Head of Equity Strategy
Summary: The past year has seen explosive growth in trading activity caused by a huge increase in new retail investors that adopted trading the financial markets during the lockdowns. The big question is whether the high growth can continue for our basket of 30 companies within the financial trading ecosystem. With volatility falling again and economies opening we see potential headwinds going forward, but the overall industry will likely continue to flourish as the world economy will continue to undergo financialization. We also talk about whether certain financial trading firms could offer long volatility exposure without the negative carry experienced in put option and long VIX futures strategies.
Today we are launching our next equity theme basket focusing on the financial trading industry as it has experienced a historic renaissance in terms of profitability, new clients, potentially a new lasting investor class. The main question is whether the good times will last.
The financial trading theme basket consists of 30 companies across institutional and retail brokerage, financial information, exchange and clearing, electronic bond platforms, and market-making with a combined value of $1.14trn. As the basket shows, the retail brokerage firms and exchanges have done very well the past year as the pandemic forced many people into lockdowns freeing up time for trading and investing, as sports betting and other leisure activities were impossible.
| Name | Segment | Market Cap (USD mn.) | Sales growth (%) | EPS growth (%) | Diff to PT (%) | 5yr return |
| Morgan Stanley | Institutional brokerage | 154,413 | 9.0 | 62.1 | 10.5 | 254.5 |
| Charles Schwab Corp/The | Multi brokerage | 132,718 | 23.3 | -2.5 | 10.0 | 171.7 |
| Goldman Sachs Group Inc/The | Institutional brokerage | 124,571 | 14.5 | 122.2 | 9.5 | 137.1 |
| S&P Global Inc | Financial information | 94,045 | 11.0 | 22.1 | 6.8 | 294.1 |
| Hong Kong Exchanges & Clearing Ltd | Exchange & clearing | 75,805 | 28.5 | 44.9 | 16.0 | 179.5 |
| CME Group Inc | Exchange & clearing | 72,526 | -11.4 | -19.5 | 2.7 | 161.4 |
| Intercontinental Exchange Inc | Exchange & clearing | 66,243 | 12.0 | 2.9 | 13.4 | 142.5 |
| Coinbase Global Inc | Exchange (crypto) | 59,290 | 139.3 | NA | 50.7 | NA |
| London Stock Exchange Group PLC | Exchange & clearing | 57,007 | 5.6 | 8.2 | 18.5 | 207.1 |
| CITIC Securities Co Ltd | Institutional brokerage | 44,790 | 14.3 | 25.7 | 23.0 | 31.9 |
| MSCI Inc | Financial information | 40,038 | 9.6 | 19.6 | 1.5 | 587.0 |
| Deutsche Boerse AG | Exchange & clearing | 32,825 | -0.7 | -9.4 | 10.0 | 118.4 |
| Interactive Brokers Group Inc | Multi brokerage | 30,718 | 12.1 | 44.9 | 22.6 | 101.8 |
| Nasdaq Inc | Exchange & clearing | 26,510 | 17.3 | 30.8 | 4.9 | 183.3 |
| MarketAxess Holdings Inc | Electronic bond platform | 18,553 | 28.7 | 33.3 | 14.7 | 311.9 |
| Tradeweb Markets Inc | Electronic bond platform | 18,875 | 13.1 | 33.9 | 5.2 | NA |
| Raymond James Financial Inc | Institutional brokerage | 17,943 | 5.0 | 14.2 | 8.2 | 176.4 |
| Japan Exchange Group Inc | Exchange & clearing | 12,542 | 7.8 | 8.0 | -11.2 | 88.5 |
| LPL Financial Holdings Inc | Institutional brokerage | 12,520 | 7.0 | -13.8 | 13.5 | 607.3 |
| Cboe Global Markets Inc | Exchange & clearing | 11,135 | 3.8 | 4.8 | 1.7 | 77.8 |
| Euronext NV | Exchange & clearing | 7,051 | 17.5 | 19.7 | 14.4 | 185.8 |
| Virtu Financial Inc | Market-making | 5,656 | 113.3 | 290.9 | 8.5 | 93.7 |
| Avanza Bank Holding AB | Retail brokerage | 5,579 | 81.7 | 145.1 | 5.4 | 465.6 |
| Nordnet AB publ | Retail brokerage | 4,700 | 56.9 | 162.7 | 28.8 | NA |
| IG Group Holdings PLC | Retail brokerage | 4,690 | NA | NA | 6.3 | 59.3 |
| flatexDEGIRO AG | Retail brokerage | 3,524 | 27.8 | 37.2 | 23.2 | 523.4 |
| Swissquote Group Holding SA | Retail brokerage | 2,304 | 32.5 | 103.9 | 20.5 | 550.5 |
| Monex Group Inc | Retail brokerage | 2,000 | 47.0 | 375.7 | 0.5 | 237.3 |
| CMC Markets PLC | Retail brokerage | 1,961 | 110.5 | 560.8 | 8.0 | 141.9 |
| Flow Traders | Market-making | 1,923 | 331.3 | 792.9 | 10.1 | 61.4 |
| Aggregate / mean values | 1,142,458 | 14.5 | 32.1 | 10.0 | 176.4 |
Source: Bloomberg and Saxo Group
The median revenue and EPS growth is currently 14.5% and 32.1% respectively showing the impact from the pandemic. The fastest growing financial trading company on revenue is Coinbase Global which just recently IPO’ed representing another important milestone for the cryptocurrency industry. Flow Traders, which started as a market-maker in ETFs, has posted the biggest increase in EPS as the ETF dislocation and widening of spreads were the biggest in ETFs compared to other financial instruments. In terms of five-year return, the institutional brokerage firm LPL Financial Holdings has done the best up 607%.
Strong performance for financial trading firms, but can it last?
The financial trading basket is the best performing basket in April and year-to-date (excluding the crypto basket which lives its own life) up 6.9% and 22.8% respectively as financial trading firms have posted strong earnings across the board. However, volatility is coming down again across many asset classes and volume is also in decline again so profits in 2021 could take a hit but still normalize at a higher level than before the pandemic. As with all our other baskets, the historic performance of 251% total return over five years is not an indicator of future returns. Our baskets are selected with the first criteria being whether a company provides good exposure or not, and secondly choosing the largest companies. This inherently creates a selection and survivorship bias in theme basket.
We continue building out of theme baskets and the next one will be on semiconductors and rare earth minerals as the semiconductor shortage will stay with the world for another couple of years according to a recent interview with Intel CEO Gelsinger. Besides the current supply bottlenecks, the semiconductor theme is a great long-term investment theme for investors as it plays into the digitalization of the world economy and eventually the IoT (Internet-of-things) theme putting the physical world on the Internet.
The main question is whether the good times can continue. With people returning to their offices as economies reopen, and volatility comes down it is difficult to see the industry continuing at the same high growth. The last year’s momentum will also most likely not continue and that in itself will make it more difficult for many retail investors and thus reduce growth.
The key events to follow for this theme basket are the upcoming IPOs of Robinhood Markets and eToro which are two giants in the retail brokerage industry, and then of course rising inflation as it could cause significant trading activity in bonds increasing profitability of institutional brokerage firms.
Can market makers offer long volatility exposure?
In our 100-year portfolio, which is designed to weather many different economic and financial seasons, we allocate 5% of the portfolio to long volatility components as this exposure is only type that can mitigate highly correlated market sell-offs. The typically way of adding long volatility components is through either long out-of-the-money puts on the equity markets or long VIX futures (around mid on the forward curve), but both implementations come with negative carry.
One way to mitigate this, is buying looking at market-makers such as Virtu Financial and Flow Traders. Bid-offer spreads widen dramatically during steep selloffs, as we observed during the pandemic led sell-off in 2020, which increases the profitability of market-making operations. Flow Traders increased its net income 9x in 2020 from the year before. As the regression of Virtu Financial and S&P 500 below shows, the raw beta (sensitivity to the equity market) is 0.07 on weekly observations the past five years. It is also notably that Virtu’s share price goes up during the market selloffs in early 2018, and then again in late 2018 during the Fed’s policy mistake, and then again during the pandemic selloff in 2020.
Key risks
Investing in the financial trading industry is not without small risks. The industry is known for experiencing dramatic tail-risk events with some recent ones being the Great Financial Crisis, euro area crisis, the recent blow-up of Archegos Capital Management, Knight Capital Group, and the Swiss unpeg hitting many retail brokerage firms. These events can cause large sudden declines in financial trading firms and something investors should consider. Financial trading companies are also trading at high valuations driven by the strong recent demand and that could lower future returns for shareholders. Trading is driven by volatility in financial markets and in 2021 there are already many signs that volatility is coming back to its low levels prior to the pandemic. This could suppress trading activity. The biggest risk to the industry is another major 50% drawdown in equities like that post the dot-com bubble and the Great Financial Crisis, as it pushes investors and traders out of the industry for a long time lowering future growth in volume and profits.
Previous notes on equity themes:
The commodity sector and the reflation trade in 2021
Bubble stocks go into ‘hyperdrive’ mode
Introducing Next Generation Medicine basket
Updating our Green Transformation theme basket
Launching Saxo’s E-commerce theme basket as more growth lies ahead
Be careful of bubble stocks and updating bubble methodology
Gaming is a long-term winning industry
Black energy takes the lead as green transformation stocks turn negative
Is the market getting too excited about travel stocks?
India has tremendous upside in the 21st century
It takes $300bn to join the mega cap club
Green transformation will drive high growth in batteries
China's future sits in the consumer and technology sectors
Has crypto industry crossed the Rubicon? Launching crypto theme basket
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