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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