Machine learning for actively-managed ETFs

It’s been one year since my landscape post on AI in Digital Wealth mgt: Sniffing out investment opportunities and the conversation continues on the Fintech Genome with the addition of new ventures and with other insightful conversations around whether Could fund strategies be better managed by Intelligent ML/Ai based platforms?

This is all happening while the rise of passive investing continues and the push for non-active ETFs continues. Statistics show that human stock picking is in decline, with Blackrock showing 64% of its assets under management in passive-focused index and exchange-traded funds and only 29% in funds that follow active strategies.

AI in digital wealth management clearly isn’t about passive and indexing. It is about discovering new sources of alpha, managing risk in a better way or about democratizing access to certain kinds of alpha. AI in wealth management is always about extracting value from data, whether it is natural language data, sentiment analysis, or numerical data processing.

Today I’ll zoom into a partnership between two AI&ML analytics providers and two Fintechs, that aims to capture alpha and offer it to all of us, in the most popular wrapper, the ETF.

Watson is not new to financial services. It is behind various IBM initiatives (e.g. IBM Cloud for financial services) and it is powering already some Fintechs, like Alpha Modus, focused on asset management services using cognitive analytics. None of these ventures have packaged financial instruments ready to be added to our portfolio.

The AIEQ ETF to be listed on NYSE

The AIEQ ETF pending its approval will be listed on the NYSE. It is the brainchild of a triangular collaboration between Watson + TensorFlow, Equbot, and the ETF Managers Group.

Watson shares its ability to parse text (news, articles etc) to uncover catalysts that can affect (positively or negatively) the individual stocks and real estate trusts under consideration.

Equbot, is the US based Fintech that sprung out of the IBM Global Entrepreneur roaster. It leverages the Watson AI abilities, to build predictive models that combine fundamental analysis and Machine Learning. It uses the open source Machine Learning libray TensorFlow to build the Equbot model. This model identifies 30-70 US stocks on a daily basis that have the greatest appreciation potential.

The ETF Managers Group (ETFMG), is the largest private ETF issuer/manager in the US, and is managing the process of filling for an ETF to be listed on the NYSE. The ETF is named the Equbot with Watson AI Total US ETF (AIEQ). Equbot is the subadvisor to this fund. Through its partnership with Watson and TensorFlow, it will develop the Equbot model which is driving the actively managed fund decisions.

Actual risk-adjusted performance can only tell whether stock picking based on the combination of ML software and cognitive analytics, is generating alpha after the taking into account the costs of active trading and managing the ETF wrapper.

Efi Pylarinou is a Fintech thought-leader, consultant, and investor. 

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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 (; or · Send an e-mail 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!



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


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. 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.

Are ETFs Trackers that Fintech can turn into Trucks with No Brakes?

Could the next financial crisis come from the over $3trillion ETF and index market? Could the trend – heavy use of ETFs – lead into the next structured product debacle? Are these trackers, prone to becoming dangerous trucks with no brakes, ready to collide in the next unexpected turn of the market road?

Fintech has undoubtedly contributed to the growth of the industry and Vanguard’s philosophy is no questioned. It is part of any and every portfolio, to a small or large degree. ETFs have become mainstream but this means that investors are not asking any more questions about the risks they are exposed to. ETFs are stereotypes for low cost, liquid, and tax efficient vehicles to gain exposure to a country, a sector, or an investment theme.  They are seen as the efficient way to execute and they often provide investors with the illusion that they outsmarted the financial professionals acting as intermediaries and offer financial advisory services. I will agree with all of the above stereotypes; only partly. The risks lurking should be understood and kept in perspective.

ETF risks

The Investment theme risk, is understood by all investors; which country, asset class, industry sector, style, one chooses to invest in.

The Tracking risk, is usually understood; how well does the selected ETF track the investment space promised.

The cost risks, can include, tax implications (commodity and currency ETFs need caution) and costs related to ETF closing procedures (e.g. Blackrock closed in 2014 as many ETFs as it opened – Lists of announcement for closures of ETFs can be found from, here). There is a behavioral cost that I see as becoming more significant through the digitization of financial services that has been undervalued. It is the fact that ETF usage has increased not only in passively managed discretionary mandates (through first generation robo-advisors) but also in DIY and actively managed accounts. This results in using low cost financial vehicles, ETF, but incurring OVERTRADING costs.

The liquidity risks, are more complex than at first sight.

There are ETFs that target illiquid markets (e.g. equity exposure to Nigerian stock market; or specific bond market).

There are ETFs that simply don’t accumulate enough volume and therefore the bid/ask spread is wide. This is because the market maker (e.g. Virtu Financial) is dealing with a narrow market. There are tons of ETFs that are low volume (close to 30% are reported to trade less than 5,000 shares per day!). Exchanges are giving out incentives to the trading firms involved in market making, to keep these structures alive (August announcement by NASDAQ). BATs is incentivizing ETF issuers by paying them to list on BATS.

There is also the Premium/Discount spread that reflects whether the ETF itself is trading above or below the NAV of the underlying portfolio. This can happen because of behavioral trends (i.e. the crowd pilling into an investment theme or an investment theme gapping down because of an event that turned it out of favor). This is the type of risk that Betterment tried to protect its clients from, when it halted trading during the aftermath of the Brexit (Covered in the conversation on the Fintech Genome, here).

The last and least understood, liquidity and counterparty related risk, is one related to the Creation/Redemption process of ETFs. This is actually the secret sauce of these structures, that gives them the intraday liquidity which is lacking from mutual funds and the tax efficiencies. The Creation/Redemption process of ETFs refers to how the shares are created or redeemed. The process is complex and if one wants to understand it, it is explained on here. The hidden risk that needs light shed onto it, is related to Authorized Participants (APs) who are the entities that create and redeem ETF shares and are sometimes the same as market makers; but not always. They are the usual suspects (large broker dealers) and have signed AP agreements with the ETF issuers (see a SEC registered AP agreement here). In summary, for each ETF, one has to think of the Issuer (e.g. Vanguard, Blackrock), the Authorized Participant AP (DTCC reports that there are currently 50 AP firms) and the Market Maker (e.g. ), and the Custodian (e.g. JP Morgan, State Street).

Screen Shot 2016-09-04 at 09.18.12

Source: Vangaurd learning

So, one can say that at least Four kinds of liquidity risks are inherent in ETFs. The AP related risk or the risk inherent in the “magic” Creation/Redemption process of ETFs; can become one that makes the speeding ETF truck to derail. It is a risk that cannot escape from a Lehman moment in the financial sector. Even if one invests in an ETF that has no direct exposure to the financial sector, through the double liquidity dependence on Authorized Participants and Market Makers of ETFs, the risk is there and real. In august 2015 when the market gapped, ETF prices were not available and active investors, those needing to hedge through ETFs; were facing a void. Passive investors focused on mirroring Indices, were dissapointed too. Panic and behavioral biases, can turn a seemingly well functioning market into one that is illiquid, volatile and distorted. All these factors are concentrated in the financial sector. There is no difference from the time of the mortgage strcutured products crisis and the out of proportion domino effect.

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.

Platform Traded Funds (PTFs): the next innovation?


The wealth management industry is behind the digital curve compared to other parts of financial services. There aren’t any noteworthy innovations in financial assets subsequent to the subprime crisis, which tainted structured products.

ETFs are most certainly the only one item that has scaled and gained broad acceptance, especially in the US. Europe follows only because investment advice is delivered mainly through banks rather than financial advisors and because tax harvesting is not tackled systemically; and for Asia money market funds and structured products make more sense. The focus on costs due to the extended ZIRP environment and the tough macro environment which result in the reduction of expected returns, has been contributing to the ETF growth too. Robo-advisros are scaling in the US. The most recent numbers are showing Vanguard with $36 Billion; Schwab intelligent portfolios with $8billion and Betterment with $5billion.

I am in monitoring mode on two fronts in this space: (a) In the standalone robo-advisory space, I am watching to see whether there will be a way to scale the business (Betterment is the only evidence right now but it is VC backed and needs to prove the ROI); (b) Will there be an innovation disrupting the ETF bread & butter (low cost, tax efficient, intraday settle) and fueling the disintermediation of the investment management business model as we know it today?

I had taken an initial look at this second topic last October, in FinTech-Ing in ETF space: Growing AUM, shrinking fees, and crypto-currencies. Since then, the passive ETF segment continues to grow. BATs is empowering this in the US. Europe and Asia, however, remain stagnant on that front.

Low cost, active, the big threat to the value proposition of traditional asset managers and hedge fund managers; has been having serious distribution problems simply because that space is controlled by the Big guys. No Fintech has been able to penetrate the traditional distribution channel.

One way this may happen is once the incumbents decide to cannibalize their own business. I look for signs of this and found three.

From New York, Ark Invest the Fintech that is focused on creating thematic, transparent, active funds (which I have mentioned here) has sold a minority stake in American Beacon who is focused on selecting managers and acting as a sub-advisor.

From Canada, the technology company Aequitas Technology Solutions had launched late last year a Fintech platform, the Platform Traded Funds (PTF). The platform offers investors NO minimum access to low cost, actively managed funds which settle on the platform like exchange traded funds. Retail and financial advisors can use the platform. Aequitas claims that on top of the “no minimum” offer, savings are around 35% compared to traditional mutual funds. The first large provider that was on boarded is Invesco Canada. So, Invesco will offer all it actively traded products on the PTF platform.

An incumbent who is cannibalizing its business on many fronts. It launched a robo advisor which we mentioned in our Spring videographic update on the robo-advisor trends and now is moving into actively managed funds.

From the US, Eaton Vance launched NextShares earlier this year and the market is watching to see the success of this product, which is an actively managed, low cost wrapper (much like an ETF which is typically passive) with intraday liquidity and tax efficiencies but delayed disclosure of their holdings. There are three NextShare products for now, trading on NASDAQ.

  • Global Income Builder NextShares
  • Stock NextShares
  • TABS 5-to-15 Year Laddered
    Municipal Bond NextShares

NextShares, recently became available on the UBS Financial Services which makes UBS, the second large firm embracing NextShares for their financial advisory network. UBS asset management is also expected to launch their actively managed wrapper after seeking approval from the SEC.

Interactive brokers is also embracing the Eaton Vance Nextshares but maybe launched their own too.

The move from Eaton Vance is significant because they are shifting towards becoming a platform by offering revenue sharing with other firms and accessing their financial advisory network. These moves are also empowering financial advisors with more tools that enable them to become low cost and efficient discretionary managers.

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.

RobinHood Freemium could enable a lot of new Low Cost Active Alpha services

The equities broker model has been slammed by two waves of change:

  • End of fixed commissions. This happened decades ago and simply opened the market up to competition.
  • Internet. This is what enabled the human broker to be replaced by servers and led to e-brokerage firms such as eTrade, Charles Schwab and many others.

Which brings us to RobinHood

RobinHood offers zero cost equities brokerage and plans to upsell to premium services later – a classic Freemium strategy. They recently raised a $13m Series A and claim traction among Millenials (who have less to invest and therefore scrutinize the current fee of about $10 per trade more carefully).

For a service that is close to zero cost on a per unit basis and falling further every day thanks to Moore’s Law, a Freemium strategy makes sense.

The question is about the upsell. If RobinHood creates their own value added premium services they will end up competing directly with the bigger e-brokerage firms. However, if they simply offer an API to anybody who creates value added services they will create an ecosystem that is far more powerful than what any single firm can create. These kinds of Low Cost Active Alpha services are complex, so it is smarter to let other entrepreneurs create them. These entrepreneurs will be quite happy paying RobinHood for customer access. This could be a classic network effects game that unbundles services and creates a stack. It is the same dynamic we are seeing in the lending marketplace business.

Today, RobinHood appeals to Millenials with less to invest. When we get another Bear Market, wealthier older investors will also scrutinize the per trade cost. At first a Bear Market will reduce trading costs as we get the usual “death of equities” stories. That will hurt the traditional e-brokerage firms but RobinHood can afford to sit it out. Trading volume will eventually return.  There is always money to be made by active traders. All they need is volatility, the actual direction matters less. Active traders care about the per trade costs. RobinHood could be one of those businesses that take off in a Bear Market.