For example, Wealthfront (formerly Ka-Ching) offers a way to bypass restrictive account minimums. Asset managers who participate give Wealthfront access to their portfolios, which Wealthfront then uses to screen funds with an algorithm based on methodology used by Ivy League endowments to select investment managers. Clients can browse a network of selected funds to invest in (28 so far, most with under $500 million in assets under management). Wealthfront uses the fund’s portfolio data to execute the same trades on the client accounts. As a registered investment advisor, it recommends funds based on answers from an investing questionnaire. Clients can choose between a broad range of strategies that include tactical asset allocation and quantitative approaches. Since its founding in 2007, Wealthfront has attracted over $100 million in client assets. It’s a fund of funds for the educated retail investor.
Another site, Covestor, offers a wide network of ‘portfolio models,’ with managers who range from the nighttime stock picking engineer to the registered financial advisor. The firm allows anyone to connect their brokerage account to its database, which it then crawls through to offer groups of model portfolios (118 in total, a mix of professional and individual) that clients can choose to mirror and invest with. It filters trades (one rule is no penny stock trades) and automatically executes them in the client’s account. Since registering as an investment advisor in 2005, Covestor has attracted more than 1,000 client accounts and an estimated $60 million in AUM. It one sense, it’s an aspiring Smith Barney meets Facebook for the self-directed investor.
These investing services are also notably transparent. The portfolio investments of managers on Wealthfront and Covestor can be seen at any time by the firms and its clients.
Finally, Marketocracy is for those who have lost faith in Wall Street. That is, faith in the Street to produce quality investment managers. The firm is part simulated portfolio platform and part research firm. Anyone can open a model portfolio on the site (no brokerage account or capital needed) and make simulated trades using $1 million in capital to build a track record. The top performing 100 at any given point are offered research contracts to be part of the ‘m100’ analyst team (which totals 500 so far). The top 10 of the ‘m100’ are designated ‘Masters.’ These model portfolios are then used to guide Marketocracy Capital Management, a registered investment advisor with around $30 million in AUM. Investors with $100,000 in capital can open up a separately managed account with an advisor to select a mix of portfolios that suit their investing goals. The portfolios are also compiled into the Masters 100 Mutual Fund, which currently has $13.6 million in assets.
This ‘m100’ team is a diverse group of mostly generalist analysts with attractive returns – seven of whom have been profiled in the recently released book The Warren Buffets Next Door by Matthew Schifrin. The top portfolio is managed by Mike Koza, an environmental engineer, who had an annualized five-year return of 30.22%. In contrast, the top-ranked fund by Morningstar, Vanguard Precious Metals & Mining, had an annualized five-year return of 12.25%. Many funds and model portfolios on Wealthfront and Covestor, respectively, also had double-digit annualized five-year returns. While it’s a somewhat skewed comparison (it doesn’t take into account fees and taxes), the numbers are still quite compelling. These social investing models are a challenge to the typical mutual fund.
To compete, the traditional financial advisor needs to provide greater intellectual value and customized service to the retail investor. This could be provided through market color tailored to a client’s investment strategy and additional research in areas like small cap or emerging markets. They could also offer sophisticated portfolio allocation to retail investors with hedges and a mix of non-vanilla products.
Elsewhere, things look good for discount brokers, where closer partnerships/marketing with social networks like SeekingAlpha (and vice versa) should drive business. The big differentiator (aside from fees) to self-directed investors is trading software. There’s also the opportunity to differentiate through an effective portfolio management platform that can integrate information from investing networks. Wikinvest has made some headway in this area and already has $1 billion in tracked investments. Low execution fees and easy integration with social investing services will help drive flow as this segment grows.
The social investing services are essentially competing networks of talent – funds, individuals, even managers using simulated capital. The winning networks will cultivate the best investing talent and match it effectively with client need. The key question now is: Where will we find the next great investor?