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Online trading enthusiasts, like many Web evangelists, talk about the Internet with reverence, as if it were a miracle-worker capable of doling out equal opportunity to the thousand-dollar investor and the millionaire insider. Although the Net has fulfilled some of these visions, mostly thanks to competition among leading online brokerages, the opportunities are not as big as true believers might lead the uninitiated to think.
Last week's buzz about small investors getting in on initial public offerings - with clients of brokerages like Etrade and Charles Schwab now in line for the first issues once reserved for mutual-fund managers and their Daddy Warbucks brethren - offered a case in point. High-octane equity research now becoming available online gives another.
IPO access and in-depth research may be available to armchair investors, but they need deep pockets. At Schwab and PC Financial Network, IPO shares will go only to clients who maintain a portfolio of US$100,000 or more. Etrade hasn't yet announced its IPO policies.
Edging toward openness
"You have to set limits by either asset level or trading activity," says Blake Darcy, chief executive officer of PC Financial Network, one of the original online brokerages. "Otherwise you'll just have too many disappointed customers," Darcy adds, explaining that "there isn't an unlimited supply of IPO shares."
Tom Taggart, a spokesman for Schwab, also dismisses the notion of truly open access, saying "it wouldn't be responsible for any firm to direct an inexperienced investor to IPOs.... They're very speculative."
But he argues that the limits imposed by his firm, which runs the online brokerage e.Schwab and last week signed pacts with Credit Suisse First Boston, JP Morgan, and Hambrecht & Quist to peddle IPOs those banks underwrite, is still an improvement on Wall Street's standard operating procedure.
"This isn't about who you know," Taggart says. "We're qualifying and targeting our most sophisticated customers."
Vernon Keenan, an analyst at Zona Research, feels that even that argument overstates the importance of online trading. He says the current trend toward wider IPO access is "a crowd-pleasing thing and a marketing tactic. But in reality the bulk of the IPO business is still going to take place in the smoke-filled rooms."
Although those rooms still remain firmly closed to everyday investors, the trend line in the virtual trading game shows that the crowd that already make trades online will grow exponentially over the next few years.
Forrester Research says the number of people holding online trading accounts will grow from 3 million this year to more than 14 million in 2002. The Forrester estimate says that group will wield $688 billion in assets.
The competition factor
Lower trading fees are in large part responsible for the drive online - as is the Internet's promise of greater control over trading and endless reams of background information. Some online brokerages charge commissions as low as $9.99 per trade, compared to the hundreds of dollars traditionally demanded - and costs are expected to keep dropping. The number of firms vying for customers is driving constant service improvements - and a marketing campaign that could rival the Cola Wars.
Etrade last week announced a $25 million marketing push to get the word out about its partnership with investment bank Robertson, Stephens to offer access to its IPOs and equity research.
"Who's going to have the brand name that works best in the marketplace? That's the next big piece," says Darcy of PC Financial Network. His firm's gambit in the branding game is a name change: Later this month the service will be rechristened as DLJ Direct - to establish a more obvious connection with its parent, the investment bank Donaldson, Lufkin & Jenrette.
Beyond marketing, though, there are bigger promises of change. Equity research - the detailed data about stocks generated by highly-paid analysts - is rapidly becoming a regular feature of the online brokerages. Of course, it, too, will be made available only to "high net-worth customers" - industry jargon for the financially well-endowed.
"When you read the fine print, you find out that the research is only for the silver spoons," says Bill Burnham, an analyst with Piper Jaffray in Minneapolis. "You never get something for nothing in life. The reason that big institutions pay millions of dollars a year to investment banks is primarily for the research. They'd be better off just getting a Schwab account if they were giving it away on the Web for free."
Eventually, observers says, brokerages may begin selling equity research on an a la carte basis to all comers. The research could be turned into a profit center by offering it as a premium service to everyday investors.
Your broker: Still analog for now
The growth of discount online services aside, the barriers still confronting small-timers mean that flesh-and-blood brokers will be a central fact of investment life for some time to come.
"Customers are not going to leave full-service stock brokers," says Joseph Ricketts, chairman and CEO of Ameritrade Holdings, which operates three online discount brokerages, including one of the originals, Aufhauser's WealthWeb. "They represent 70 to 75 percent of the business, and I don't think the Internet is going to change that. A lot of people would rather play golf than worry about their finances."
That may be true for the time being. But Burnham, at Piper Jaffray, forecasts that "the critical point is five or 10 years from now. Will online brokerages have matured enough so that people will keep their accounts with them as they age and get more sophisticated, or will they migrate to the full-service brokerages?"
In the short term, the online trading industry will also need to prove it can weather downturns in the market. If the Dow takes a dive, will the phenomenal success of online trading prove to be just a function of the bull market?
"I think people trade on the way down, too," says Quote.com chief executive officer Tom Henry. "Certainly it will be a sobering experience to people who missed the last crash, and people will be scrambling to preserve and protect, but they'll still be trading."
Mildred Wulff, an analyst at Jupiter Communications, sees that as overly optimistic. "After the 1987 crash, retail trading dropped by about 31 percent," she points out. "That's why a lot of these institutions want to diversify their offerings: They want customers to view them as more than fair-weather friends."
Reliability still a question
And whether the market is heading up or down, online trading services still must show they can reliably handle high trading volume. Past glitches include a May 1996 Etrade crash that cost the company $1.7 million in compensation for thwarted trades.
"The cloud over online trading is that you're subject to the vagaries of the Internet," says Keenan at Zona. "When we have billion-share days, that requires big data networks, and so brokers will need to upgrade their capacity."
In addition to shorting out computers, action-packed Web trading has the potential to zap investors' common sense.
"The higher trading costs used to prevent people from doing something insane," says Randy Befumo, an analyst at the Motley Fool, which provides bulletin boards and market reporting for independent investors. "Now, the low commissions cause anyone with a PC to think they can compete with the major trading firms and beat the market. And they're going to lose a huge amount of money."
Burnham compares online trading to another Web boom industry: gambling.
"It has become very seductive and addictive to trade for the sake of trading," he says. "People buy at 4:15 and sell at 4:16, and the low costs make it easy to do that. But the fundamental risks of investment haven't changed. People need to be aware of that."
Risk isn't the message online brokerages are sending with the limited new availability of high-end equity info and IPO participation. What the digital trading houses are selling by giving even the smallest investor something big to aspire to is an older, simpler message: Buy low, sell high, baby.
