The GameStop saga and subsequent meme stock phenomenon that played out last year brought to light the growing power, relevance, and influence of retail investors in capital markets. A retail investor is one that typically trades small amounts of money out of their own pockets infrequently. They differ from institutional investors who frequently trade large sums of money on behalf of institutions such as pension funds and insurance companies. Globally, retail investors own roughly 27% of the world’s listed companies’ equity and institutional investors own the largest piece of the pie at 41%. In the local space, however, retail investor participation remains very low given that they own only 3% of the country’s listed companies despite strides made by ZSE Direct. The retail trading platform has been instrumental in the three-fold increase in daily trades on the ZSE from an average of 120 to 330 since inception.
Although volumes traded by retail investors are usually small in comparison to institutional investors, they often bring about positive effects on liquidity and the volatility of equity prices. The primary significance of retail investors is pinned on their unconstrained investment pool. Unlike institutional investors, retail investors face very minimal constraints in their investment strategy, such as religious beliefs and steep minimum investments limits on some strategies. This means that retail investors are free to inject liquidity in stocks that do not typically fall within an institutional investor’s risk budget. This includes stocks that are illiquid or too small for institutional investors. In the absence of retail investors, stock market activity is limited to blue chips and a few other large cap stocks which are favourites among institutional investors.
A look at the trading statistics on the ZSE show that the average volumes traded daily in eight illiquid small cap stocks increased by 93% two years after the introduction of the ZSE Direct platform. To confirm the impact of the retail platform and its users, we performed a similar test on five liquid large cap stocks and volumes before and after ZSE Direct’s debut differed by only 1%. That said, there is no ironclad evidence that improved retail investor participation results in better share price performance or investor returns in small cap stocks over an investment horizon exceeding two years.
Retail investors also lower price volatility because they have varied investment horizons, no recurrent legal obligations, and no investment policy statements to adhere to. The investment horizon of retail investors depends on their goals. Some invest to make a quick buck from speculative trades, others invest in preparation of future expenses such as university fees for their children, and some keep their emergency fund in the stock market where it can earn a return until needed. This list of goals is not exhaustive, and it highlights how the timing of investment decisions by retail investors is varied and different from institutional investors. Institutional investors, on the other hand, are obligated to settle liabilities such as annuity payments, insurance claims, quarterly tax payments, etc. In addition, institutional investor responsibilities such as rebalancing investment portfolios typically result in transactions occurring on a quarterly basis. These payments and transactions are usually periodic in nature and drive volatility based on phenomena like the “January” effect and “End of Month” effect, and retail investor activity can soften the blow on stock prices.
There are several records that also concur with the above. According to Ozik et al (2020), retail trading helps lower bid-ask spreads and dampen the price impact of trades when institutional liquidity dries up. Welch (2020) add on and note that retail investors were a market-stabilising force during the March 2020 coronavirus-induced market crash by staying the course with their investments and buying when stock prices dipped.
We also add that retail investors are very vocal on social media, and this has been key in capital markets awareness. A survey done by Junior Achievement USA after the GameStop saga revealed that most teens turned to social media (43%) for information on the stock market, followed by parents (35%), websites (30%), and school (29%). The increase in social media accounts that talk about stock markets continues to generate interest in the stock market and, subsequently, trading activity. In Zimbabwe, we note prolific social media influencers on Twitter whose conversations on the stock markets and their investments have driven participation by other retail investors on the ZSE. With all this in mind, we see potential in the performance of the Victoria Falls Stock Exchange (VFEX) since the introduction of VFEX Direct. We also opine that the growth in retail investor activity on the stock market could open an opportunity to broaden local capital markets through a small cap ETF. Such an instrument can pool liquidity from investor liquidity and drive institutional investors’ interest in small cap stocks as well.
Mtutu is a research analyst at Morgan & Co. — [email protected] or +263 774 795 854.
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