters is in the options trading. Robinhood had about $2 billion in revenue in the first quarter-- sorry, about $2 billion in assets invested in options and about $200 million in revenue in options trading from payment from order flow that’s 10% of the asset value invested in the first quarter. That is a tremendous cost in the payment for order flow, and that is where I would be concerned that regulators are going to say there's got to be a limit on that. And if that goes away, that is larger than their payment for order flow for equities trading.


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