Eric Plumpton is a Banking and Finance graduate with honours from the University of Malta. His professional background consists of 3 years working within the iGaming industry and most recently working as a Risk Advisor at Deloitte. He is deeply interested in the world of Investments and Regulation where he keeps up to date with current market trends and emerging opportunities as well as being on the forefront of potential risks emerging from new regulation.
Below is a summary of the findings from his dissertation which is a study analysing retail investors’ perception on Social Investing as an Alternative to Traditional Investment Brokers.
The full dissertation can be downloaded at the end of the article!
This study aims to tackle the principal-agent problem faced within the Investment industry. The principal-agent problem is a conflict in priorities between a person or group and the representative authorized to act on their behalf. For the purpose of this study, the principal-agent problem was broken down into four main challenges which are; transparency, trust, costs and performance whereby these factors have been addressed throughout this study. These challenges will contribute to the aim and objective of this study whereby retail investors are asked through a survey to address these challenges when going through the investment process with Traditional Investment Brokers vs eToro’s CopyTrade platform.
The analyzed literature in this field shows that investment brokers and portfolio managers have different incentives than those of their principals which leads to the principal-agent problem development. This in turn is reflected in the trust investors have towards their agents where from a research study conducted by Edelman and CFA Institute (CFA & Edelman, 2013) only 53% of investors trust investment management firms to do what is right.
This research study will contribute to the study on online communities and social trading platforms of research where it will try to identify if eToro’s CopyTrading feature can reduce the principal-agent problem.
For more information about eToro’s CopyTrading feature, I would recommend reading the article “The Popular Investor Program” (eToro, 2021) that best explains the features found on the platform.
Perception of Trustworthiness
This part of the research report adds to the body of knowledge on the trustworthiness of financial industry agents in both online and offline environments. Several ideas and questions were posed during the discussion of the literature review section, where numerous empirical studies demonstrated investors’ lack of trust in their agents.
The results of the research study indicate a similar outcome when reviewing answers to traditional investment brokers, with 36.92% of survey participants claiming that their local investors have their best interests at heart. This figure is consistent with other countries’ studies in this field, as shown by the CFA Institute’s study (CFA & Edelman, 2013). This statistic alone raises some questions about the financial industry’s prospects, as most institutional investors who participated in the survey were relatively young.
Having said that, a 51.75% majority of eToro participants trust their agents to mitigate potential risks and actively manage the portfolio in the best way possible, according to the survey results. In accordance with the hypothesis that eToro does, in effect, minimize the lack of trustworthiness against agents.
This section of the research study then continues by going into detail about the platform’s security, where the findings show that both platforms perform on the same percentage level when it comes to contributing to the protection of retail investors’ funds and assets, as perceived by the participants.
Communication is one field where traditional investment brokers have proven to be superior to eToro. According to the results, 62.05% of participants agree that their questions would be answered by traditional investment brokers, although this is not the case with eToro, as the majority of participants took a neutral stance with 53.63%, indicating that they are uncertain.
The final issue investigated the field of conflict of interest and unbiased advice between agents and principals. Reviewing the findings reveal that eToro is helping in reducing this issue by only having 14.03% of participants who believe that the popular investor cannot stick to the investing plan outlined, compared to 21.1% who believe that there are conflicts of interests between Retail Investors and Traditional Investment Advisors.
The importance of trust between the principal and an agent could be seen in the literature review. According to Sorkin’s study (Sorkin, 2013), 28% of participants do not think the finance sector prioritizes their interests. This statistic is concerning for the financial industry’s future on its own, but as shown, this research study builds on it by illustrating that participants on eToro trust their agents more and the figure for conflicting incentives is reduced to 14.03%, proving that eToro is managing to reduce the principal-agent problem based on retail investors’ perception in terms of the trust.
Perception of Costs and Transparency
This section of the research study is the most conclusive when it comes to addressing the principal-agent problem. According to N Shah, one of the major contributors to this issue is the compensation structure of agents (N.Shah, 2014). This is also supported by Laffont and Marimort’s claim, in which they go into further detail in their research analysis exploring the principal-agent problem, arguing that conflicting incentives and information asymmetry are additional causes of this problem. (Laffont & Marimort, 2003)
From analyzing the results, the study’s findings reveal a strong indicator that retail investors believe eToro is doing a relatively good job of reducing the problems mentioned above when compared to traditional investment brokers. When asked about their perceptions on conflicting interests with both platforms, 30.12% of participants disagreed, stating that the investment broker would promote securities depending on how much commission or fees they will make when this was compared to the retail investor’s perception on eToro this figure drastically decreased to 13.15% showing a clear reduction in participants believing that their chosen Popular Investor has conflicting interests than theirs. Thus, the platform is managing to align investors’ and Popular Investor’s incentives together as perceived by retail investors. According to Laffont (Laffont & Marimort, 2003), conflict of interests is a significant factor that contributes to the principal-agent problem, which eToro is managing to reduce through its CopyTrading innovation.
This is mainly due to eToro’s compensation structure towards Popular Investor’s. Should the Popular Investor’s manage to increase their profits and AUM (Assets Under Management) this will ultimately increase their income so the Popular Investors are incentivized to perform to their best abilities, in turn, retail investors copying the Popular Investor will benefit alongside this.
Adding on to Laffont and Marimort’s theory where they argue that private information is another factor that adds to the principal-agent problem (Laffont & Marimort, 2003). According to the research study’s findings section on the Perception of Transparency on Costs and Commissions, the majority of participants conclude that all platforms do their best to be transparent about the costs of investment, with 56.03% and 57.02% believing that their platform is open about the costs of investing, respectively. Having said that, eToro has managed to reduce the number of participants who disagree with this statement, with only 11.4% of retail investors disagreeing with eToro’s platform not being transparent, compared to 18.98% who disagreed with traditional investment brokers being transparent regarding their investment costs.
This would imply that from a retail investors’ perspective the factor of private information is also being reduced by eToro’s CopyTrading platform. Another factor to mention is the price of the costs incurred from investing where participants gave their thoughts on if they believe the costs incurred from investing with traditional investment brokers or eToro respectively are reasonably priced. From the findings, one can observe that 24.4% vs 8.77% of participants disagree with this statement respectively. As a result, retail investors view eToro as a less expensive and more transparent alternative to traditional investment brokers.
Contributing to Mas Collen’s hypothesis, he argued that moral hazard and adverse selection are two subfactors of information asymmetry that add to the principal-agent problem (Mas-Colell, 1995). These two considerations were also discussed in the research study, which examined retail investors’ perceptions of these variables.
Adverse selection results from hidden knowledge, so the research analysis was designed to put the transparent statistics provided by both platforms to the test while also observing the participants’ perceptions on the topic. Participants were asked if they were kept up to date on relevant statistics and if they found them useful. According to the results section on platform statistics perception, eToro appeared to be the most transparent platform, with an overwhelming majority of 72.2% considering the platform’s statistics useful, compared to 49.39% for traditional investment brokers.
Retail investors are given the tools they need to make the right and more informed decisions about their investments through the use of transparent and useful statistics. This, in essence, will help to reduce the issue of adverse selection, and will indirectly help to reduce the principal-agent problem. As shown by the figures above, eToro was the platform of choice in this category.
Lastly, this section tested the second category in Mas Collell’s theory, moral hazard, where he argued that this factor can arise whenever principals are unable to monitor their agents (Mas-Colell, 1995). The research study tested this factor by asking the participants if they can easily view the portfolio they invested in.
The results were largely in favour of eToro, with 87.72% of participants agreeing and just 1.76% disagreeing. As opposed to Traditional Investment brokers, 46.98% agreed and 15.96% disagreed. The large percentage disparity between the two figures reflects poorly on the local industry and how transparent their platforms are built. Monitoring one’s portfolio allows one to quickly detect the changes undertaken by the portfolio manager, and the client will then evaluate this action and determine whether it was done in their best interest. The first step in resolving the principal-agent problem is to make it simple to monitor agents working on behalf of retail investors.
Perception of Performance
The sections above were then followed up with assessing retail investors’ perception of performance. Factors such as trust, costs and transparency might hinder the expected performance of the portfolio, so the research study was set to put this to the test to see where retail investors’ sentiment lies in terms of performance.
Participants were asked if they believed their portfolio was expected to outperform the index benchmark on both platforms. According to the findings, most respondents on both platforms had a balanced view with which they neither agreed nor disagreed. The difference was determined by how many participants disagreed with this statement; for traditional investment brokers, 16.85% disagreed, while on eToro’s platform, only 7.89% disagreed. While most participants maintained a neutral stance, it is worth noting that the number of participants who disagreed was reduced by eToro’s CopyTrading platform.
Another assessment of performance was assessed through the use of overtrading where the participants were asked if they believe that their chosen portfolio manager for both platforms would overtrade to meet performance requirements. Similar findings were discovered, with the majority of participants holding a neutral position for both platforms, but eToro managed to lower the number of participants who disagreed with this statement, with 7.89% versus 16.57 % in favour of eToro.
The research study reveals a high percentage of uncertainty in the participants’ responses to performance. Though eToro did manage to minimize the number of participants who disagreed with these statements, the remainder of the participants are unsure about their interpretation of performance.
This scepticism can be caused by the preceding factors of trust, cost, and transparency considerations, in which retail investors lack faith in the abilities of the chosen portfolio manager. Another factor that might contribute to this uncertainty might come from a macro perspective where investors are uncertain about future market conditions. In the end, what matters most in terms of performance is the portfolio manager one chooses and the strategy one employs.
To Round It All Up
In conclusion, the study aimed to bring investors that use traditional investment brokers and eToro’s CopyTrading platform to the test, to assess retail investors’ perceptions of the principal-agent issue using trust, transparency, costs, and performance as the four driving factors contributing to the outlined problem. Based on retail investors’ responses one can determine if eToro is proving to be a viable alternative to the service provided by traditional investment brokers.
Following an analysis and discussion of the research study’s findings, it can be concluded that eToro has proved to be a competitive alternative to traditional investment brokers. Based on the responses obtained from the participants, it is clear that the principal-agent issue is minimized by the use of transparent statistics, monitoring, and incentive alignment offered by eToro’s CopyTrading platform. The positive perception gathered from retail investors who took part in the research study gives hope to prospects that are shaping the financial industry in today’s digital age. Through innovation, eToro managed to pioneer a first of its kind system which tackles the principal-agent problem in a different light. Through its system eToro empowers retail investors with the tools required to assess which portfolio manager best fits their investment strategy. On the other hand, it manages to align the incentives of the portfolio managers with that of retail investors through developing a new compensation structure best fitted to work in favour of both parties involved.
Based on the findings, it is clear that this type of system is well received by the local investors who participated in the research study. One can predict a trend in which more platforms with similar inbuilt systems, such as eToro’s, are developed since the local market has expressed a preference for the type of system.
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Any views or opinions presented in this article are personal and shouldn’t be taken/used as professional advice as we are not qualified financial advisors.
Any statistics mentioned have all been linked to their respective documents together with their ownership.
Lastly, we would like to note that this article has no tie to our professional jobs and was conducted in our free time.