Time for the SEC to adopt an Open Research approach

As Bernard Lunn reiterated in yesterday’s post Blockchain needs to become technically boring, much like TCP/IP in depth knowledge has become for internet users.

In wealth management, ETF structures have become technically boring long time ago.

Nobody cares and often most users don’t understand the magic redemption/creation process. Most users don’t even know the instrumental role of Authorized Participants (APs) in the smooth functioning of ETF markets. For those wanting to know more around this topic, we outlined the main risks in Are ETFs Trackers that Fintech can turn into Trucks with No Brakes?

Naturally, the media highlights malfunctions in the ETF market during flash crashes. As robo-advisors have accelerated the growth of low-cost passive investing, mainly through ETFs, we have been following such events which showcase incidents of illiquidity and mispricing. Check last summer’s mis-communication debacle in The Betterment/Brexit incident – What the Fintech Genome community spotted.

At the same time, we don’t get excited anymore by the fact that we can invest in the Japanese stock market (and many other country trackers) while they are even asleep and from almost any location.

ETFs are boring!

Except for the recent disapproval by the SEC of the Bitcoin ETF filed by the Winklevoss Bitcoin ETF, $COIN. We covered the “boring” part of it (i.e. the amendments) last week Wedding announcements pending between Old & New Finance Tribes: Bitcoin in an ETF gown!

We need to revisit the topic after the rejection this weekend, to cover two areas:

1.    What did we learn about Bitcoin trading, during this event

2.    What did we learn about the state of capital markets, following this event.

Mid March Bitcoin trading

Lots of worthwhile observations from the market reaction to this event.

Bitcoin is trading as we speak, with a twelve hundred handle (in USD) which is not that far from where it was hovering before the decision. That shows that the bitcoin market continues to shrug off events (from 2 recent PBOC decisions, to the ETF rejection). Market capitalization is also more or less in line, having recovered from dips, to the $20bil area.

This reflects, in my opinion, the steady growth in customer adoption which is outpacing merchant adoption for the first time. Although we don’t have aggregated comparison data to justify this, we can at least point to the most recent Coinbase results that are impressive in terms of the numbers of users and digital wallets; and to the “color” we crowdsource from our network.

Screen Shot 2017-03-13 at 09.46.42

Bitcoin, behaved very much like conventional assets traded in centralized exchanges, this weekend.

Bitcoin, the P2P digital asset which is settled in a decentralized way, experienced a flash crash following the announcement of the rejection. More importantly, the bid/ask spread widened substantially ($35-$60); the volume dropped and then surged ($17bil-$20bil); the price discrepancies between exchanges were large ($50-$100); and the intraday high-low was very wide ($50-$170).

Screen Shot 2017-03-13 at 09.30.26

 

Source: CoinDesk BPI exchange

Disclosure: I had sold my Bitcoins before this weekend (with an 80% profit) and managed to re-open a small position at $1,100 (moved into cold storage, to be forgotten).

If you prefer a professional fund manager, making the decisions on your behalf, for your digital currency allocation, there are two alternatives that I can suggest for your review.

Hedgeable, the next gen robo, has incorporated Bitcoin in its asset allocation via a partnership with Coinbase (who provides the digital wallets and cold storage needed). Hedgeable views Bitcoin as an alternative asset, like a currency, in determining the optimal allocation for each client.

ArkInvest, the US based fintech creating thematic fully transparent ETFs, is the first fund manager to invest in bitcoin in its ETF, ARK Web x.0 ETF (NYSEARCA: ARKW). ARK has made its investment through the purchase of OTC publicly traded shares of Grayscale’s Bitcoin Investment Trust (OTCQX: GBTC).

Capital Markets processes are dysfunctional

In a nutshell, the SEC after 4yrs and 6 amendments, rejected the Bitcoin ETF on the basis that they can’t allow an unregulated asset (that is not physical), to be wrapped in an ETF wrapper. As if soybeans, and pork bellies that trade through futures are regulated and cant be “hacked” by weather conditions or viruses.

I cannot but reiterate Ian Goldin’s mantra

“Today is the slowest day of the rest of your (our life)”

Over the next year, there be more digital currencies issued than in the last 4yrs (even if there are no more than half a dozen that gain significant traction). Isn’t this actually how the ETF market has emerged, i.e. a few really large ETFs?

Screen Shot 2017-03-13 at 10.11.43.png

There will be more ICOs listed (albeit small size), than in the last 4yrs. There will probably be an OTC trust publically trading, linked to a basket of digital currencies (e.g. Bitcoin, Ether, Dash, Ripple, ect) out of Europe (not the US).

Looking at the SEC’s archaic process of inviting commentary from the people, a kind of hearing process, around the Bitcoin ETF; I italicized the SEC questions below:

  1. The proposed fund, if approved, would be the first exchange-traded product available on U.S. markets to hold a digital asset such as bitcoins, which have neither a physical form (unlike commodities) nor an issuer that is currently registered with any regulatory body (unlike securities, futures, or derivatives), and whose fundamental properties and ownership can, by coordination among a majority of its network processing power, be changed (unlike any of the above). Moreover, as the Exchange acknowledges in its proposal, less than three years ago, the bitcoin exchange then responsible for nearly three-quarters of worldwide bitcoin trading lost a substantial amount of its bitcoin holdings through computer hacking or fraud and failed.57 What are commenters’ views about the current stability, resilience, fairness, and efficiency of the markets on which bitcoina are traded? What are commenters’ views on whether an asset with the novel and unique properties of a bitcoin is an appropriate underlying asset for a product that will be traded on a national securities exchange? What are commenters’ views on the risk of loss via 56 57 See supra note 3. See Notice, supra note 3, at 25 n.19. 12 computer hacking posed by such an asset? What are commenters’ views on whether an ETP based on such an asset would be susceptible to manipulation?
  2. According to the Exchange, the Gemini Exchange Spot Price is representative of the accurate price of a bitcoin because of the positive price-discovery attributes of the Gemini Exchange marketplace. What are commenters’ views on the manner in which the Trust proposes to value its holdings?
  3. According to the Exchange, the Gemini Exchange is a Digital Asset exchange owned and operated by the Custodian and is an affiliate of the Sponsor. What are commenters’ views regarding whether any potential conflict of interest or other issue might arise due to the relationship between entities such as the Sponsor, the Custodian, and the Gemini Exchange?
  4. According to several commenters, there is a need for the Exchange to provide additional information regarding “proof of control” auditing, multisig protocols, and insurance with respect to the bitcoins held in custody on behalf of the Trust, in the interest of adequate security and investor confidence in bitcoin control. What are commenters’ views on these recommendations regarding additional security, control, and insurance measures?
  5. A commenter notes that the Gemini Exchange has relatively low liquidity and trading volume in bitcoins and that there is a significant risk that the nominal ETP share price “will be manipulated, by relatively small trades that manipulate the bitcoin price at that exchange.”58 What are commenters’ views on the concerns expressed by this commenter? What are commenters’ views regarding the susceptibility of the price of the Shares to manipulation, considering that the NAV would be based on the spot price of a single bitcoin exchange? What 58 See Stolfi Letter, supra note 4. 13 are commenters’ views generally with respect to the liquidity and transparency of the bitcoin market, and thus the suitability of bitcoins as an underlying asset for an ETP?
  6. The Exchange asserts that the widespread availability of information regarding Bitcoin, the Trust, and the Shares, combined with the ability of Authorized Participants to create and redeem Baskets each Business Day, thereby utilizing the arbitrage mechanism, will be sufficient for market participants to value and trade the Shares in a manner that will not lead to significant deviations between intraday Best Bid/Best Ask and the Intraday Indicative Value or between the Best Bid/Best Ask and the NAV. In addition, the Exchange asserts that the numerous options for buying and selling bitcoins will both provide Authorized Participants with many options for hedging their positions and provide market participants generally with potential arbitrage opportunities, further strengthening the arbitrage mechanism as it relates to the Shares. What are commenters’ views regarding these statements? Do commenters’ agree or disagree with the assertion that Authorized Participants and other market makers will be able to make efficient and liquid markets in the Shares at prices generally in line with the NAV? What are commenters’ views on whether the relationship between the Gemini Exchange and the Trust’s Sponsor and Custodian might affect the arbitrage mechanism?Use the Commission’s Internet comment form (http://www.sec.gov/rules/sro.shtml); or · Send an e-mail torule-comments@sec.gov. Please include File Number SR-BatsBZX- 2016-30 on the subject line. 14 Paper comments: · Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.

Who actually sent commentary to the very important and well posed issues raised by the SEC? The SEC publicizes this data with names and responses (click here). The list shows very few business affiliations and is really short given the issue at stake. It does include the Bitcoin critic, Jorge Stolfi, Full Professor/Professor Titular, Instituto de Computação/Institute of Computing, UNICAMP, university professor; the Bitcoin proponent –fund manager Chris Burniske, Blockchain Products Lead, ARK Investment Management LLC; Kyle Murray, Assistant General Counsel, Bats Global Markets (the exchange to be listed); and a few more.

Crowdsourcing information, filtering the relevant data, ranking and weighing it by “reputation”, is what should be done by the SEC.

Such Capital markets processes cannot be left anymore to forums that include ranking algorithms of their communities members, to select the “best conversations” (for example, thread on Reddit). Fintech innovation is still very scattered. Sentiment analysis fintechs (e.g. Sentifi), crowdsourced scientific research (e.g. Stanford Daemo), and applying machine learning; are floating out there and need to be incorporated in the decision making processes in capital markets.

This is the kind of micro-services that the SEC can implement in their digitization process. ArkInvest is already using an innovative process in their own research Open Research Ecosystem. The Innovation Ecosystem brings cross-industry innovation leaders together to design and invent their innovation journeys.

Screen Shot 2017-03-13 at 10.38.58.png

Source: ArkInvest

The SEC needs to replace its old-fashioned invitation for comments process, to one that uses technology to make the research process meaningful (not simply procedural, a tick in the to-do-list), efficient, and value added.

 

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

 

Wedding announcements pending between Old & New Finance Tribes: Bitcoin in an ETF gown!

bitcoin-etf

Source

In many countries weddings announcements in newspapers are still a necessity and in others they have become a tradition or have moved to social media.  Over the next month or so, in the US there are three pending wedding announcements. The two ones upcoming on March 11 and March 31st, are the more crucial ones.

If you are hoping that this post is some sort analysis of whether the wedding announcement event is already priced into Bitcoin’s price or not; then you are in the wrong place. I can however, recommend this scenario analysis Estimates on the price impact and capital inflows of a Bitcoin ETF.

In this post, I want to highlight facts around the pending weddings, because these are innovative ETFs in dynamic market conditions and there is no appropriate comparison really. Some have drawn conclusions from the approval process of the first Gold ETF (GLD) but in my opinion, it really doesn’t serve any purpose.

Also, because it so peculiar to be witnessing the potential of packaging a decentralized asset into a conventional wrapper like the ETF. We are moving towards a world that for every asset there will be an ETF, but to see Bitcoin wearing an ETF gown (wrapper) is awkward.

Dates and pending wedding announcements

March 11 – The Winklevoss Bitcoin ETF, $COIN

March 30 – The SolidX bitcoin ETF

Thereafter – An ETF wrapper of the GBTC Grayscale Bitcoin Trust, which already trades on the OTC market (like a closed-end fund)

The Winklevoss ETF journey

The Wilkenvoss brothers filed to the SEC 3.5 yrs ago for approval of an ETF linked to Bitcoin. They have also constructed an index the Winkdex to track the price of Bitcoin.

WinkDex is calculated by blending the trading prices in U.S. dollars for the top three (by volume) qualified Bitcoin Exchanges during the previous two hour period using a volume-weighted exponential moving average. This proprietary formula weights transactions proportionally by volume as well as exponentially by time to give greater weight both to higher volume transactions and more recent transactions.

The twin brothers first filed for a listing on the NASDAQ stock exchange in July 2013, this is exactly the time that M-pesa in Kenya linked with Bictoin. The filing was for 1million shares and each share would be worth about 1/5 the Bitcoin price. At the time, Bitcoin was trading around $90. Therefore, the original filing would be wrapping up in an ETF roughly 200,000 Bitcoins. The max offer was $65million.

Since then, there have been 6 amendments that have addressed various issues of concern.

Naturally, one of the first concerns were around safety and consumer protection from hacking. This financial structure has not been targeting retail investors but rather institutional investors that are subject to regulatory constraints in terms of the kind of financial structures they can hold. Right now only the XBT Tracker comes close (EUR, USD, SEK versions). It is traded on the German and Swiss exchange but is not ideal because the backing up of the shares is not one-to-one with bitcoin.

Retail investors are better off doing their own research and investing directly into Bitcoin via some service a la Coinbase, and avoiding the additional costs of an ETF financial structure of this type.

The Winklevoss Bitcoin ETF carries a kind of insurance called the Fidelity Bond, since October 2015. This is a requirement in the state of NY where the custodian of the ETF, Gemini is registered. The fidelity bond coverage includes, among other things, insurance against employee theft, computer fraud, and funds transfer fraud. Gemini is a New York State-chartered trust company that is owned by the twins and acts both as a custodian and as a bitcoin exchange.

State Street was chosen in Oct. 2016 as the administrator of the ETF that will oversee pricing and reporting.

During the 3.5 yrs journey and the six amendments, the Twin brothers decided to change the listing from NASDAQ to BATS. Just the last two months there have been two very significant amendments to the original filing that need to be understood: a) the size of the deal has been substantially increased, b) a hard fork clause has been decided.

The size of the deal is now 10 million shares (tenfold increase), $100million (instead of $65million) and the max price offer that was $65 has been lowered to $10! If approved and fully subscribed, the ETF structure would wrapping up roughly 80,000 bitcoins (much less than originally filed for).

In the prospect of a network split following a software hard fork, the creation and redemption of the ETF will be suspended during the first 48hours. This maybe fine-print (maybe not) but it is important not to miss. Thereafter,

the $Coin ETF (the administrator in consultation with the custodian) will default to using the chain with the most hashing power, but will reserve the right to decide otherwise.

In other words, the ETF will choose the the chain (after a split) which enjoys “the greatest cumulative computation difficulty for the 48 hour period following a given hard fork.”

“If the Custodian, in consultation with the Sponsor, is unable to make a conclusive determination about which Bitcoin Network has the greatest cumulative computational difficulty after forty-eight (48) hours, or determines in good faith that this is not a reasonable criterion upon which to make a determination, the Custodian will support the Bitcoin Network which it deems in good faith is most likely to be supported by a greater number of users and miners.” Source

Needless to say that this recent amendment is controversial already in the crypto communities.

The differences with the rest of the ETFs

The SolidX bitcoin ETF structure is similar to the Winklevoss and mainly differs by offering classic insurance in case of theft. Another difference is that while the Winklevoss ETF relies solely on its own bitcoin exchange, the Gemini, for price discovery; the SolidX ETF uses multiple exchanges.

The third proposal outstanding, the GBTC Grayscale Bitcoin Trust, differs in that it is already trading over the counter. We have referenced ARKInvest in multiple posts since they are innovating in investment management, and are the first public managers to invest in bitcoin via GBTC.  It has been trading much like a closed-end fund and therefore (at a discount or a premium). Their ETF filing hopefully, will alleviate this discrepancy.

Related Wilderness Tips

For traders that have an itch, you can bet on the probability of approval or disapproval of the Winklevoss ETF which is now at 52% (up from 30% a month ago). Check COIN_BH17 on the Bitnex exchange.

For the Winklevoss brothers:

If BATs doesn’t get the honor to list the first Bitcoin ETF, maybe the Winklevoss brothers should consider switching to SIX and seeking approval from FINMA instead. Over the past few days, we have seen the announcement of the Crypto-Valley association headed by one of the best, Oliver Bussmann; and chalet and apartment rentals by VisionApartments accepting payments in bitcoin.

For retail investors that have missed on the bitcoin rally because they didn’t want to do the homework of opening a digital wallet, understanding cold storage, and didn’t want to invest through ARKInvest either; these ETFs when approved are not the solution to your indecision. Go get a wallet.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

 

 

Active trading is hazardous to our health! What to do?

Passive is the new black

“If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle,” Buffett wrote in the famous annual letter of Berkshire Hathaway.

Yes, there is the innovation of the ETF financial structure that we shouldn’t forget was incubated in the womb of the nowadays-incumbent land. It was early 1993 that the first ETF, the S&P SPDR, began trading. This is was a time of financial engineering nirvana in the WTC. I was there, sitting at the desk that Myron Scholes ran, the fixed income structured products desk at Salomon Brothers.

Yes, there is also the innovation of robo-advisor investing that Wealthfront and Betterment led. Adam Nash and Jon Stein both merit substantial credit for advancing the idea that fees eat into returns in a significant way in the long-run, and designing a tech-enabled solution.

Vanguard’s passive investing cult comprises of mutual funds and ETFs. In 2016, Vanguard reports that net inflows into their funds amounted for $227 billion in new money, compared to $407 billion for the industry – more than half of the total assets (Source).

The ETF industry in the US showed record inflows: $284billion. Don’t miss the State of ETFs keynote given at InsideETFs in January, by Dave Nadig and Matt Hougan of ETF.com.

screen-shot-2017-02-27-at-8-57-56-am

The robo-advisory space has shown impressive growth, with Betterment and Wealthront amassing around $10bil (doesn’t mean they are profitable since the CAC remains very high). Vanguard’s robo (also not profitable yet) with $47billion, Schwab with $12+ billion and the rest of the US robo D2C space around $15.5billion.

I also need to point out an even stronger trend towards indexing vehicles, that relates to ETF Trading and its correlation to market volatility.

Flow numbers in the US into general passive vehicles of all sorts (mutual funds or ETFs) are even higher: $844 billion for 2016!

But it is not just flows, it is also the amount of ETF trading, that tells an even stronger story. ETF.com tracks the amounts and shows a fairly steady and significant trading activity over the past three years, around 30% of total value on the exchanges comes from ETF trading. They also report that the correlation of the ETF trading activity with volatile trading periods is significant but heading lower, from 70s to the 60s (VIX versus ETF trading).

Even Warren Buffet, echoed in this year’s annual letter for the first time, that when he buys a company it doesn’t mean that it is forever.

 “But we have made no commitment that Berkshire will hold any of its marketable securities forever.” (Annual Berkshire Hathaway shareholder letter)

Actively managing passive investments, is the puzzle

The passive low cost investing culture, is here to stay and the only valid question going forward is

“How can we make the best out of it, for the long run (of our life-time)?”

Given that we are embracing low-cost investing at various rates in different regions, the other major reason we manage poorly our money, is in a nutschell

All kinds of cognitive biases

Screen Shot 2017-02-27 at 10.12.20 AM.png

Source: TED talk by Victor Haghani, of Elm Partners, who uses the puzzle of the missing billionaires. This helps us explore how and why most of us fail to capture the returns offered by the market.

We are in dire need of an approach that combines the best features of low-cost index funds with the appealing and successful aspects of active management, all for a 1/10th the price that many of us currently pay.

Who else can help us on this front? Maybe Watson? One thing is for sure, we will be seeing more Deep Learning applications to managing portfolios that use low-cost financial structures and mitigate for the cognitive biases.

For now, here a few straightforward Fintechs to consider as an investor or an independent advisor.

Elm Partners, the US based Fintech can be an “advisor” to manage our assets Forever at a low cost (discretionary management only for accredited investors, 12bps per annum). Elm Partners, was founded and is run by Victor Haghani, a partner at LTCM, which gives an additional message as to where the industry thinking is heading to.

Logical Invest is a global Fintech that offers services using low-cost ingredients and sophisticated quant rebalancing but for self-managed accounts. They offer 13 strategies (monthly rebalancing signals provided) with a monthly subscription model (from $30 per month per strategy). These are used by DIY investors and financial advisors. They recently launched The Quant Trader application, coined as the Swiss army tool for investing. It allows optimization between the 13 existing strategies and customization. They also partnered with The Estate Planners Group (US investment advisor) to offer separately managed accounts based on the Logical Invest signals.

Alpima, is a UK based Fintech but a global Fintech, that offers multiple strategies (coined Bricks) that can be used independently or to create a multi-strategy portfolio (coined as Stack). There is an extensive menu of Bricks (e.g. from Multi-asset, to others Equity focused) that can be customized and can be used to create a personalized Stack that is dynamically optimized and rebalanced. The advisory fee is 40bps per annum and combined with low cost execution (e.g. Interactive Brokers) can compete in solving the missing billionaire puzzle. The audience is DIY investors, financial advisors and private bankers with discretionary assets under management.

Which other Fintech is competing to solve the “missing billionaire puzzle” in a simple way?

Disclosure: I am a subscriber to the Logical Invest strategy signals.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

Can proptech mixed with fintech save Generation Rent?

stocksnap_eabrchjrov

Thanks in part to low interest rates and globalisation, property markets in many urban centres across the world seem to be spiraling out of control. Sydney’s median house price has shot past the AU$1.12M mark, surpassing even that of New York, while across the Tasman New Zealand’s largest city, Auckland, has seen median dwelling prices drift close to NZ$1M.

The market dynamics are similar in the UK, with research from the Resolution Foundation indicating there is a significant ground shift occurring, from owning a home to renting one instead, amongst working-age households. In the year 2000 around 55 per cent of households lived in an owned, mortgaged property, a figure that has since dropped to 41 per cent in 2015. Over the same period, those in private rentals climbed from 11 per cent to 25 per cent. The social ramifications of this shift are profound.

Generation Rent, as they have come to be known, now find themselves stuck between a rock and a hard place, facing a potent mix of stagnant wage growth and skyrocketing house prices. Perversely those that have scraped together a deposit face the risk of long-term low inflation, potentially locking them into a possible debt trap for years to come.

Once, owning a home was considered a safe and sure bet for building long-term wealth for the middle class. However with this asset now out of reach for most, some fintech start-ups have spotted an opportunity to service the appetite for property via a range of more accessible and affordable vehicles.

BRICKX in Sydney is one such fintech (or proptech) startup. Via fractional property investment, the company allows investors to purchase units, or ‘Bricks’ of a home. The investment also entitles investors to a fixed share of any rental income generated.  The upside of fractional investing is that investors can spread their risk across a basket of rental properties, plus cash in on capital gains at any time by selling their Bricks to another buyer.

For those lucky enough to have significant equity stashed away in a home today, fintech startups like Point in the US are providing an alternative to the traditional banks when it comes to accessing stored wealth, specifically for reinvestment back into the property market. Point, an Andreessen Horowitz backed startup, purchase’s a fraction of a homeowner’s dwelling, only collecting this back (plus capital gains) when the original property is sold. Homeowners also have the option to buy out Point at any time.

While Generation Rent might not be able to access services like Point directly, parents, who are increasingly financing children into their first home, could. Data from the Reserve Bank of Australia shows the proportion of first-home buyers borrowing from their parents to finance their first property purchase has more than doubled since the 1970s. With many in the Baby Boomer generation under financial pressure themselves through tech driven workplace disruption, any financial solution that doesn’t impact monthly cash flow is a bonus.

Building societies and small banks have a great opportunity to partner with fintech startups in the proptech sector to propel innovations like these forward, scale and bring them to the mass market. These types of partnerships can have real social impact if executed correctly – there is even scope for government involvement. One thing is for sure, we need to creatively rethink how home ownership works and take this opportunity to address the real long term problems uncertainty and insecurity around housing can cause.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Jessica Ellerm is a thought leader specializing in Small Business.

The vertical integration of SoFi has the core entry point right!

sofi

There is a question that beckons for an answer.

In this fluid world, owning the customer is the challenge.

Each individual is managing a balance sheet, e.g. assets and liabilities.

Serving which side of the balance sheet, will prove to be the best entry point to develop a long lasting relationship with the end-customer?

Tech-enabled financial services are not a dream anymore. From telcos, to internet providers, to social networks, they can all aspire to offer financial type of services. Starting with basic personal financial management tools (PFM), to transactions services, all the way to investments. Most PFM and transaction related services are already very low margin services and heading to zero. The remaining higher margin services are further down the value chain and mainly related to investments. Despite the fact that margins in some segment of investment services, are being squeezed from low cost online offerings (robo-advisors), there are still substantial margins that remain. Even though they are decreasing also, they don’t seem to be heading to zero.

Markets are efficient but the time needed to reach this equilibrium type of state, is uncertain. Technology is altering the investment segment of financial markets and creating havoc for financial advisors and asset managers alike.

Seems like there is a new segmentation being formed in the investment segment of the market, with one part of it being cannibalized and another part not. But the latter one, has no other option but to redefine its value proposition and is being pushed towards some kind of Vertical Integration.

At the same time, we have to admit that technology has not been able to sweep the unadvised assets, still sitting around despite the negative deposit rates in most of the world and despite the old-fashioned vault keeping services that deposit taking institutions offer. We have been pointing to this fact,

The Unadvised Assets, and the quarterly data that we collect show no significant change in the “Lazy Cash” figures.

(Read Oh, the things you could do with the enormous Cash pile!). That covers the asset side of most balance sheets of individuals.

On the other side of the balance sheet, there are our liabilities or our debt. This is the part that actually weighs more than saving and investing. From a more holistic perspective, the debt side of our balance sheet is heavily defining our decision making, our life-style and is more sticky. Debt decisions and debt management, affect much more our life. They not only are typically, larger in size, both absolute and percentage wise, but our life is much more sensitive to these factors.

In other words,

allocating capital and managing the risk on the debt side of our balance sheet is larger, more complex, and determines whether we reach our goals or how far away do we end up. This is primarily where we all need advice (human, bionic, hybrid) in the first place, and subsequently in the investment segment of our finances.

Incumbents and Fintechs, for the most part, have got this order of priorities wrong!

Incumbents have a long history of silos between business units, segmentation by product areas, and very low cross-selling rates. The large ones are struggling with the daunting task of integration, platformification, or a holistic approach to the existing large customer base.

Lets watch and see, whether Marcus for example, the consumer lending innovation from Goldman Sachs truly succeeds in destigmatizing personal debt (check out Will Goldman become a verb? Watch the Marcus ads!)? And then, in an invisible way, manages to simplify your first mortgage. And create a full stack for the customer, by integrating their deposit taking offering, their debt offering and management, and their investment capabilities.

On the Fintech side, will it be Betterment which is investing its recent large (for the robo space) funding round into the investment segment of our financial needs, that will invisibly move from its current Home improvement loan offering in certain states, to a full fledged mortgage offering?

Or will it be SoFi, who is investing its ten fold recent funding, into the mortgage segment already, that will easily move into the investment robo-offering later?

SoFi has been growing through the refinancing part of the value chain starting from student loans. From that same niche, they have been growing for more than 3yrs, their mortgage business. In other words, they have been advising their customers on how to manage their debt, from student loans to mortgages! In November, SoFi announced a partnership with Fannie Mae and a new offering, the Student Loan Payoff ReFi.

With SoFi’s new offering, the Student Loan Payoff ReFi, homeowners will have the ability to refinance mortgages at a lower rate and pay down the balance of an existing student loan. With its cash-out refinance student loan payoff plan, SoFi will pay down the student loan by disbursing payment directly to the servicer of the student debt. SoFi is a Fannie Mae approved seller servicer. Source

 This is not just another offering that is cheaper and faster. This is about parents who have co-signed student loans, that will be able to free up their digital assets. It is also about homeowners that manage student debt, being able to optimize the way they manage their capital and risk.

While the headlines are focused on the Zenbanx acquisition (covered in SoFi buying Zenbanx either signals the first Mega NeoBank or a unicorn losing the plot), what is really happening is

the creation of a platform business that is about managing both sides of the balance sheet for retail customers, that has been built around the core business of advising retail on the debt side.

SoFi is a business innovator because it has the priorities right in building a successful business to serve retail customers.

SoFi has realized early on, that the value lies in managing the debt side of the balance sheet for retail customers.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

A little bit of P2P is all I need – Mambo in Lending

mambo-no5

Ladies and Gentlemen, the lending sector merits a Mambo song and I’ve started the lyrics for you all to create your own version.

A little bit of Prosper in my life

A little bit of Lending club by my side

A little bit of Funding Circle is all I need

A little bit of Lending Home all night long

 

A little bit of Monica in my life
A little bit of Erica by my side
A little bit of Rita is all I need
A little bit of Tina is what I see
A little bit of Sandra in the sun
A little bit of Mary all night long
A little bit of Jessica here I am
A little bit of you makes me your man 

There are dozens of platforms for your Sandra, Tina, or Mary; and most of them offer ways for retail to access the primary market of loans, be it consumer loans, small business, student, invoice, real estate loans etc. However, it remains tedious and complicated to manage portfolios be it 10k or 100k or more. Diversification leads to having to deal with Thousands of orders and even then, retail can’t optimally spread holdings across the FICO spectrum and at the same time be diversified with respect to other risk factors (e.g. industry concentration, geographic concentration etc.).

Bottom line it is really hard work to manage a portfolio of P2P loans on a platform. Monica, Erica, Rita,… are high maintenance! Hector, a NY based retail investor on the Prosper platform, attests to that too in Back to the future of P2P Lending, we interview one of those peers.

Add on to that reality that often retail will be “politely” front-run by those managing loan portfolios with the quantitative support that retail doesn’t have.

Most mass affluent retail investors that could allocate 100k or more to P2P loans (viewing it as a fixed income alternative with a reasonable expected risk-adjusted return compared to high yield) would and should be looking to diversify beyond one single platform.

No matter how wonderful Monica is, it is very sensible to have Jessica or Mary also on one’s side. It reduces platform risk and it reduces lending subsector concentration risk (smallbiz, invoice, real estate). These are even more important in a market that has taken a step backwards in terms of its progress in developing a secondary market. Remember that in the US lending market right now, we only have Lending Club that hasn’t shut down its secondary market business. Prosper did. At the same time, note that Small Business loan platforms like Funding Circle require 50k minimum which makes it very hard for retail to include it in a diversified loan portfolio.

Add on to that the Faith and Trust that retail needs to have to any and all of these platforms in terms of their credit assessment algorithms, because realistically speaking there is no way for a retail investor to perform any due diligence on that front.

With all these considerations in mind, I go back to humming

A little bit of P2P is all I need

A little of Prosper in my life

A little bit of Lending club by my side

A little bit of Funding Circle is all I need

A little bit of Lending Home all night long

This is the exact mix of platforms included in a soon To Be Issued fund by LendingRobot, a SEC registered investment advisor. They have been assisting investors to manage P2P loan portfolios over the past 5 years. They have recently offered an automated service for 45bps per year that employs ML algorithms. This has been in the form of a managed account up to now. Lending Robot will soon launch a hedge fund for accredited investors that employs the ML algo and invests in these 4 platforms.

In the US, there aren’t many listed vehicles for retail to invest in the marketplace lending space. There are a few publicly traded stocks (if the equity part of capital structure is what you are looking for)

Market capitalization in Bil

Lending Club – LC

$2.4

Lending Tree – TREE

$1.33

Yirendai – YRD an ADR from the East

$1.17

OnDeck – ONDK

$0.3

There are plenty of quasi-lending bets that a retail investor can also consider through ADRs of Chinese companies in the Internet of Finance space which has heavy lending components. The likes of Alibaba, JD Finance, Tencent could be considered but of course, these are broader plays. Renren (RENN) is one that retail may have missed because the brand is associated with a social internet platform with a focus on games, social commerce, social networking etc. The market cap of this tech platform is close to $14bil. Did you know however, that Renren has significant equity holdings in SOFI, Lending Home? Lendacademy reported

“Renren has participated in SoFi’s series B, D, E and F rounds for a total investment of over $242 million. According to the 2015 year end report, “The Company held 28.85% and 21.20% equity interest of SoFi as of December 31, 2014 and 2015, respectively.” 

I suggest that it would be better to consider buying SoftBank, the Japanese telco & internet giant (SFTBY ADR) because through the Vision Fund ($100billion!) they have invested heavily in SOFI.

“the conglomerate – Softbank- convinced SoFi to eliminate the idea of an initial public offering (IPO) and allocate the $1 bln investment to accommodate SoFi’s growth.” Source

Moving to another part of the capital structure, River North Marketplace just recently (in Sep 2016) launched a closed-end fund RMPLX which investors can buy any day but you can only redeem four times a year (AUM $40mil). Lots of diversification offered:

“buying from a few different originators, we get diversification there from an idiosyncratic risk that might arise at one originator, as well as we get different types of loan segments, so unsecured consumer, small business and specialty finance… there’s diversification in those different segments. Then, again, to further thinking about diversification, there is diversification across geography. We have loans in all 50 states. We have a variety of different credit characteristics, so there’s lots of diversification in this pool.”

In the US, retail investing in marketplace lending requires and will require for a while, Monica, Rita, Jessica, Tina and Mary on our side. Lets keep Mambo humming and diversifying as we are chasing investments that can generate yield on a reasonable risk-adjusted basis.

Europe offers more closed-end funds that make sense to consider for UK residents but are have additional complexities for other Europeans due to differential taxation and currency risks. Orchard platform, a leading Fintech focused on the secondary P2P loan market for institutional (NsrInvest is more for retail) tracks these funds in their weekly snapshot.

orchard-snapshot

 

Premium/Discount (rounded) NAV in millions
P2P Global Investments (P2P)

-20%

£608 Mixed with equity
VPC Specialty Lending (VPC)

-17%

£293 Pure multi sector loans
Funding Circle Income Fund (FCIF)

+7%

£172 Pure SME loans
Ranger Direct Lending (RDL)

-8%

£160 Multi sector (pure) loans
SME loan Fund (SMEF)

-7%

£49 Pure SME loans

A glance at this ranking, explains why Funding Circle will be looking to raise more shares this year (ordinary upon approval of existing shareholders or C shares). Seems also that the SME focused fund structures are favored over the multi-sector ones (including consumer loans etc). This snapshot also leads us to continue mambo humming in lending with Monica, Rita, Jessica, Tina and Mary on our side.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

 

Calpers and the quiet data driven disruption of Private Equity

calpers

Private Equity is a classic clubby insider high margin business. If open data and networks always disrupt these types of business, then Private Equity is overdue for disruption. 

This post offers:

  • A brief history of Private Equity.
  • Private Equity in context to other asset classes.
  • Two big problems facing Private Equity.
  • The disruptive power of open performance data and what Calpers is already doing to bring about this change
  • One disruption scenario.
  • One venture going after this space.

This post is specifically about investing in mature, profitable private businesses. This is in contrast to early stage investing which is already being disrupted by crowdfunding networks for both accredited and non-accredited investors. Private Equity deals are usually control deals (vs early stage that are normally minority equity), so we usually refer to this as Private Equity Buyout. 

A brief history of Private Equity Buyout

Private Equity Buyouts has gone through three iterations:

  • Version 1: Lean Conglomerate. This was pioneered by Hanson Trust in the 1970s. They bought underperforming old companies and put in financial discipline and a new CEO who got a piece of the action after the business was sold. Hanson Trust was an operating company with diverse businesses, so the right name is conglomerate, but they kept Head Office very small and they were always willing to sell a business if the price was right. Their mental set was closer to a Fund than an operating company, so the appropriate tag is Lean Conglomerate. Many other firms did well applying the Hanson Trust model in different markets (often learned while working at Hanson Trust). For example, Misys took the Hanson Trust model and applied it to software and now there are many such software conglomerates.
  • Version 2: Leveraged Buyout Funds. This cut the HO function down even further so that Conglomerate morphs into Fund, but the practices and techniques were similar. KKR was the pioneer in the 1980s. These Funds use leverage to juice returns and force cost cuts. Using strong cash flows to pay down debt, a Fund could sell after 5 years without even changing the business and still get a good return.
  • Version 3. Take Private. This requires more work than the Leveraged Buyout model. It is about fixing what is dysfunctional in public markets – an obsession with quarterly earnings. Transformational change requires more than one or two quarters. One example is the $11.3 billion 2005 Sungard deal. Sungard, like Misys, had grown through acquisitions and at a certain point the result was too messy and the business needed to be revamped out of the eye of public investors.

Private Equity in context to other asset classes.

Private Equity is small in total assets compared to asset classes such as Public Equities and Fixed Income. Private Equity is one part of Alternatives which was $7.2 trillion in 2013 vs $56.7 for Traditional Investments. But note the growth rates.

screen-shot-2017-02-10-at-08-11-26

However, Private Equity is big in one area which is Fees. In this FT article it is revealed that one pension fund alone (Calpers, more on them later) paid $2.4 billion in fees to PE Funds.

High growth and high margins means that any entrepreneur listening to Jeff Bezos (“your fat margin is my opportunity”) should be paying attention.

Problem 1: Software is eating the world.

Private Equity Funds pitch themselves to Investors as being more conservative/less risky than their wild cousins doing early stage equity. They will do rigorous analysis of the past 10 years or longer to see how predictable the cash flows are. No dangerous projections based on new products for them, their models are rooted in real world actual results of proven products.

That sounds good, but is based on a fundamental error which is the assumption that the future will be like the past. The Digital Era overturns that assumption.

Consider the printed telephone books aka “Yellow Pages”. They were a license to print money for a long time and many Private Equity Funds bought into them for that reason. Now it is hard to find people who use printed telephone books for anything other than doorstops.

Or consider hotel chains after AirBnB or Private Banks after Robo Advisers. How do you model future cash flows in those scenarios?

Problem 2: capital oversupply

When everything else changes, you can count on the law of supply and demand as a constant. Private Equity has been such a good business for so long that investors have been pouring money into the best funds (who then get high fees on AUM and the ability to do the mega deals). The problem is that this results in a lot of capital chasing the best deals (what Private Equity guys call “dry powder”) which raises prices on entry and that depresses returns on exit.

Calpers – its the data stupid

Into this closed, clubby world (”if you have to ask the price you cannot afford it”) comes Calpers (California Public Employees Retirement System) with their Private Equity Program Fund Performance Review. This is data transparency in action. It is only one investor but that investor is so big that it is a significant data point. You can sort all the PE funds online by all these different criteria.

screen-shot-2017-02-10-at-08-28-45

Our thesis is that this data will drive a lot of innovation. Entrepreneurs will be able to show what they offer vs the competiton by referring to this data. It is like an Index for the Private Equity business.

Disruption scenario

Our thesis is that disruption will come from Family Offices, managing money for the Ultra High Net Worth Individuals (UHNWI) and their families. In the US alone there are 3,000 single-family offices with assets under management between $1 trillion and $1.2 trillion.

Four key points about Family Offices:

  • They like the high returns of Private Equity and don’t worry about the lack of liquidity with money “locked up” for years (because they are managing money for multiple generations).
  • They are agile because they don’t have any “explanation risk” (if something goes wrong they can learn from it and move on, they don’t have to explain their actions to investors).
  • They don’t compete with each other.
  • Many are still run by entrepreneurial families (who are used to taking measured risks to get better returns).

This makes the Angel List model of following a proven investor applicable to Private Equity. This is already happening in a small way with small networks of like-minded Family Offices working together on deals (referred to as “club deals”). This is where the entrepreneurial genes of the Family Office counts. Let’s say Family Office A made their money in Pharma and Family Office B made their money in Software. Family Office A follows Family Office B’s lead in Software and vice versa.

Angel List obviously works at the early stage end, but the brilliance of their innovation is that they take of all the “boring plumbing admin” stuff like reporting. That can apply to any form of asset management, including Private Equity.

Axial

One company going after the Private Equity space is Axial. They recently raised a $14m Series C and are led by a proven entrepreneur called Peter Lehrman who was part of the founding team at Gerson Lehrman Group (technology platform for on-demand business expertise).

Image Source

If you want to see these insights before your competitors, join over 16,500 of your global peers who subscribe by email and see these trends reported every day. Its free and all we need is your email.