CV.IM - A New Kind Of Investment Management Account
Our portfolio company Covestor launched a new kind of investment account today, called Covestor Investment Management (CV.IM).
I had written a longish blog post explaining why I think this is so interesting and explaining how I've been been a beta tester/investor for the past couple months and how I am doing. But investment management is a regulated business and the lawyers didn't like my post. So I am going to link out to others instead.
Covestor has a post on CV.IM. Here's how they describe CV.IM:
account or MMA. With an MMA you can invest directly alongside professional and retail
investors, managing their own money in their own account. It is a new category
of Investment product that gives you access to expert managers like a hedge
fund with the security and transparency of a managed account.
Techcrunch has a post on CV.IM. Here's what they say:
accounts. They never hold any of your money. CVIM merely links their
trading data to a brokerage account you set up either with TD
Ameritrade or Interactive Brokers. You select which accounts you want
to follow, and CVIM automatically instructs the linked brokerage
account to mimic the trades in proportional amounts.
And my partner Albert, who sits on Covestor's board has a post on CV.IM. Here's what he says:
When we invested in Covestor it was in part because of the fit with our “Power to the People” thesis:
To us, this appears to be one of the great constants of the web. It
is taking power away from existing large institutions and pushing it
out to smaller entities and often all the way to individuals.
investment management firms and the individuals are people who are
investing their own money.
This is a new and different approach to investment management. I am thrilled to be able to participate in it as both an investor in Covestor and an investor in CV.IM.
I’m in love with this idea. That’s why you’re the VC and I’m not. 🙂 I love that you guys, along with StockTwits, are challenging “the norm” for investing.
thanks for saying that. i appreciate the encouragement.
It’s a neat idea, but if the cost is the same as investing in a mutual fund, what’s the benefit? It’s a mutual fund with a nicer website…
well you can choose your “portfolio managers”, allocate funds across them, change them as you see fit, see the exact composition of your portfolio (actual stocks and total holdings of each). there’s a lot of differences.
Transparency about the holdings in the portfolio, investment decisions and trading activity is a big thing for a more sophisticated investor.There are very few (none?) mutual funds that lets you even see 100% what securities the fund is holding at any given time, and most of the retail ones don’t ever list all the holdings, just the top ones in their quarterly reports.But still, eventually it’s gonna boil down to returns. If the CV.IM portfolio managers can’t beat the indexes their holdings compare to, there really is little point in keeping your money there.
I totally agree with your last point. Although I would argue that if you can get close to the indexes consistently with cvim, that may be good enough
Isn’t there an issue with conflict of interest and flawed incentives if the “portfolio managers” are investing their own money with the knowledge that potentially thousands of other investors will be following them with the same trade shortly afterwards?
Hi Vladimir. I am one of the founders of Covestor. The model managers are not aware of how much money if any is following them. We also impose restrictions on them whcih include minimum liquidity levels (to ensure they can’t move the stock with their following) and compliance periodically reviews their other brokerage accounts to ensure innapropriate behaviour. I hope that helps. Do get in touch if we can give you further detail
Hi Perry. That does help, thank you. But it still seems that even the minimal assumption and knowledge that there is someone following PMs would affect their decision making – both potentially good or bad. Oversight of the PMs will clearly help. If this does become a popular way to invest, it’s hard to imagine that any stock will be liquid enough to not be moved by thousands of simultaneous buy orders.
Well that’s not really any different than a mutual fund or hudge fund buying a large position. This is simply a disaggregated version of the same thing
That’s right Fred. But unless this disaggregated version can make the purchase in one big order (which it seems that it should be able to) then those followers (clients) at the end of the line are left at a disadvantage.
While in theory your idea is awesome, Perry, your answer leaves a lot to be desired.First off to your assertion that you require minimum liquidity levels, directly from your website:Securities restricted to Stocks and ETFs traded on US Markets- with a market capitalization greater than US $50 million- with a minimum daily trading volume of 10,000 shares- no Pink Sheets, excluding ADRsNo pink sheets. Great. But Market Cap minimum of $50 million? MINIMUM DAILY TRADING VOLUME of 10,000 shares????? I can move 10k shares in a heartbeat. So can a lot of other people. That’s ridiculous.Secondly, you say that managers don’t know how much money is following them. BUT, also from your website:””The investors managing the models are compensated for their data, based on the number of clients subscribed to their models. This fee is currently set at $120 per subscriber per annum pro rata.””So they DO KNOW how MANY PEOPLE are following them. Which means that they have an indicator of how much money they have following them. They WILL KNOW at a minimum how much money is following them as you require at least $10k. Furthermore, any smart person will realize that the 80-20 rules applies (in this case I’d say like 90-10) where your top 10% of investors on the site take up 90% of the money.Thirdly, you have notorious penny stock trader/self-promoting snake oil salesman Timothy Sykes listed on your front page as one of your listed models. I think that really hurts your credibility.
I agree with these points, and this there are some significant risks here, but if you dig a bit deeper it’s clear they have at least considered these over at Covestor. Having looked at their regulatory filing (found here https://cv.im/forms-and-agr… they claim that Publishers must certify that they are aware of the applicable laws, including those regarding manipulation of markets. That being said, their method for enforcing this may leave something to be desired.
Thank you for your comments Murkey10. I apprecaite the feedbackThe key issue with this is that it is all fully in our control. We monitor for high risk activity (of course we know what kind of volume is following who and the impact on daily trading volume) and the likely implication of model manager activity. These are all variables that we have controls to manage for on the back end (I think you would be more than impressed with what happens behind the scenes)I should add that they actually don’t know how many people, if any are following their trades. (even with subscribers) As you will also note,on the about and fees pages, we also offer the capability for anyone to subscribe directly to license the data feed, which we manage syndication of. As such the investor managing the model does not know whether or not there is any trading activity occuring as a result of their ‘subscriptions;I can’t comment on any individual managing a model as you will appreciate. All I can say is that we are a Registered Investment Advisor and have strict rules for participation. It is an open platform and we will be rapidly building the number of individual and professional investors available for subscriptionWe would welcome you as a client. I am more than happy for our operations team to be very open on how it all works and if you have further feedback we are always open to improvement
Thank you for the response (and thank you Simon).You say that you have automated systems and rules and filters and manual oversight, etc. I understand that. My problem is that you have not set out a clear SYSTEM that is fully transparent for investors. Also, I take issue with your rules that you do have in place. I understand that you have the rules.For example:Why not move up the liquidity trading per day to a Dollar based volume instead of a measly 10,000 shares?Why not move up the microcap $50mil requirement?It seems like you expect us to trust you with just “These filters are fully in our control and can be changed at any time.”It just so happens that several of your “managers” are also investors in your company. I didn’t see that disclosed on your website.I don’t even know where to begin on the conflicts on interest inherent in this model.I must say though that it’s amazing to see technology attempt to take on the financial sector — a place where innovation often hits a wall.
Hi Murkey10. Can I invite you in to our offices and we would welcome the opportunity to walk you through our systems. Perhaps you could share your experience and help give us feedback. Our objective IS to be fully transparent to investorsOnly one of our model managers is an investor in the company. Rikki Tahta. He is our Chairman and helping us learn about the experience of managing a model. This is disclosed openly, both on his profile and on the team page on both websites.
Fascinating concept. I’m not in a great position to invest more than time at the moment so I look forward to historical evidence of 3 and 5 year returns with this model. Now if there were more incentive to be one of the “guinea pigs” it may change my and others willingness to jump in.
These are all good comments and I think its great to get the feedback and its apparent that the management of covestor wants it and will listen to it
Hi murkey10, I run operations here at Covestor – thought worth me adding to Perry’s comment as we’re keen to be open and transparent about the controls we have in place.As we have a fiduciary responsibility to our clients we have process, technical, legal and economic levers to protect our clients from financial loss as a result of fraudulent activity.As you rightly pointed out we have some liquidity filters around market cap and trading volume. These filters are fully in our control and can be changed at any time. Should we encounter attempts to manipulate the market, we can have a number of tools at our disposal including terminating a model manager from participation on our platform, temporarily suspending clients from auto-replicating the suspected model manager and calibrating our liquidity filters.We monitor all trading activity of the model manager. We have automated rules and manual oversight to restrict which model manager trades we auto-replicate for clients. The model manager does not know which of their trades will be replicated. For example, one such rule limits our clients exposure in aggregate to a small percentage of the average trading volume for a given security to ensure the clients are always liquid.From a legal perspective, upon signing our agreements, model managers are required to disclose details of all their broker accounts and agree to allow us to audit these at any time.If you have any further questions or comments we’d be glad to respond.
It will be interesting to see how this plays out. Many years ago I had a similar idea for institutional stockbroking – instead of just calling up every day with trading ideas, why not run a model portfolio and let the investors see if you’re any good? Soon after (and unrelated to my suggestion) some hedge funds (eg Marshall-Wace) adopted this model as a broker filter.The underlying logic behind the idea is sound: actions speak louder than words.
This is an interesting concept. Beyond the potential conflicts of interest, I think scaling of this service could pose issues for clients in the future. One of the benefits of a mutual fund is the ability of the fund to execute high volume trades at a strike price which benefits everyone who owns part of the fund. There seems to me to be a scale issue here – assuming the user base grows significantly you may have significant numbers of individual investors chasing the same trade. Unlike investors in a mutual fund, these investors will get different pricing on their trade depending on the lag to execution and may see portfolio performance diminish as a result.
Hi Sam, I am one of the founders of Covestor. Of course you are absolutely right there will be hurdles for us to overcome as we scale. However, specifically to your observation of the benefits of a mutual fund from a price execution perspective, our platform will allow us to aggregate all desired client orders into a single order for execution by the broker. When we block orders in this way, this ensures all clients obtain the same trade price. Post execution we can then allocate the appropriate quantities to each individual client account. I hope this addresses your comment.
Will you be able to aggregate orders from clients with different brokerage accounts – i.e. Ameritrade, Scottrade, ETrade, etc.?
To become a CVIM client you have to open a managed account which we help you with. Currently this is available with one of either TD Ameritrade or Interactive Brokers.
I have no idea how CV.IM works, but if a ‘followed’ investor wants to execute a trade, it could certainly be packaged-up with all the ‘following’ trades into one single block. This way everybody gets the same price, and the resulting block trade (if it’s big enough) could also be done at a discount – like most block trades in liquid stocks.Just a suggestion.*Update: glad to see Simon Veingard answered along the same lines.
Simon from covestor just replied and said that’s how it works
There’s no reason covestor can’t batch up all the orders and process them as one big one
That’s great. Good to see people innovating in this space.
Fred – this seems like a real game changer to me. Congratulations on your investment in [email protected]_F
good the cat is out of the bag, now can someone else finally promote this thing other than just me! 🙂
I think this is brilliant! I have been investing for some time now, but it is simply impossible to trade, work and study at the same time. I love the new CV.IM. Hope that you can be able in the future to tweak and mix different strategies from different PM.To Fred and his team congrats again. I saw the news in tech crunch first but was not at all surprised when I saw that it was a portfolio company of USV!!The best to all
I believe this concept has a lot of potential and that with the right evolutionary decisions that it can become a major substitute for mutual funds and other forms of traditional investment management. But I don’t believe that this is a game changer yet. I say this not as a finance expert but as a small yet active investor who participates in finance discussions and online investment networks – essentially as a potential customer.First, I don’t see how this offers a more valuable way to invest than current mutual fund models. The fee structures seem to be similar. I am still putting my investment decisions in the hands of one or more individuals (at best a small group). Although these individuals do have a track record, so do the portfolio managers of any respectable fund. I don’t understand where the “power to the people” concept is present – is it just from the fact that Covestor’s PMs are regular people or that there might be more transparency?Second, there are numerous new challenges and issues that this “new” model creates:- Although this has been discussed below – the fact that portfolio managers invest their own money creates incentives for them to abuse their position of power, their knowledge that they have a following which will follow their investment patterns – just saying “trust us, we have strict rules and procedures” isn’t enough to put me at ease, and I doubt you will be able to give everyone a tour of your operations- These same investment managers can easily and quickly utilize their positions for personal profit through side-portfolios. With options, they can do this so quickly that “periodic checks” aren’t enough.- The tax and broker fee implications are unclear – if my trades are automatically executed after the portfolio managers, that means that capital gains tax implications aren’t necessarily optimized. This is also the case with broker fees.- I’m not sure there is a clear alignment between the product you are offering and the target market – I (a 20-something with a little bit of cash) seem to be more likely to experiment and invest with CV.IM than older, more established individuals. But I, and many of my peers, trade via discount brokers such as Scottrade and E-Trade. I’m sure that more brokers are on your roadmap and that further agreements will follow but something doesn’t jive right now.I express this feedback with the motive to help you create a better product. I’m sure that you’ve thought about most of these challenges but am confident enough to believe that my thoughts might still be helpful. Please don’t hesitate to contact me if you believe that additional feedback or support would be useful.
Vladimir. Thank you for your support and comments. We really appreciate the feedback, This is day 1. We’re forcing an old comfortable industry to face transparency and competition and I recognize there are plenty of challenges to look forward to.
Awesome. This industry is definitely ripe for real transparency and an Internet-driven populist shake-up.
While transparency is a huge issue, another one is lack of education about how markets work. While definitely watching the more seasoned investors at thier work is extremely helpful (not all of us are going to be lucky enough to have craftsman-like guild training on Wall Street) it isn’t clear that without some background about the whys and hows, how this will work for those who are starting out or don’t know.I don’t have a lot of cash and I am just starting to learn about investing-in some ways, thinking about internet models- Forex is probably more idea because I can play. But I can see how a model works for you if you want people who are alright slightly seasoned with the investing world, and want a leg up.What is the plan on expanding disruption though, much like Forex, if there becomes a need to explain to people the whys and hows of the way trading works. A system like this could cause the best screamers to win- not the best traders- if the people entering it don’t have a modicum of education, at the worst. At the best, you find new people you want to follow.
Power to the people is about letting anyone who is good manage a portfolio.Imagine there’s a 18 year old kid out there who is a genius and can make a lot of money trading stocks. An approach like this allows him to do that without having to go to work for a hedge fund or mutual fund.That’s what’s different. Its an open platform
interesting stuff. so as the portfolio manager, you try to outperform the market (and other managers) with the incentive of receiving a commission/percentage from Covestor for all of the people following your trades? I guess I’m left wondering exactly how much does the portfolio manager get for being transparent and letting people follow them? Is it a function of how many followers you have, or how does that work?Would consider setting up my custom hedge fund replicator portfolio on covestor since its seeing 29% annualized returns since 2002… but would need clarification on how the manager is compensated here. After all, as a manager, your portfolio is your secret sauce.
I hope the covestor mgmt team will stop by and answer this. I have a general idea of how it work but don’t want to say anything that is incorrect
Hi Marketfolly. Appreciate the questionYes, Our objective is to share the fees we recieve from our clients following your model. If you are not regulated we are not allowed to compensate you based on assets following you or on performance. In that regard our relationship with you is simply as a publisher, whereby we license your trading data from you from which we create and manage the model available for subscription. As above we will also resell the trading data if someone wishes to subscribe to that directly (rather than having the model auto trade). Initially we are paying the model managers $120 per year, pro rata (calculated daily) per subscriber following your model.We would welcome an application to manage a model. Please send us more background on yourself and any audited performance history. I should say that we don’t give away your ‘secret sauce’ we are simply giving you the opportunity to leverage the hard work you are already doing.
hey thanks for the response, glad to see you all taking time to address everyone’s questions and give everyone a better idea as to how things will work.Okay, so $120 per year for each manager would then mean it is a function of scale as the more followers a manager has, the more money they would make and that is their incentive to generate alpha and outperform. Is that the only incentive then, just monetary? Was just curious.Fully appreciate what you all are doing and think it is a very intriguing idea. I’m just wondering how you all will garner a list of managers “worth” following, you know? As another commenter pointed out below, I’m sure the amount of clients you all receive would be driven by what managers are available for them to follow. Thanks for the invitation to apply, as I’ll have to consider all of the logistics involved and wrap my head around the tradeoff here.
No problem marketfolly. These things are complicated and as someone earlier mentioned it is all in the detailYes. It is a function of scale. The more followers they have the more they can earn and this is only limited by capacity in your model (given the liquidity constraints discussed).Re other incentives the investors are interested in doing this, as when they share portfolios on Covestor, for all sorts of reasons. Not all are interested in income by any means. These include reputation, credbility, discipline, job development, entertainment and importantly often a wish to help others. The motivation to generate alpha is more that they are doing this with their own money.We screen the model managers on a range of criteria. Ultimately it is an open platform (unlike any other in that sense) so the most ‘attractive’ will rise to the top. There is no ‘best’ when it comes to investing. What suits my objectives very likely does not suit yours. Ultimately we will let the market decide.
So, is this a sales channel for Registered Investment Advisors effectively? I have to presume the SEC would never let everyday individuals effectively be portfolio managers in this construct.
Not exactly. You can be a model manager as an individual too
This is a certainly an interesting idea. Among other things, the success will depend on what managers are available to “follow” and what the transaction costs/fees are. It seems that retail / CV.IM transaction costs will need to be higher than a mutual fund. Is that not the case?
Exactly, that’s kind of what i was hinting at on my earlier comment. Potential users/clients will need to have plenty of good options in the manager pool to entice them to join. And, as such, it would have to be in covestor’s best interests to give those managers great incentive to be on the site in the first place. One of the co-founders just said a manager can “earn $120 per year pro rata (calculated daily) per subscriber following (a manager’s) model.”With that setup, it is obviously in the manager’s best interests then to generate alpha and outperform, as the more followers they have, the more money they make. I’m just not sure $120 per ‘follower’ would be enough to persuade some heavy hitters to join covestor. Because right now with their transparency, Covestor has vetted some lesser known managers with great track records. I feel they will still need some more well-known, ‘credible’ names to really step it up to the next level in terms of clients. And, what is the incentive for those managers? Just a little bit of monetary compensation? Publicity regarding your track record? Just not sure it’s enough to bring top-notch managers on board.But then again maybe I’m totally off base here and they aren’t aiming for a heavy hitter lineup of managers but are instead focusing on everyday traders/investors who have great track records but are relatively unknown on a larger scale. (And by heavy hitter I don’t mean huge fund managers). Either way, it will be interesting to see.
I’m not sure that’s true steve. Working with interactive brokers make the transaction costs very low
I agree the cost per transaction is very low, but I suspect not as low as for a “professional”. And if you’re “following” an active trader, you may be turning over your portfolio pretty often. So it could add up.
Great idea.This is something for the seasoned investor who knows what he/she is doing though. Individual investors you follow can change investment strategy instantly without notification.
Thank you Jan. It is a good point. We monitor the model managers investment activity (and of course the clients can see the activity in real time in their own account). When they sign up to manage models they complete a strategy/suitability profile for the model whose investment activity is then screened.As an RIA we have an obligation of suitability to our clients. This is implemented both at the subscription level (if your risk appetite is lower than the score of the model you are not allowed to subscribe) and at the trade level both in terms of restrictions on the Model Managers and personal restrictions you may have (e..g if you work for Google and are restricted from trading in google this will be excluded from replication). This is partly why the time from trade capture, through suitability and replication, to completed execution in your own account averages around 2 minutes currently.
Anyone that achieved significant profits over the last 12 months should not be trusted trading OPM in size. Their beta will crush everyone eventually.Just my two cents.
First in the light of full disclosure I do not know enough about this yet and would like to look further into your portfolio company. I like the argument it removes the power from large institutions and pushes it into smaller investors hands. Great value proposition.I find a few implicitly troubling thoughts that come to mind, from the compliance perspective. They are questions I have no answers to yet and I can only infer you have been asked before. Nor are they judgemental. Just Q’s /wo A’s.What of potential moral hazards for the ten “portfolio managers”? Would they gain the ability to forecast eventual “lemming-like responses” to their own movements? Would managers with “pop-star” status have an unfair advantages in respect to hedges (options, short positions, etc.) they might be induced to use outside the Covest universe? Could it become a completely transparent form of front-running?What of the large amount of capital movements derived from the aggregation of thousands of “smaller entities” and investors who follow and mimic the “managers”? Do the managers become a collective of grass root investor capital and wield similar economies of scope in the power of their “trades” that institutions did in a given equity? Is it truly a dissolution of power from institutions to the smaller investors or a shift of power to an institution in different attire?These are not opinions…just questions. Now I can read the other 59 comments to see if Group Think is pervasive on this! From a 5 Force…it looks great…if the barrier of regulation does not go up any higher I suppose…
We’ve asked ourselves all of these questions before we invested and the management team is well aware of them and has built a number of controls and monitoring tools to stay on top of these issuesBut innovation and experimentation means taking some risks, trying new things, and I am sure that Covestor will learn from the experience of operating this system and adapt and change some things over timeThe feedback from the users and potential users like yourself is a valuable component in all of this. So thanks for your comment. It is appreciated
I have never ever heard of blind copycat trading being described as an ‘investment management strategy’, but I congratulate you on this brilliant idea all the same. Please go ahead and encourage as many stupid people to do this by convincing them that they can trade without actually learning how to trade, so that they can lose even more money in the stock market to those like me who can.
Glad to see you are picking the easy industries to disrupt *tongue firmly in cheek*. I’m a fan of ‘going BIG or going home’ but I’d be interested to hear the thinking regarding the time horizon on this?Finance (if you can paint an industry that broad/diverse with one word) is the ideal target for internet disruption in terms of an old, centralized, anti-transparent, protected industry where a small number of actors leverage their position in existing institutionalized power structures to take a disproportionate amount of profits compared to the value they create for the economy….but i also think it is the most difficult to disrupt because it is so institutionalized in the current economic and political systems that i don’t know that you can even separate them (ex. who got the bailout money first? why?). I mean when the financial industry gets disrupted the same way media is now…..we’re talking some larger fundamental changes to our society….i’m all for keep on keepin on….but the timing and is the big question for me….thoughts?
I am sympathetic towards promoting transparency and level playing fields, but I think there are some flaws to the premise in this case.The key question is whether any of the model managers in this pool will actually have the ability to outperform the market (alpha), and related to this, how easy is it to measure and and identify these managers.It is very, very hard to measure good performance and distinguish it from luck. A lot of active investors think they can beat the S&P 500, but almost nobody does in expectation. The survivorship bias is huge in a system like this. I have read comments from people pointing to one or two managers who have beat the S&P500. Do these readers understand the extreme survivorship bias in covestor hand picking 10 managers from a large pool where some do well and some do not? There will always be people who do well by luck, but the question is going forward, will they do as well?It’s a disservice to make people think they can distinguish good investment models easily. I saw statistics for some of the model maangers that showed sharpe ratios over a 3 month period. As a professional, I know this kind of number is meaningless (as is a 2 year or 4 year number, for that matter), but I worry the average user will not? There are very sophisticated ways to correct for survivorship bias and estimating performance durability, but they are buried in technical academic papers and are difficult to understand.The problem with active investing/trading and why it’s such a drain for society to have people spending so much time trying to do it is that it’s very difficult to measure results accurately. Were you lucky, or were you good? The uncontrollable variance in the end product is huge, unlike a lot of other fields. If you try and build a jet on the side and it crashes, you know immediately whether or not you were a success or a failure, and whether you should stop wasting your time. This feedback is precise. In investing, if you buy shares of Google and do well, it could be for a million different reasons completely unrelated to how good an investor you are. This fools people into believing they might have skill, and in this case, might fool people into believing others have skill.Investing to beat the market is extremely hard. There is no other field that I am aware of where so many people think they can do it casually on the side and do it well. It requires 100% of your effort and a lot of training and talent. Nobody thinks they can just spend a few minutes a day and do brain surgery on the side.Typically the only people who win from services that encourage active investing is the brokerage houes that takes commission, and the wall street market makers that collect bid/ask spread for trades done that contain no alpha. People argue commission isn’t an issue because it’s so low, but bid/ask spread + commission can add up. Let’s imagine that people buying a 25 dollar stock pay .5 cents for commission, and then 1 cent for the bid ask spread. This is 6 basis points (6/100 of 1% point). Your average investor using a service like this would count that as insignificant. Yet if you just do 2 trades a month where you exit a position and go into another stock, this would add up to nearly 3% a year in commission costs on your portfolio alone. That means the managers you are following need to outperform the S&P500 by 3% just to break even, and more if you want to outperform. If an investor is wrong and the manager he is following simply tracks the S&P500 over time before commission, that means that investor loses 3% a year. If the markets return 8% Over 15 years, a million dollars invested will turn into 3.17 million if you just buy the S&P500. If the manager you are following matches the S&P500 before commission, your million dollars will turn into only 2.1 million. That means you will lose a million dollars alone over paying “just” a small amount of commission.Clearly, these low costs add up to a lot, and again, I am afraid most investors using a service like this would not appreciate how big it can be. Even worse, instead of this helping disintermediation, most people doing this type of thing just help perpetuate the wall street elite. Do you know how many hedge funds and wall street trading groups would love to make markets for some guy who is doing “swing trading” or “market timing”, or any other similarly bogus trading strategy? They love orders like that!Finally, even if we were to imagine some model managers have durable, long term alpha, the end problem is that this type of system is not scalable. Alpha is rare and zero sum. It cannot by definition be spread amongst everyone. Even if someone had skill and we get around the problem of being able to identify those individuals reliably, the market impact that a string of orders put together would over time effectively negate their alpha. It doesn’t matter if orders are batched and everyone gets the same price. The larger the block of shares to buy, the worse a price you are going to get for the group. That is simply a market reality. You cannot buy a million shares of Google in a few minutes without moving the price up dramatically.My perspective is: Skip trying to find the next hot manager, or trendy trading strategy. The notion of being able to find the next 18 year old investing genius is a romantic one, but in the end highly, highly unlikely. Most likely for every true prodigy that a covestor user finds and follows, there will be 10 users following zero alpha managers that happened to get lucky, and will lose their followers commission over time. In my opinion, that is the true median case for users of this service.Instead, buy SPY (S&P500 ETF). It is perfectly transparent, you can see exactly which 500 stocks it holds and at what weightings. For your average investor, the only way to win in investing is to do 2 things that surely work over time: Diversification, and saving commission costs.
Hi E.PieThis is Rikki from Covestor here. Thanks for the detailed and intelligent comment you’ve left. Quick disclaimer: I’d prefer doing it over a drink as this post touches on a lot of investment theory and opinions and begs a good give and take. But given constraints of time and space, please forgive me if I am a little superficial in reply and don’t turn this into a discussion board. Keep in touch and if you are in NY I’d happily share a beer with you.Summary: (for those who don’t want to read beyond here). CVIM is not for you if you believe: a) all active asset management is useless or b) all talent has already been discovered and employed by Wall Street. If however you do think a talented person can outperform the average and they don’t all work for Morgan Stanley – then we have a great proposition.Long response now follows:We believe that active management adds value. That a person working hard and making intelligent choices will outperform the average. If you do not believe that; then I agree the best strategy for you is to buy an ETF of whatever broad market index best matches your personal time horizon and liabilities. The S&P may not be best for everyone, maybe the Russell or an international Index is better for you. Regardless we are on the same page here. ETFs have the lowest cost structure.However many people do believe in talent, which is why the world has bi-furcated over the last 10 years into Hedge Funds (all about the talent) and ETFs (all about the liquidity and low cost). Mutual funds are a bit of an anachronism now.So if you believe in talent how do you recognize it? Here you make good points but should add the “uber” truism – that past performance is no guarantee of future results, regardless of how long. The problem in a world of limited information is investors overly rely on past performance. Our view is give as much information as possible, respect the intelligence of our clients and let them decide. Everyone has their own take on how to identify a talented person – personally understanding the individual making the decisions and a respect for their intelligence and work is a greater indicator for me than past results. We believe it’s all down to transparency.We don’t believe all the talent can only be found on Wall Street. I do agree that investing like many other skills requires training as well as raw talent and someone who dedicates themselves is better than a part-timer. However I do not subscribe to an ivory tower view that talent exclusively resides in the investment banks or hedge funds. Any good MBA, CPA, engineer etc … can apply the basics of corporate finance, securities valuation or capital markets theories. Its a bit like programming, there’s talent all over, self taught or from great schools but people grow, move and leave and the talent stays with the individual not the company. Personally I find coding significantly more complicated than securities valuation. (I will stick my neck out here and say with 6 months training I bet any good programmer can be a good securities analyst but only a small minority of securities analysts could be passable coders).Are model managers on Covestor disadvantaged vs Wall Street? There is only one instant I’d really agree with you – in flow trading (see brief thoughts below). Otherwise thanks to Reg FD, the internet and the intense competition of the online brokers, the playing field has been leveled. CVIM is just a better model for capturing and leveraging talent – than a pooled fund. It has all the transparency and security of ownership of a managed account and access for anyone given their risk / suitability outlook.Are the transaction costs a prohibitive hurdle. Your maths is right – but the issue you overlook is the relative cost vs the institution. Everyone pays commissions, they are bundled into the price of the security so are invisible to the fund investor and do not form part of the expense ratios. Even ETFs pay commissions. At parity between an individual and institution, the trade cost becomes irrelevant to the performance hurdle. Two things are driving that trend. 1) increasing electronic trading and 2) the global reduction in lot sizes. There is no fundamental reason for any economies of scale in a fully electronic world – so what is happening is overtime institutions trade in smaller and smaller lots sizes across different localities through their EMSs (Execution Management Systems) to hide the ‘information’ in any order. 10 years ago the average order size on a European exchange was $60,000, now its $5,000 and dropping. The consumer benefits as a by-product. So I don’t disagree with your maths but its one part of the picture and a reducing problem.I should remind anyone who is still reading at this point – that we are an Investment Advisor. We take NO transaction commissions from the brokers and so our goal is aligned with our clients – to reduce the commissions paid by choosing the best partners and automating wherever we can.You call some strategies” bogus”. That is your right to choose what works for you. However there is a huge body of investment theory around different and conflicting theories. We want you to have access and to decide what you like and who you like and be able to pick more than one of them. That’s what Morgan Stanley Wealth Management offers its high net worth clients.You point out some strategies are not scaleable. Yes I totally agree. That’s one of the advantages of CVIM. Some of the strategies can’t scale over $20m and yet $40m is considered the minimum scale for a hedge fund. We have already indicated that for some models we are limiting the capacity because of scale. As you also know – the asset management industry typically goes through stages of underperformance as assets grow. ie a talented young manager on their first fund succeeds well, raises more and more capital and can’t recreate with $1bn what they achieved with $50m.Flow trading: The main area that Hedge Funds have a distinct advantage over individuals in liquid public securities markets is in flow trading. Over 30% of all transactions are flow trades – ie positions held within 2 minutes to take advantage of tiny disparities in prices. The competitive advantage there is engineering 🙂 with a fight for speed between exchanges and institutions in driving milliseconds off the trading time. Oddly enough that actually suggests the opposite conclusion to your assumption that a hedge fund manager is waiting to make a market on the other side of a CVIM client. Index funds with programmatic capital flows are much more predictable than a human manager and given decreasing lot sizes flow trading just helps to make pricing more efficient.As I said above – we could have a long and enjoyable beer over all of this and I can only respond simply here. But you raised a lot of discussion points and given the effort and thought you put into your comment I wanted to respond and give you confidence that there has been a lot of thought behind what we are doing. CVIM is not perfect yet but it does represent a real value proposition to participants.Thanks for the feedback.Cheers Rikki
Hello Rikki,Appreciate your response, it is clear you guys have done a thoughtful job approaching this. I would just make a few comments to your response.1. My point is not that all active management is useless. My point is that the individual, active investor is highly, highly likely to fail compared to his/her institutional counterparts. Investment, despite the proliferation of online research and lower transaction costs, is still something that has advantages to scale.There are very good reasons to be employed by wall street or a hedge fund. Both institutions dedicate themselves to investing and have scale, so the opportunities are significantly more favorable. The information you naturally see across a wide range of investment products: debt, equity, commodities, volatility, can help inform investment decisions in a way that sitting at home with e-trade never can match. If a kid does well as an 18 year old equity investor, why shouldn’t we put him in the middle of information flow on a trading floor, being able to talk to people who are knowledgeable about other parts of a company’s capital structure, such as bank debt, senior secured bonds, convertibles, volatility, etc.? I do not really believe this thesis that there should be no reason an average investor cannot be as smart as someone on Wall Street. They could be equally smart, but investors are still naturally advantaged to be part of that ecosystem, so it is optimal for society to have him/her in that position.Hedge funds devote millions of dollars and teams of people to count cars in parking lots of retailers and buy the best research available. Not to mention that the massive amounts of capital that they have at their disposal gives them access to investment opportunities that no average investor will ever see. Warren Buffet is prized because people know they can go to him for 5 billion in capital overnight in an emergency–and the risk/reward of that transaction is proportionally favorable. No average investor will ever see things like that.I agree with you that investors put too much faith in past performance. But we disagree in what we should put faith in. I don’t believe understanding the individual making the decision is a good criterion, because your average investor probably does not really understand how to tell whether an individual will make good investments. I prefer relying on structural advantages. We know large hedge funds, endowments, etc. have structural advantages. They have scale. They devote 100% of their time to this enterprise. Their holding periods are long. They have lockups, unlike individual investors in your system. If Yale wants to invest in commodities, it’s not how an individual can–they can put down 100 million to own large tracts of timber and hold it for 20 years. That is the nature of investment opportunities that are available to you when you have scale. It has nothing to do with how smart you are in this sense–the average small investor will never have access to those opportunities. This is why David Swenson, manager of the Yale endowment and one of the godfathers of portfolio investing, advises people to buy ETFs and not to try and beat the market–becuase if you are not willing to devote the resources and scale that other players are to this problem, you can never compete. This is why I cringe when I read things about, why should a hedge fund only have those types of returns, why not smart individuals–it is more than just an individual’s pure talent.As for how easy it is to learn programming vs investing: my perspective is they are both hard. As an MIT trained computer scientist, I understand your point, but as a finance professional, I also doubt that anyone trained for 6 months has the expertise to consistently beat the markets, especially without access to the Wall Street ecosystem.So the question is, given that we both believe in the existence of investment talent, what is the optimal form for society to harness it? Covestor seems to think it is as an individual advisor on a site compensated by users that follow him, whereas I think it makes a ton of sense to have that talent plugged into the information flow of wall street or to tap the resources that a large multibillion dollar hedge fund is willing to commit. I firmly, firmly believe that large numbers of individuals doing this part time and unwilling to devote significant resources (both time and money) will never compete with institutions that will work tirelessly and invest resources liberally to win. And even if an individual had the talent to compete, they would still earn higher returns at an institution like Yale, hedge funds, or wall street firms.A few David Swenson quotes to sum up this point: “I’ve got 19 professionals…to identify high-quality investment opportunities. An individual doing it part-time on weekends just can’t compete. And even if the individual spent the time and energy necessary, access is a huge issue. Institutions have access to a far broader range of alternatives than individuals do…..they [individuals] should implement the portfolio with low-cost index funds because there’s no opportunity for the individual to reliably beat the market on an after-fee, after-tax basis.”2. I do not believe with regards to trading cost that there is parity between an institution and an individual.For the ETF example, you are absolutely right, they do incur their own transaction costs. The question is, for the transactions they undertake, how efficient can they be, and how many fewer times will they rebalance compared to an active investor that is following a 2 week swing trading strategy? My point in the initial post was that I fear people will be far more active than an S&P500 fund that rebalances a few times a year when the index composition changes.And to your parity point, I don’t believe electronic markets make things as even as people think. The costs just become more subtle. Large institutions that have access to VWAP execution algorithms that go through Wall Street portfolio trading desks, in turn have leased out state of the art systems and co location sites with exchanges. They can execute by sitting on the bid or the offer and knowing when to cancel and replace within milliseconds. The millions of dollars invested in infrastructure like this is not going to be available to your average Ameritrade user. Certainly if your users transact via market orders they will be paying more than an institution with scale. If they try to post limits to capture bid/ask spread, they will still be disadvantaged compared to high frequency firms that optimize OS kernels to be micro seconds fast and buy the fastest connections to exchanges available. Sure, ETFs/mutual funds can be inefficient in their execution, but they do have options that are not available to your average investor.So I disagree in that I do in fact believe there are economies of scale. If you manage enough money, it makes sense for you to invest millions in faster infrastructure because the amounts traded justify the cost. You certainly cannot do that as an individual investor.If investors do demand a framework like Covestor to mimic active investors, then the suggestion I would have would be to help an investor understand the marginal contributions to risk and transaction costs. How many friends have I talked to, that if you were to just look at the concentrated positions they were holding, their associated option implied volatilities would show them that there was a 25% chance of losing half their money over the next year. They never realized it and would never have done a trade like that in the first place! Consequently, I like ETFs because they force significant diversity in your portfolio composition. With people doing active trades, they might not realize that even following 3-4 model managers, the trades they get into from a portfolio level might be increasing their portfolio risk dramatically, far more than a diversified index. So maybe the ability to demonstrate how their portfolio risk would change IF they were to authorize the trade of a manager they were following, before the trade is done, and let people decide from there. Even a VAR metric would be helpful. If the manager is really investing for a >2 week horizon, a few hours waiting for a trade confirmation should make no difference execution wise over time.Always up for drinks, especially for a topic like this that I care quite a bit about. I too want the best for the average investor, I think our philosophies are just different as to what tools are needed for that to happen. I live in NYC so feel free to email me at [email protected] if you want to grab a beer.
This comment makes me think of clayton christensen. Disruption always comes up from below from the little guy who can’t possibly compete with the large company with scale economics. Except it turns out they can
I am all for the little guy who tries to disrupt/compete against institutions with scale. But I think the casual/part time investment advisor is not the right horse to back in taking on the institutions.I imagine you or any other VC would never provide millions of dollars of funding for a guy who claims he can take on Google, but wants to work on it casually on the weekends. Then why should people entrust their money with the investment advisor who is not willing to go as far as SAC capital is? Who wants to do a full time job and compete in the most competitive markets in the world, just on the side?
You are wrong about that. We invested in delicious when it was a side project of joshua schachter’s
But the question is, does your delicious example represent the median case?I have never denied the possibility that in a pool of 100 model managers, a few can have consistent alpha vs the market. But if 80% of them do not, that is a real issue for a site like this that caters to a lot of individual investors.When you pair an active manager with an individual investor, the stakes are higher than I think most people realize. For example, browsing the site there are a lot of model managers that do 30+ trades a month. Say we take this to mean an investor following him will do 40 on average.Even with optimistic assumptions, with a .5 cent commision and a 1 cent bid/ask cost (similar to my example above), this means that doing 480 trades a year would cost a portfolio 30% of its value in a year. That is absolutely enormous.So to justify losing 30% of your portfolio in transaction costs in a single year, people had better have a good chance of finding a very, very talented manager. I don’t believe most people understand the true costs of active trading, and the likelihood that they will find such a manager, and that worries me a lot.
Hi E. PieSounds like we agree that active management can outperform the average, and disagree that established Wall Street institutions have a lock on success. At Covestor we have both professional Investment Managers and individuals managing their own funds and believe an open platform and meritocracy is best for the client.Good discussion and I look forward to mulling it over a beer.Cheers Rikki
I don’t have much to add beyond E. Pie’s excellent critique, except possibly the gloss that talent in active portfolio management may very well be real and identifiable (albeit with great difficulty), but the advantages of this kind of talent would most likely be negatively offset by making the individual investment decisions transparent and publicly available, even if only the resulting trades and not the concepts behind them.I wonder if the proposed incentive structure — getting paid solely based on the number of followers one has — will attract the truly most successful portfolio managers. I am thinking here about the tradeoff between the advantages of “flying under the radar” — keeping your investments decisions private, undisclosed, and not transparent — versus full and open disclosure, on the side of which to factor the resulting attempts by some to represent prowess as a portfolio manager through the inevitable use and abuse of (self) marketing mechanisms such as Twitter, Facebook, etc.Given everything that we have learned about the psychology governing markets from the insights bequethed by behavioral economics, I am tempted to believe the former path of opacity, possibly combined with a calculated strategy to hedge against certain managers who attempt, through whatever means, to gain the most followers, would produce the greater returns under such conditions.
Well the good thing is we’ll find out
In terms of what asset classes people invest in here, has anyone looked at gold mining companies lately and seen how the Gold Pricehas affected their earnings and future prospects?
hardly ever. but the management of Covestor wanted me to be careful with this one, for obvious reasons.
the regulators will ruin everything, that is my big concern here. they have already ruined so much and prevented countless innovations and investment opportunities for you and everyone else from manifesting. still though this offering from covestor it is almost like textbook internet strategy, you gotta give props.
Its hard to invest in startups. You have to be a qualified investor in the US, to start
They already ruined my blog post!
Why aren’t there easier ways for average people to invest outside of pooling there money into institutions which then invest for them. Who says I have to like CalPers choices? (if I were a resident of California)- wouldn’t the game changer be easy-enter, easy exit funds that are designed to allowed members to understand and cohesively agree on their investments. And if they wanted to do startups- despite the risk- by all means.
This could be an interesting idea: similar to Covestor’s synchronized aggregated trading offering (that’s what it is, triggering group actions based on user-defined trust relationships), couldn’t the same approach be done in equity investments in startups. I guess the big difference is the illiquity of startup equity compared to public equities. Still…Given the recent navel-gazing of the VC industry and the role that it plays in the ecosystem, something to think about.
what a wonderful question Shana 🙂 finally something I could relate to in this dark topic (which Fred ironically published shortly after I wrote this: http://www.iamronen.com/?p=….From Fred’s comment that you have to be “a qualified investor” – I got an image that money is like a gun – you need a license to carry it and use it. Beyond the amusement I found in that image – there is probably a truth in it. I guess that governments realize that investing is a risky business, and are afraid that if unqualified people play around with it they can lose… everything. Which then makes them a burden for the government. This is not unlike countries that outlaw/regulate gambling.Your question moved me because of a deep under-current I felt in it. Why can’t people get involved directly in the things they believe in and want to see grow and expand? People have a beautiful natural tendency to believe in… well… what they believe in – obviously! What a wonderful world it would be if people could actually act on this?The thing is that, for many reasons (industrial revolution comes to mind), we live in a society where revenues (as in $$$) are the primary benchmark of “good”. If incidentally it makes the world a better place – great, if it makes it a lesser place, but the profits are good – that’s OK too. You can find a growing tier of investors who are actively including additional benchmarks – such as social benefit (alongside financial success – to guarantee sustainability). Eventually money will be recognized as a relatively low-priority indicator that it is.When that happens, people will be able to pursue the things they believe in, the entire system will be geared towards this. Until then, most people’s natural instincts are in collision with the dominant forces, and the system will obliterate them.Fred, for example, has created a mechanism to deal with this. He has found a way to pool other people’s money (probably people who believe in him) to pursue the things he believes in. He has built a reasonably sustainable mechanism for playing this game without risking his family or his finances. I wouldn’t be surprised if he also risks some of his personal finances to pursue ventures close to his heart, ventures that may be financially even riskier then the business investments he makes. But this is probably a very small percentage of his personal holdings.Fred invests millions in companies, but I’ve also witnessed him invest hundreds in some social causes. When that balance has shifted, when he (and others) manage to lay the foundations for bridges between these worlds… well I am looking forward to that.For me your question is not about money. It is about freedom for people to pursue their beliefs, that freedom is a basic life-force, currently subdued by misapprehension.It’s getting better and going to get better. Disruption (as Fred likes to call it) is pounding some economic systems into dust. You can still see & sense as some financial paradigms are fighting to reassert themselves … they will fall again… because IT (the bigger picture – this world we live in, not Information Technology) is simply not about money… but that’s just me :)oh… one last thought… something I learned in Yoga & Art… Fred… if it’s hard, you are probably doing something wrong…or ummm… there’s a better way to do it… maybe a little surrender and shifting weight… there is an easier way to do it… and easier is so much more fun!
Mutual funds aren’t a bad option. But its hard to know what you actually own
“average people” – so much misapprehension in two words… what makes them average? their income? we really need to tread carefully… we have been tricked into feeling average…
I more fully develop the question, here: http://www.shanacarp.com/es…But Mutuals Funds are out because as You Say Fred, I don’t really know. At least Vaguely, would some sort of concensus structure cause two effects:1) Because everyone is roughly average and exposed to the same amount of financial average information through the fund (they are welcome to research outside), would this group outperform the market through a wisdom of crowds?2) Depending on how this mysterious fund is structured – if forcing the members to vaguely do the research themselves (switch off positions, can’t vote unless is part of a research project, ect), would this also increase the viability of being a successful investor away from our pretend fund.3) Would this group behave in any way differently than a traditional fund or and index fund, or some other kind of Fund out there. What would it’s risk tolerance be? Would suddenly a group be massively applying social values to the market because they now can?And I think, if properly structured and got enough people, would meet “qualified investor” status. It just would be a very different way to invest. Just needs a good legal/contractual structure.