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Receiving “Likes” for good returns

November 24, 2020

reading time: 5 minutes

by Stephan Lehmann-Maldonado, guest author

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On social trading platforms, everyone can see which securities other investors are buying. And every strategy can be copied at the click of a mouse – with all the opportunities and risks this brings with it.

Sexy selfie poses are not for Fabian Marco Gerspacher. He prefers to follow stock prices and analyze currency markets – in addition to his job as a chemist at the Fraunhofer Institute. But the thirty-year-old has become something of an influencer. To put it more specifically, he has become a “Popular Investor”, as eToro calls them.

eToro was founded in Tel Aviv in 2006, and is the leading social trading platform. It competes with Austria’s Wikifolio, the US’ Zulutrade, the UK’s Darwinex and Naga, which is based in Cyprus. Gerspacher is one of eToro’s poster children.

Social trading transfers the basic idea of social media to the financial markets. Instead of vacation, food and family pictures, people share investment strategies with the community. Investors showcase their choice of securities and explain their reasons for this – with varying degrees of success. As on Facebook, some establish themselves as trendsetters, or in other words, influencers, while others remain imitators or followers.

Investing like an investment guru

People who are looking to get followers need one thing above all: good investment results over a certain period of time. Above-average returns make it interesting for other investors to observe and follow the movements in their portfolios. Exactly how this kind of “copy-paste” approach is effectuated on the stock exchange depends on the platform. 

Social media for investors
Social media for investors

With eToro, one click is all it takes to automatically execute every transaction done by a “Popular Investor” 1:1 with your own money. The platform also makes it possible to copy and combine the strategies of several investors.

 

Unlike eToro, Wikifolio’s “copy” function only works indirectly. Followers do not effectively invest in the same securities as their role model, but in a certificate. This certificate is a debenture bond that accurately tracks the performance of the model portfolio. These certificates also allow investors to invest according to strategies. But in addition to the risk of the strategy, they also carry the default risk. In the worst case scenario, investors would therefore have to write off their claims if the platform were to go bankrupt.

Excessive willingness to take risks

Social trading platforms have managed to give investing a hip image. In addition, its promoters say that the interaction on these platforms helps to improve investors’ expertise.

At the same time, however, there is a danger that social investors could be blinded by the returns generated by model investors and as a result, copy their strategy without proper reflection. The economics professors José Apesteguia, Pompeu Fabra University, Jörg Öchssler, Heidelberg University, and Simon Weidenholzer, University of Essex, conducted a social trading experiment with students in 2018. They concluded that copy-paste platforms can indeed lead to an excessive willingness to take risks. This is because when investing, social traders not only rely on the expertise of another investor, who is usually a lay person, they also assume the risk profile of another investor, which may deviate significantly from their own risk profile.

As per the end of 2019, Gerspacher was in the red with his investments, but he probably still earned good money. eToro rewards influencers with an annual management fee of 2 percent. This means that if, for example, 1000 followers invest 10 000 euros each to copy a portfolio, the influencer receives 200 000 euros.

So one thing is clear: influencers earn more than followers, even when it comes to social trading.

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