Robinhood: A Shot across the Bow

            About ten months ago, I discovered a startup promising commission-free investing for the masses. Despite believing that too good to be true, I joined the waitlist at the 55^th spot.  Robinhood’s app released to the public yesterday and I couldn’t be more thrilled to be sticking it to the Jordan Belforts of the world. $10 per trade, while not prohibitively expensive, does force some digression in investing than might be prudent.  The app’s interface is gorgeous and streamlined but further commentary must be reserved until I’ve used it more.            

            Robinhood is just the latest in the larger democratization of finance trend.  The finance industry is notorious for being stuck in the past.  Despite advances in technology reshaping almost every facet of everyday life, finance relies on infrastructure invented during the Nixon administration (ACH being the archetype example).   In areas where it does excel technologically, banks keep the advantage to themselves.  Yet in a part of the world hell-bent on the disruption of any and all industries, Silicon Valley has taken it upon itself to shatter these bastions of a bygone era.             

            We saw Wealthfront in the last post, which is making algorithmic investing available to everyone, not just hedge funds and other groups with staffs of math PhDs.  As a counterpart to Edward Jones and other wealth advisors, SigFig delivers quantitatively sound investment picks in a manner understandable without needing a degree in finance.  If you happened to see GoPro’s S-1 filing, you’ll notice it was underwritten by the usual suspects, JP Morgan, Stifel, Citigroup, and the rest of the big banks.  Upon closer inspection, you’d notice that a young startup called Loyal3 was given 1.5% of the new shares to offer to the public at large for the IPO price.  Prior to Loyal3, a lay investor could only buy shares in the secondary market, typically for substantially more than the banks paid.  But now, the spread between IPO price and open market prices became accessible to everyone, or at least the lucky ones that snapped up those shares as soon as they were available.  (Twitter is an excellent example of this, with an IPO price of $26 but starting in the open market at over $41, a risk-free profit of more than $15 per share for the underwriting banks.) Slowly but surely, we are seeing the finance industry become more equitable, and more accessible, to the general population.     

            So niche startups like SigFig, Loyal3, Betterment, Quantopian, Self Lender, Stripe, and the rest wield technology to make finance easier for everyone.  Now we have Robinhood to add to this crew: a company competing with existing brokerages without charging any commission at all.  At the time of this writing, there are about 500,000 people on the waiting list. Wall Street ought to take this as a warning shot: old ways and manual processes will continue to fall in the wave of new technology.  On the other hand, they might surprise us all and welcome the competition.

"Nasdaq congratulates Robinhood on their launch" 

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Wealthfront: Investing for the Future

            After working for some time at a company which specializes in automating a touch-heavy component of the mutual fund business (intermediary compensation between brokers and their dealers), the things I had heard about the finance industry being behind the times suddenly became very real.  People from within the industry would confess to using infrastructure and technology from the 1970s yet had no plans to change it because their companies had enough money to continue being inefficient.  Having seen and heard other horror stories over my years of working in finance, it is incredibly clear that the majority of the industry is in major need of a makeover.  Yet it is slow in coming because incumbent leaders (financial advisory firms, investment banks, brokerages, etc) are monoliths that face neither competition nor the resource constraints that cause companies in other industries to innovate.  It is customers that are implicitly punished with high management fees, delays in transaction processing, and other inconveniences associated with failing to keep up with the zeitgeist.

            Luckily, in the 21^st century there has been a renewal of interest in the money management space which has led to all kinds of new tech startups like SigFig, Betterment, FutureAdvisor, PersonalCapital, Mint.com, Nutmeg in the UK, etc have been pouring immense energy and resources to pick up the slack with the ultimate goal of making it easier for non-finance people to enjoy transparency in knowing where their money is going and how it is performing better than it would be if it sat in a bank account or some other investment service.

            It is in this context that Wealthfront comes in.  The cause of making investing better for the people is a noble one and they have picked up a lot of publicity lately for doing just that (and also for closing a massive round of new funding).  Like many investment services, Wealthfront automates the complex process of finding a perfectly balanced portfolio.  Yet what makes them unique is the low management fees (and no commissions) which allow the service to be utilized by the general public. All of the sudden, esoteric investment strategies, daily rebalancing, tax-loss harvesting, and other features previously only available to a lucky few are at the fingertips of anyone who cares to sign up. 

            People have noticed.  Wealthfront’s massively disruptive business has garnered them over a billion dollars of assets under management in just two and a half years.  It will be interesting to see if traditional finance institutions take notice enough to alter their own businesses to keep up with the times.  It seems unlikely, but in the face of such new technology from Wealthfront and their peers, it might be hard to stay relevant for the generations of investors going forward.  I’ve always enjoyed helping friends get started with investing and offering specific guidance with which securities to pick.  Yet after reading about the automated investing industry, I think my direction for them will be much more succinct going forward. 

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Mark Cuban on a Great Pitch

            I recently read an article on TechCrunch about the four broad components of a good venture capital pitch according to Mark Cuban.  It is a good thought exercise for any startup, however, regardless of if or where it is in the process of fundraising because developed thoughts on each point are crucial parts of the nascent company's soul searching process.  These come in the form of answering four questions: what is your core competency? Why are you great? How will you scale? How is your idea protectable?  The first two relate to business and the latter two relate to product.

            The business questions are Sun Tzu repackaged for the 21^st century. “If you know the enemy and know yourself, you need not fear the result of a hundred battles…If you know neither the enemy nor yourself, you will succumb in every battle.”  It is of paramount importance that a company understand itself internally as well as externally as it is oriented in some market space.  The core competency question asks what you’re the best at and the question of “greatness” compares you to your competitors.  How are you better than other players in the space?

            The product questions relate to what comes out of your business.  Once the idea is executed, how difficult will it be to reach 10,000 people, 10 million people, a hundred million, and so on?  Is the product touch-heavy enough that employee-count will have to grow dramatically to accommodate an increased user base (such as insurance) or is it fairly self-service where most of the interaction is done independently by the customer (such as Pinterest)?  In this case, there is not a right or wrong answer since some products require more company involvement by nature than others.  Yet it is still important for a growing company to understand and convey the scaling situation to be adequately prepared ahead of time.  The question of being protectable is straightforward.  Barring instances where the first-mover advantage in highly capital intensive industries seals dominance (utilities, natural resource extraction, etc) there are always copycats out there that will try to capture market share when they identify good ideas.  Since protection is vital, patents are so important.  Beyond that, it is important for a company to be its own biggest competitor.  If a company does not innovate itself, someone else will innovate it to obsolescence.

            In my own experience with researching and writing investment memos, absent answers to any of these questions means it will be sent back for revision.  Yet once they are answered, everyone involved in the investment process will have a clearer idea of what the company in question is about and be able to make an informed decision from there. 

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Impact Investing As It Hits

            If you asked me a couple years ago what I thought of “double-bottom line” investing, I might have half-jokingly guessed you meant only considering net income, a reference to the peculiar formatting of that item on it's namesake statement.  Yet since working at Kiva for the past few months, I’ve come to appreciate more the merit of taking ideology and other intangibles into consideration when investing as opposed to merely seeking the highest monetary return.

            At Kiva, we often use terms like “risk-tolerant capital” or “patient capital” in conversation to describe the liquidity that runs through our pipes.  It has been unique, coming from a traditional finance background, where cash rules everything around me, to see the inner workings of a finance firm that facilitates lending money at zero interest.  What inspires people to do this?  Having been part of the organization for some time, I see the return first-hand.  Conscientious citizens given the opportunity to put their money where their mouths are will seize it and give nearly 1.5 million borrowers not a hand out, but a hand up: a chance to build themselves out of poverty. 

            The vast majority of investors, however, do not have the luxury of allocating their money simply based on good feelings.  Happily, impact investing has become an entire field with methodologies and funds that emphasize values without having to compromise financial return.  By looking at how internal and external stakeholders are affected by a business’ operation, an investor can decide whether holding them in a portfolio would be consistent with his or her values.  The commonly used metrics are summarized by a research paradigm called ESG analysis: environmental, social, and governmental measures.  

            According to MSCI and Pax World (providers of research and funds, respectively) environmental measures include carbon emissions, carbon footprint, energy efficiency, water stress, raw material sourcing, toxic emissions and waste, electronic waste, as well as opportunities in clean tech, green building, and renewable energy.  Social measures include labor management, human capital development, opportunities in health and nutrition, chemical safety, privacy and data security, and access to healthcare, among others.  Governance measures include levels of corruption, anti-competitive practices, fraud, etc.  To make an investment decision, the interested party chooses metrics relevant to the company being evaluated and draws a conclusion based on the findings.

            This kind of evaluation is esceedingly difficult for the individual investor who does not have the capacity to do this research independently and would find a subscription to research services prohibitively expensive for his or her needs.  Thankfully a lot of mutual funds and ETFs have sprung up in the past few years that invest according to ESG principles, though finding one that consistently outperforms the S&P 500 benchmark remains a unicorn hunt.  I may have some rebalancing to do ahead of Q3 dividends.  If this internship has taught me anything, it’s that the highest payouts may not be taxable. 

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International Waterways

People!

My senior thesis for economics is finished and published on the website. A couple of you have asked to read it and now it's here.  The topic is international rivers, the Nile and Mekong in particular, but the concept is common-pool resources.  CPRs are a variety of resources whose usage is shared amongst several parties.  The subject becomes complicated because the repercussions of certain actions or usage do not fall on the perpetrators of the action in the first place.  Rivers are a classic example because users upstream, whether for agriculture, fishing, or otherwise, end up impacting the outcomes of users downstream.  Over the course of time, stakeholders have sought to find ways to reconcile differences using economics, politics, biology, ecology, etc. and that is the matter at hand here.  The document can be found in the Writing Samples page as well as in the link below.  I hope you enjoy reading it as much as I enjoyed writing it.

The Curious Task of Shared Goods: International Waterways and their Treatment as Archetypal Common-Pool Resources

Acknowledgements:
Kristi Ellis, Morningstar Academy
Dr. Michael Rizzo, University of Rochester
Dr. Stephen L.S. Smith, Gordon College

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Microfinance 3.0: On the Shoulders of Giants

            This is the last of a three part series. Part 1 can be found here and part 2 can be found here.   
            The first post in this series focused on the inception of microfinance and the second talked about the current state of microfinance.  This final one will talk about its limitations, and in light of those: where to go from here in the future. As one browses Kiva or some other equivalent site, he’ll come to the realization that there is a soft cap on the size of a given loan.  While the average loan is in the two or three thousand dollar range, the number of available loans tapers sharply after around five thousand dollar mark.  There are essentially two connected reasons that larger loans are unrealistic: the repayment period and the large number of lenders.  This is best explained by way of example.

Realize that to operate an individual typical loan, with an eight month repayment period to 135 lenders (based on an actual project), Kiva has to collect eight times and disburse that as 1,080 repayments altogether.  If the scale was brought up to a ten thousand dollar size, at $25 per average lender, this is 3,200 repayments ([10000/25] * 8).  Of course, the borrower would need more time to pay the money back, perhaps a decade, meaning 48,000 repayments ([10000/25] * [10*12]).  Kiva already processes an immense amount of payments continuously, so one would have to be uncharitable to believe that they could not scale up to meet this challenge, but it would at least be cumbersome.  This is not to mention that from the individual lender’s perspective, who wants to wait a decade to get their $25 paid back?  Half of the fun of funding microloans is watching the money lent out come back so that it can be sent out again.  It gives people the satisfaction of seeing their money participate in double, triple, and ad infinitum amounts of good as long as they opt to relend it.

So we see the limitation of microfinance for borrowers who wish to start a business that requires more capital than a few thousand dollars could provide but is not so large that an entrepreneur could get funding from a private equity fund or other traditional means, perhaps in the range of 10-50 thousand dollars such as starting a dairy processing facility or a large water filtration service. 

Because of their extensive networks with partner microfinance organizations on the ground in developing countries, while being situated in the richest country of the world, Kiva and other US-based organizations are uniquely and ideally situated to conquer this limitation if they have the volition to solve it.  Yet to this day, one does not see them acting on the somewhat obvious solution.

The question is: are there investors to whom the larger scale of 50,000 dollars would not be problematic?  The follow-up question is: is there a context wherein a payback period of several decades would be a feature rather than a bug?  Glad you asked, because the answer is yes!  This might even be worth developing an entire post for in the future because this one has already covered a lot of ground.

Kiva builds bridges between people who have money and those who need it.  That has always been the mandate.  Yet by myopically focusing on the individual lender platform, they have failed to hunt in a greener pasture: the US capital market. The clear solution, therefore, is that medium-sized loans be financed through the issuance of bonds to institutional investors.  Bond markets are massive, robust, and there is no shortage of lenders who would jump at buying this kind of security, even though it is riskier than a traditional corporate bond (the securitization of subprime mortgages during the housing bubble proved that).  Investors who buy bonds do it for many reasons, but one of the primary appeals of bonds is that it gives steady income from repayments for an extended period of time.  Another is that it provides protection against interest rate risk since repayments are contractual.  So to put it succinctly, scale is unlimited and the bug, as we say, becomes a feature. 

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Microfinance 2.0: By the People, For the People

            This is the second of a three part series. Part 1 can be found here and part 3 can be found here. 

            Last week we talked about the savings groups that allow individuals living in poverty to be able to get periodic access to more liquidity than they would otherwise be able to get.  At some point, a Bangladeshi economics professor named Mohammad Yunus realized that the amount of money required to make some simple life improvements was as little as a few dollars.  These could be the same things as the savings groups facilitated but also might be things on a larger scale.  In Bangladesh, the “larger scale” could indeed be the equivalent to just a few US dollars.  In other words, an insignificant sum in the developed world might be a huge sum of money in the Third World.  This reality became an important feature as Mr. Yunus innovated the microfinance machine: a platform for allowing philanthropically minded individuals who could spare a few dollars to pool their resources and fund loans to the poorest of the poor.  These loans, which range from $25 to a few thousand dollars, are used in some capacity to help a person who does not have access to a commercial bank’s credit to make some investment that would help them work out of poverty. 

This “investment” is usually related to their line of work such as seeds, tools, and livestock for farmers, input factors like raw materials for manufacturers, and goods to be sold at a grocery store or restaurant.  Having thus borrowed a sum of money, the person taking the loan directs the resources in an appropriate value-adding way and pays back the loan.  He is able to keep the profits to fund further expansion, sending children to school, or improving life in some way.  It is not uncommon for individuals and groups to take increasingly larger and larger loans as they build up a good reputation for repayment and expand to bigger and bigger projects.  While outliers exist, the soft cap on microfinance loans tends to be approximately what can be repaid in a couple years and in practice has been a few thousand dollars.

There are several organizations that facilitate the creation and repayment of loans, but their particularities are beyond the scope of this piece.  The prominent ones are Grameen Bank, the first microfinance organization, and Kiva, a San Fransisco based non-profit that streamlines the lending experience for anyone who has a desire to be their own “banker to the poor” (as Yunus phrases it).  While almost all finance institutions build pipelines between those with money and those who can utilize it, Kiva has been unique in microfinance circles as it sources funding from small-scale investors rather than institutions like banks, pension funds, governments, or high net worth individuals.  Kiva does not only empower the poor in developing nations, it gives anyone with $25 dollars the opportunity to help change someone’s world.

Interjecting with a personal note, I’ve had an overwhelmingly positive experience lending through Kiva.  The interface is informative, beautiful, easy to use, and that’s not even mentioning their mission. 

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Microfinance 1.0: Bootstrapping from the Bottom

            As we are all aware, hundreds of millions of people are living in poverty all over the world.  While many societies have been able to build their way to modernity since the Industrial Revolution, there have been many others that have not.  Sometimes this is due to lack of natural resources.  Other times it is due to ongoing regional conflict, and still other times cultural or religious norms inhibit growth.  The state of the world’s poorest is a tragedy of the human condition but much progress has been done to alleviate it in our lifetimes.  Globally, poverty is at an all-time low and its rate, according to the World Bank, has dropped from 43.1% in 1900 to 20.6% in 2010.  This is a testament to the “rising tide lifts all boats” adage, but it also often due to the sheer ingenuity of the poor themselves.

            Such evidence of the poor building themselves out of poverty can be seen in the innovation of informal savings groups.  This is the idea that a community of individuals get together periodically (daily, weekly, monthly, etc) and pool savings to distribute to a member of the group.  The recipient of that meeting’s proceeds gets to take advantage of a big inflow of money to make a relatively large purchase or some kind: tools, seeds, and the like.  Ultimately each member pays as much into the system as they receive but the arrangement works well because it allows each individual to have that access to a large cash flow all at once rather than having to try to save for n number of periods.  Other features include enforceability because members of the groups can visibly check to see that the other participants are contributing as their arrangement requires.  Anyone who shirks the responsibilities is visibly noted.  It might seem like one could forego the group and just save the same amount that they pay every period until the needed amount for some given purchase has been saved.  That does happen most of the time, but the reason that people sometimes chose to forego pure savings and opt for this system instead is the reality that frequent small cash outflows and a large inflow periodically is more palatable than trying to keep cash on hand, for security or any other given reason.

What we witness in this primitive capital market is a simple and yet unquestionably effective way of facilitating access to money.  The particulars of each group, pay-in rates, payout periods, and other factors vary from group to group.  But the general concept stands at the base level.  You can read a more thorough explanation of savings groups here (starting on page 7) if you’d like.  Though it is a limited solution, it is particularly beautiful because it can be implemented with no more than willing participants and the infrastructure of a record keeping pen and paper.  For want of a pen and paper, good memory can suffice. 

This is the first of a three part series. Part 2 can be found here and part 3 can be found here. 

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What the Price Says: Facebook brings WhatsApp into the fold

            Right in the wake of a failed Snapchat takeover bid, the M&A folks at Facebook are the toast of the business world and the founders of WhatsApp, Jan Koum and Brian Acton, are the debutantes of Silicon Valley.  I’m sure you’ve read the headlines: Facebook buys WhatsApp for 19 billion dollars.  That’s four billion in cash, 12 billion worth of Facebook stock, and three billion in restricted stock to be paid over the course of four years.  And that’s billion with a “B”. If you glazed over seeing three big numbers, let me put that in real terms.  19 billion dollars, as TechCrunch contextualizes, is: four times the market capitalization of BlackBerry, one third the market cap of Ford and Hewlett-Packard, and 25 times the size of Facebook’s last in-the-public-eye acquisition, Instagram.  I’ll add anecdotally that the London Olympics of 2012 cost 15 billion dollars, as did NASA’s Mars rover program.  I could go on… 

            Let’s not forget that at their last round of fundraising, the company was valued at 1.5 billion dollars.  So the question on my mind, your mind, and everyone else’s mind is: what possible reason could Facebook have to spend such an immense amount of money on a texting app?  With a claimed 400 million active monthly users, that’s $47.50 per account.  For comparison, it takes a decade to get that much nominal ad revenue from a Facebook user.  It would be even longer if we were discounting to the present value.  At the current subscription price of a dollar per year, whatever the discount rate is, Zuckerberg will be lucky to see the break-even point before retirement.

            While all those numbers are true, and our friends at 1601 Willow Road deserve all the funny looks they’re getting from pretty much everyone else, two sentiments seem to float to the surface that explain this occurrence.  The first is, as one can imagine, a desire to expand into different markets.  Most of WhatsApp’s users are in emerging markets like Mexico, Brazil, and India (countries with lower adoption rates of Facebook itself).  These days, the sun never sets on the Zuckerberg empire.  The second sentiment, and this might explain the magnitude of the deal, is a fear of obsolesence.  From niche news sites like TechCrunch to mainstream sources like ABC and The Guardian, the consensus seems to be the same: the people Facebook is meant for, the “cool kids”, are browsing elsewhere.  Time will tell whether the acquisition was worth the cost, and with over a billion users already, Facebook has quite some time before it goes away.  Yet it must be in the back of Mr. Zuckerberg’s mind that a decade ago, one Harvard student single-handedly took down the incumbent social network: MySpace.  

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The Case of the Missing January

            We in the finance major learn about something called the “January Effect”, where an investor can theoretically earn outsized returns by buying securities in January versus other months.  Why is that?  There is a matching phenomenon that there is a big sell off of securities in the previous December because investors are eager to take the tax advantage associated capital losses on investments that are performing poorly.  The intuition makes sense but in the past decade, the market has been down in as many Januaries as it has been up.  In fact, the average month increase when the DJIA was up was a little over two percent (2006, 2007, 2011, 2012, 2013).  On the other five Januaries, where it went down, it fell by over four percent (2005, 2008, 2009, 2010, 2014).  The January Effect seems about a legitimate as the Leading Lipstick Indicator: the intuition is there and “60% of the time it works every time”, as Brian Fantana says.  Yet we would be remiss to make buy and sell decisions citing it as a rationale. 

            As I write, the DJIA has fallen around five percent this year, the worst since 2009…when we (along with the rest of the world) were in a bona fide recession.  What could be the cause of this?  Ironically, though not surprisingly, one of the stabilizers that helped cancel the recession is contributing to the poor performance now.  This is, of course, quantitative easing which has been propping up the stock market as much as the economy.  Now that it is scaling back, down to 65 billion dollars this month, the chicanery of the animal spirits is a little more dramatic and a little more visible than usual.  People have been calling it a “taper tantrum”.  Let’s hope that when Janet Yellen takes the helm of the Federal Reserve on Monday she’ll have the volition to successfully wean capital markets off the easy money they have become accustomed to.

            The other major contributing factor to this month’s poor performance comes from the developing world.  According to Reuters investors have pulled nine billion dollars out of emerging market funds and bonds in the past week. Yikes.  It seems like a lot of the volatility in has been due to weakening exchange rates (Turkey and Argentina, notably), but from reading the news, I get the impression that it largely reactionary as investors see their peers selling off their assets.  Hat tip to the animal spirits.  

From Yahoo Fiance, cue sad music.

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