Institutional investors caught on the back foot by the rise of the retail investor and crypto

Co-founder and CEO of AI data analytics start-up, Qi, says retail investors now dominate equity flows, which will force institutional investors to assess their cost structures, performance and how they use data.

“The rise of the retail investor will make life harder for institutional investors. They’re changing the rules and are now such a big part of trade flows, that institutional investors can no longer afford to ignore them,” Mahmood Noorani, CEO and co-founder of Quant Insight (Qi) told The TRADE.

Ten years ago it was the traditional bottom-up equity investors that dominated equity flows, but that’s no longer the case, says Noorani, who has a background in macro investing for hedge funds, asset managers and investment banks. He points to figures published by JP Morgan, which suggest that 60% of US equity flows are now driven by retail investors, and only 25% are coming from traditional bottom-up equity investors.

The average trade account on online retail trading platforms such as Charles Schwab is now $350,000, says Noorani. The number of online trading accounts is also growing exponentially. Online trading platform Robinhood, which was at the centre of the GameStop David and Goliath battle between retail investors and hedge funds, which played out on US stock markets earlier this year, has grown its user base from half a million in 2014, up to 22.5 million in 2021. India has an estimated 50 million online trading accounts, and in the crypto space, there are now more than 100 million users worldwide.

“That growth is astonishing,” says Noorani. “We’re moving to a world where everyone is an investor. Billions of people will be involved in markets in some shape or form, which challenges the traditional market structure where we put money to the side and let the professionals take care of it.”

For decades, Noorani says a lot of the innovation in the trading space came from banks and hedge funds. But in the last few years, he says most of the ‘outside-the-box’ thinking has come from the retail sector – meme stocks, crypto, non-fungible tokens (NFTs).

“When I go to big asset management firms with trillions of dollars in assets under management, they’re not doing anything to spur innovation,” he says. “They are conservative and caught on the back foot by the rise of the retail investor and crypto.”

The overall performance of the institutional investor world hasn’t been great either, says Noorani. “We’ve seen the long-term shift from active to passive. The bottom line is that humans and assets managers have not done a good job beating benchmarks to justify the fees they are charging.”

In the next 10 to 15 years, he predicts that the active to passive shift will run and run and run and that slow moving asset managers will continue to lose market share to individuals investing for themselves. “Retail trading will continue to expand and traditional investment management firms will need to think about their cost infrastructure.,” he says. “One of the things about AI is that it helps reduce costs,” observes Noorani, but he doesn’t believe that machines are ready to replace humans. 

We could end up, continues Noorani, with an increasingly bifurcated world where poor performing funds’ fee structures will be driven down and become more of a commodity. “There will only be a small number of firms that can justify the high fees,” he predicts. 

Having cut its teeth in the institutional world – where Qi’s analytics, which rely on vast amounts of computer processing power and advanced AI algorithms to run real-time analysis on millions of data sets, are used by equity long short funds, investment banks and macro funds – Noorani says his company is now looking to sell that capability to online brokers targeting individual retail traders.

Noorani says data is what will help big institutional investors get their edge back. “Institutional firms are trying to get their hands on data to better understand retail flows,” he explains. They are turning to alternative data sources such as satellite imagery, credit card receipts, the number of trucks on the road, and satellite imagery of Walmart car parks so they can get a better idea of retail sales and how that impacts equities.

“We are seeing an explosion in the amount of data, but data is not a solution,” says Noorani. “It is a headache. Getting insights about relationships from the data is where we’re moving. The world of macro-investing was traditionally dominated by subjective analysis, gut feel and hunches. But the future of investing is increasingly going to be analysing hard data, getting hard evidence for what is going on in the world and how that impacts asset prices and asset allocation decisions.”

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