roboadvisors

ROBOADVISORS & DIGITAL WEALTH: Artificial intelligence battles in financial markets but conquers in cryptocurrencies

It has become commonplace for users of online platforms to expect that their attention i.e. time spent using the platform, converts to loyalty -- in the form of an artificial intelligence algorithm that knows them better over time e.g. auto-populating search fields, recommending preferred clothes to wear, books to read, or food to eat. Yet, when it comes to applying such sophisticated algorithms to financial markets, why aren't such quant funds always outperforming the market?

Artificial Intelligence is most useful where the problem set is narrowly defined, i.e., it is well known what is being optimized and how, and where the fuzzy data needs the structuring at scale that AI provides. A narrowly defined problem may be – given this particular set of personal characteristics about a person, should they be allowed to borrow this particular amount of money based on prior examples. A poorly defined problem may be – predict the price of a stock tomorrow given thousands of inter-correlated data points and their price history. It all boils down to the reliance of quant investment strategies reliance on pattern recognition: models look to correlate past periods of superior returns with specific factors including value, size, volatility, yield, quality and momentum. Such approaches have several fundamental weaknesses: (1) hindsight bias — the belief that understanding the past allows the future to be predicted, (2) ergodicity -- the lack of a truly representative data sample used in the model, and (3) overfitting --  when a model tries to predict a trend in data that is too noisy i.e. too many parameters or factors. Logically, over time the anomalies that these quant strategies are relied upon to exploit should dissipate, given the swift pace at which technology, competitors, and data moves to correct such anomalies. This is not stopping the likes of augmented analyst platform Kensho (acquired by S&P Global for $550 million), crowdsourced machine learning hedge fund Numerai, and the industry-leading quantamental funds of BlackRock. There is an inherent contradiction in that the approach exploits inefficiencies, but requires market efficiency to realign prices to generate returns.

With Cryptocurrencies, the strategies are different. Native Cryptocurrencies i.e. Ether and Bitcoin, are considered unconstrained assets, with limited correlations to other assets. Additionally, the data sets and factors that need to be considered when trading Cryptocurrencies are far fewer — many of which are speculative and co-dependent, resulting in far more predictable patterns than in financial markets. Because most of Cryptocurrency trading is autonomously and algorithmically driven, patterns are more easily discernible and human trading behavior often sticks out in stark contrast to established market behavior.The issue of course is not the opportunity to profit — it’s the magnitude of such profits. Currently, Cryptocurrencies simply do not have the volume and liquidity necessary for autonomous trading strategies to be deployed in large quantums. Percentage returns for algorithmic Cryptocurrency trading may be significant, but beyond certain volumes, especially when assets under management start approaching the hundreds of millions of dollars, traders need to get far more creative and circumspect in deploying funds as the opportunities are far fewer at larger order sizes.

For now at least, AI and machine learning are still some ways away from consistently beating the financial markets, but with a bit of tweaking they may be a lot closer to beating the Cryptocurrency markets. Evidence of this is already beginning to show -- in 2018 Swiss asset manager GAM's Systematic Cantab quant fund lost 23.1 percent, as well as, Neuberger Berman is considering closing their factor investing quant fund over poor performance. All this whilst Cryptocurrency quant funds returned on average 8% over the same period. While the prospect of searching for phantom signals that eventually disappear could dissuade some people from working in finance or Cryptocurrency trading — the lure of solving tough problems coupled with the potential to dip into the $200 billion opportunity means that there will always be more than enough people who will try.

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Source: Autonomous NEXT Keystone Deck (Augmented Commerce), PWC (2019 Crypto Hedge Fund Report)

2019 FINTECH PREDICTION: Government and Enterprise Platforming, led by AI and Mixed Reality

We have saved our favorite for last. Over the last decade, consumer tech has undergone a cycle of platform building, user aggregation, data mining, and value extraction, resulting in GAFA monopolies. Exhaustion with social media networks and big tech, and the adjacent issues of privacy and radicalization, in our view, will lead to problems building new splintered consumer attention platforms for AI, AR/VR and other new media ground up. This implies that consumer platforms based on new technologies will be much more long-tail oriented, serving niche markets with very strong fit. Communities may be passionate, but smaller.

Enterprise tech lags retail adoption by, give or take, 5 years. Similar platforming has not fully penetrated on the enterprise side -- Salesforce is not yet the AI monopoly we should all fear, and Open Banking is barely a fizzle. Therefore, we expect increasing data transparency, aggregation and monetization to occur in enterprise underwritten by venture capital investors. As an example, augmented reality adoption and economics will be driven primarily by municipalities, utilities, large industrial manufacturers, and the military. We have seen this from multiple big tech players. Earlier this year Facebook doubled down on the enterprise-centric use case for mixed reality -- announcing its Oculus device-management subscription for enterprise users. Similarly, VR has found a fruitful niche as a training platform with OssoVR teaching the next generation of surgeons, and Walmart using VR to train its retail staff. Additionally, artificial intelligence at scale are to be directed largely at the workflows and manufacturing processes of large corporates. Take South African deep learning startup DataProphet who use AI and machine vision to reduce defects and scrap in the manufacturing sector by more than 50 percent. Don't get us wrong -- consumer AI is extremely important -- but within Financial Services, the scope for this in the corporate world is even larger.

The corollary is that the pricing pressure that started in consumer Fintech -- roboadvice (150 bps to 25 bps) or in remittance (600 bps to 10 bps) -- will spill over into B2B banking, money movement, insurance, treasury management and product manufacturing. An inevitable outcome, like that in the first entry above, is pressure on profit margins as prices equilibriate. For those companies that are able to re-design operations using a digital chassis, they will be able to compete on the margin with Fintech unicorns. Those that are not should exit, or retreat into more bespoke, relationship-driven business lines. This is where we are likely to see even more M&A activity over the course of the year.

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ROBOADVISORS & INVESTING: Robinhood's latest $8bn valuation means that scale players need to wake up

There’s no such thing as a free lunch in life, but there are such things as free trades on Robinhood. What Chime did with banking, Robinhood has done with trading. Their massive 4 million active user base is enviable to every other Fintech. So then it's no surprise that the firm is estimated to be valued at $7-8 billion, following a $200 million fund raise with existing investors. Founded in 2013 by two former Stanford University roommates, Baiju Bhatt and Vlad Tenev, with the goal of  building a brokerage service that democratized access to the financial system -- specifically, stock trading and its significant barriers to entry (costs, fees, and minimum capital requirements). Since it's launch, millennial investors -- an elusive audience to traditional financial services firms -- have flocked to the service to trade stocks, options, cryptocurrencies and exchange-traded funds, at low-to-no fees.

Such success stems from the app's ability to earn fees via indirect channels such as marginal interest, lending, a $6 per month premium product called Robinhood Gold -- offering up to $1,000 of margin to trade with, and lastly, rebates from high-frequency trading and payment order flow. Here, third-party market makers, such as Citadel Securities, Two Sigma, and Virtu, pay Robinhood a rebate for processing trades on the app's behalf, apparently to offer better execution quality and prices. Whilst that sounds noble, it must not be forgotten that such a non-transparent practice -- as noted by CNBC -- could encourage brokers to send orders to market makers that offer the most generous rebates, and not necessarily the ones who offer the best prices for stocks. However, this is likely not to be the case as Robinhood's leadership has stressed that "we don’t take rebates into consideration when we choose which market maker will execute your orders. Also, all market makers with whom we work have the same rebate rate". Last year Bloomberg reported that Robinhood made in excess of 40 percent ($69 million) of its 2018 revenue from payment order flow.

Additionally, Robinhood is planning a U.K. launch to muscle-up against the likes of challenger broker Freetrade -- a London-based twin of Robinhood, and challenger bank Revolut -- who has indicated its intention to offer a free trading platform in the near future. The interesting aspect here is that Robinhood has been desperate to become a full-service bank, with evidence of this coming from last year when the company ended up with egg on its face after announcing its intentions to launch savings and checking accounts with 3% interest rates (30 times the U.S. national average) - despite not being FDIC insured (which is illegal). All too soon after this discovery was brought to regulator's attention, the product was rebranded as a "cash management program" and references to deposit protection were swiftly removed. Yet, the pursuit continues, as the company's second attempt has recently been made via an application for a bank charter in Push-to-Offer Traditional Banking Services with the Office of the Comptroller of the Currency (OCC).

Lastly, there are rumors that Robinhood is expecting a much bigger round of funding later this year, which could value the company at over $10 billion. This, coupled with the success of the company's latest commission-free crypto trading app, U.K. expansion, and launch of its full service bank, should make scale players in the industry such as Schwab, E-Trade, M1 Finance, and Fidelity fairly nervous. From zero-fee index funds, to zero-fee trading of single stocks. Fee-free trading apps like Robinhood, Vanguard, and FreeTrade have initiated a pricing war between scale players and themselves. So long as the strategy to fight this war remains: platforms and marketplaces who cross-sell products with the aim to retain customers and lock them into a sales cycle, this tech-enabled price war will squeeze margins down to zero. Last one to the bottom is a rotten egg.

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Source: Robo-Advisors with the most AUM (via Roboadvisorpros)

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Source: Robinhood (via Bloomberg), Robinhood Gold (Robinhood Blog), CNBC (article), Robinhood Crypto (Robinhood Blog)

ROBO ADVISORS: Robo-advisors are winning but leaving cash on the table

We will keep this brief. In a recently updated, “Robo-Advisors with the Most AUM” the top 5 robo-advisors, consisting of three Fintechs and two Incumbents, remained in the same position as last year, although each of them have seen gains in Assets Under Management (AUM) and the number of accounts. Yet, the jury is out as to whether gathering assets or gathering users are good measures of success -- we wrote about it here.

A lot of digital wealth management innovation targets people who have been excluded from the traditional wealth management business because the amounts they have to invest are too small for the economics of traditional wealth management to work. So the strategy is to target this opportunity by getting to the consumer, earn them loyalty with at least one good service, perhaps free, and then lock them into a full financial services relationship. The expected outcome of this is to see a reduction in the number of these individuals and/or the assets they hold -- Unadvised assets - the liquid cash in real wallets and check & savings accounts.

Daily fintech's Efi Pylarinou, has done the heavy lifting on this, finding unadvised assets in the US, EU, and UK to be around $14.5 trillion, $13.7 trillion, and $3 trillion respectively. Surprisingly, each of these on average have experienced growth of 9% over the past 3 years. Such findings point to the fact that, since their inception, robo-advisors have had none or a negligible impact on unadvised assets. Although unadvised assets are impacted by all innovations in Fintech, robo-advisors are more likely to be the ones that incentivise you to split up with your cash to some degree in hopes of generating returns with very little friction/costs. And if this is a direct result of trends in monetary policy, public markets, and human behavior superseding the digitization of capital markets, when should we expect the reversal to occur?

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Source: Robo-Advisors with the most AUM (via Roboadvisorpros)

DIGITAL WEALTH: Betterment gives in to its premium retail clients and drops its $100k minimum

Roboadvice – the automation of wealth management services – continues to put pricing and product pressure on the industry. Traditionally, financial advisors assess their fees as a percentage (1-2%) of the individual portfolio amounts they manage. Portfolio minimums have safeguarded the work expended by advisors in relation to the percentage fees earned. Roboadvisors like Betterment or Acorns feature lower barriers for customers as a result of their digitally native infrastructure, and thus low minimum balance requirements for a fixed set of portfolios - which require little human input. This not only enhanced B2C business for such Robos (i.e., individual investors opening accounts), but also B2B business (i.e., other financial firms using roboadvice powered platforms on behalf of clients). Betterment recently acknowledged dropping its $100k portfolio minimums for its 40bps premium service which gives retail clients the flexibility to customize their exposure in certain asset classes. We see this move in two ways, (1) to cater to the customers demanding greater flexibility, and (2) attracting and capturing customers from the ever-present competition, such as Acorns, Wealthfront, and Schwab.

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Source: Valuewalk (Wealth management), Betterment (For Advisors)

DIGITAL WEALTH: Schwab's $30 subscription, Abra and Bitwise on digital assets explain the future of wealth management

Roboadvice is close to our hearts as one of the first themes, but for digital lenders, to erode the walls around the most expensive parts of financial services. Between Mint.com in 2007 and our world in 2019 is an ocean of difference. We highlight three symptoms that show just how far we have come. First, Schwab announced a new pricing model for its digital wealth and financial planning offering. Core robo portfolios will remain free by earning interest on the cash allocation (listen up stablecoins!), while the human-augmented service will cost $30 per month with a $300 onboarding fee. While prior attempts at paying directly for planning services were attempted unsuccessfully by Learnvest, and Robinhood has a freemium model where a subscription fees earn you a margin account, Schwab is a way-bigger fish. 

We've pointed recently to the importance of understanding subscription as a shift from selling a manufactured product for a price (even if it is financed over time) to filling a consumer demand holistically. Subscriptions don't have lockups, can't take excess economic rents if your account grows from $100,000 to $500,000, and shift the business risk back to the business. They also squarely place Schwab among the likes of Apple, Google, Netflix, Microsoft, Salesforce and other *modern* consumer companies. Goodbye 1.5% on a minimum $1 million in assets for overpriced private equity and IPO access.

For now, $30 will only get you traditional money management. But if Bitwise and Abra get their way -- among dozens of other high quality companies -- investment infrastructure and associated choices will be changing entirely. Bitwise, a crypto-index fund with a passive approach, had authored a stellar document linked below describing the state of digital asset markets. In it, they show how to separate the 95% of noise in fake, manufactured crypto exchange volume created by bots to game rankings from the 10 real exchanges on which demonstrable human activity is taking place. We are building in the age of the Internet, and with that comes fake traffic, fake news, fake Twitter followers, and fake financial products. This document, and efforts by folks like Messari and DASA, is clearing the way for digital-native assets to actually work. None of this ecosystem, from investors to products to allocations to exchanges to crypto regulation, even existed in 2007.

So where is it going? One example is Abra, which has grown from a pure Bitcoin wallet to a provider of a synthetic asset allocation built using contracts-for-difference. While CFDs may not be accepted in all jurisdictions, don't look at manufacturing but at the customer. If a user can access stocks, bonds, real estate, private equity, gold, commodities, Bitcoin, tokens, banking accounts, loans and payments all from an app, that is the Holy Grail. And that is what the next 10 years is all about. The custodians and broker/dealers that have traditionally supported investment businesses, from Fidelity to Schwab, will move to integrate, own and support digital assets as well. And in that environment, solutions will not need derivatives to offer what is the most sensible package for the consumer. It will just be on your phone.

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Source: RIA Biz (Schwab), Yahoo Finance (Schwab), The Block (Abra), MessariDASABitWise 

PAYMENTS: Is Digital Banking hurting the Underbanked?

Here's a conundrum. You don't have a bank account and therefore cannot set up a digital payment option. Now try ordering and paying for an Uber! This example reveals a simple truth: digital services -- and in particular digital financial services -- can be regressive (benefit the haves, hurt the have-nots). As countries like the United Kingdom, China, India and the Nordics move towards demonetization, driven by technology and policy, the social and structural implications of getting rid of cash could make things a lot worse for the most vulnerable. Based on a recent UK report linked below, lowest grade workers and the unemployed use cash 49% of the time for their purchases, while those in the highest professional occupations use cash only 39% of the time. And conversely, card use is split at 37% (low income) vs. 44% (high income).

Weird. Fintech is supposed to be a democratizing force that allows anyone, regardless of account size, to access quality financial product. Let's stick with the UK for a clean analysis. If you look at penetration of mobile devices, 85% of the populace owned a smartphone in 2017, massively up from 52% in 2012. So that means, generally speaking, most people have some payment-enabled digital hardware that they can lug around in their pocket. And yet that device is not the financial key (yet) for the unbanked and underbanked. Why? One hypothesis is to look closer at the rails on which money travels, and their interoperability.

The first is paper cash. It requires no intermediaries, at least in concept, and therefore 100% of the population is able to "self custody" a little bit of it under their bed, and use it for commerce. The second is banking. Banking intermediates the financial system, and allows for modern services to function and thrive. But it also has an onboarding cost, set by the banking industry's risk tolerance, set by the legislator and the regulator, which may be prohibitive to some share of the population. It excludes "bad risks" by design. Banking also introduces costs into moving money around, which must be covered through business activity, and often warps into unethical economic rents (i.e., overdraft fees). When we talk about mobile payments, what we are really talking about is extending the banking system into the population that has adopted mobile phones -- and this excludes unbanked mobile users. As homework, we suggest the reader think about WeChat (mobile UX, media industry intermediation, government rails) and Bitcoin (mobile UX, hardware industry intermediation, blockchain rails) as being a solution to avoiding the regressive outcome. 

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Source: Access to Cash (Report), Consultancy UK (2017 mobile penetration), Latin America's Banking Revolution (Euromoney)

FINTECH: SoFi, Square and Twitter as the Horsemen of the Fintech Apocalypse

SoFi has thrown two bricks through the window of the finance industry this week. The first is a set of no-fee Exchange Traded Funds (ETFs) to be distributed through its proprietary roboadvisor and third party brokers like Fidelity and Schwab. SoFi is the second meaningful institution -- after Fidelity -- to price beta exposure to public markets at zero. We think back to Napster and the collapse of music prices to zero as distribution channels shifted from (a) buying records to (b) "piracy", i.e., kids trading songs with each other on the web. It's not that the cost of manufacturing the song, or the ETF, is nothing. Rather, when distributed to millions of users, the fixed cost trends towards nothing and the variable cost is de-minimis.

The business model implication for Music was to give away the very core offering, and to charge for t-shirst, concerts, and the convenience of using Spotify's neat interface. The business model implication for investment management is to give away the very core offering, and to charge for asset allocation, planning, and a subscription to an easy-to-use financial services bundle. There is more to be said about hiding monetization, about making it hard to see and quantify. Arguably, Google, Facebook and the other web companies have made this trade-off opaque; we get the core offering for free, and pay invisible, unfelt things that aggregate into monstrous compromises. Similar dangers lurk here -- from Robinhood's liquidity selling to algo traders to Fidelity's "infrastructure fee" of 15 bps to mutual funds on its brokerage shelf. Money will be made somewhere, and as a mere human consumer, you likely won't see how.

The second brick from SoFi is an agreement with Coinbase to power SoFi Invest's crypto currency trading within the lender's digital app. Targeting Robinhood and Revolut with this move, SoFi is delivering on the vision of a broad cross-sell of financial products to a captive Milliennial audience. Coinbase needs the trading, as its revenue is highly correlated with crypto asset prices. The exchange has been fairly indiscriminately listing coins, like the divisive Ripple XRP, to get its 2017 groove back. Maybe the rumored Facebook coin will do the trick. What we want to point out further is that the CEO of SoFi is the former COO of Twitter. Jack Dorsey, the CEO of Twitter and Square is a well-advertised Bitcoin and Lightning network supporter. Square controls Cash, the most popular (sorry Venmo) peer-to-peer money movement app in the United States. In 2018, the app facilitated $166 million of Bitcoin sales. These bits of data tell us one thing -- SoFi, Twitter and Square share a fact base, institutional talent overlap, and a likely vision for the future.

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Source: SoFi ETFs (Wealth ManagementFinancial Planning), WSJ (Fidelity), NY Times (Facebook), Motley Fool (Venmo vs Cash)

DIGITAL WEALTH: Schwab abandons desktop wealthtech as industry moves to open banking and investing platforms

We weren't planning to write about traditional wealthtech, but man, it's hard to pick your jaw up from the floor after reading this. Schwab Advisor Services, a $1 trillion assets under custody business, is selling its desktop portfolio management technology PortfolioCenter (which manages 2,300 advisory firms) to Envestnet for an "immaterial" price. The cost to Schwab of trying to pull those users into the cloud from desktop was higher than giving away the business, which generates about $10 million in revenue. Schwab retains its cloud version of the software, PortfolioConnect, as part of confusingly named AdvisorCenter. Reminder that one of the larger Envestnet shareholders is BlackRock, both a competitor to and manufacturer for Schwab's offering.

Fidelity paid up $250 million to buy eMoney, a cloud-based chassis for digital wealth management in 2015. The industry's conclusion was that custodians were going to be providers of technology in a freemium model, giving away tech and making money on capital. The independent wealthtech software houses (Orion, Black Diamond, ENV, AdvisorEngine, SigFig) could be in trouble. The Schwab sale of its client base given the cost of management legacy tech is enlightening. At the core, custodians are horizontal financial product platforms, enabling brands (e.g., RIAs, Cryptofunds) to deliver services to their customers. Sounds a lot like the other things happening in finance, which is open banking and data aggregation platforms building API-first layers. Can't be API-first with a desktop executable file!

So then what does a real platform look like in 2019? One take is something like Plaid, but we've discussed it before. Instead, take a look at Cambr. A joint venture between a community banking private equity firm (Stone Castle) and a core processing company (Q2), deposit products into tech apps are one integration away. Another version of a conceptually similar play is DiFi -- Digital Financial, previously Market76. Or, if we go one level down, every single bank participating in European open banking initiatives is becoming a financial product platform. See the awesome ranking Innopay has done of these below. And last, Apple itself. The hardware maker owns a massive attention and payments footprint, and is enabling none other than Goldman Sachs to launch a credit card. Apple is the platform, Goldman is the brand. We can see why Portfolio Center isn't super exciting. 

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Source: RIA Biz (Schwab sale), Schwab website, Fintech Platforms (CambrDiFi), WSJ (Apple & GS), Innopay

ROBO ADVISOR: Digital wealth re-fuels, as Acorns raises $105M from NBC Universal, Nutmeg $58M from Goldman.

Digital investment apps are the American poster-child for B2C financial technology. The vintage of the theme -- over a decade old -- has cooled some of the excitement about the transformational potential of mobile-first money management. Other products, like digital lending, payments, insurtech and challenger banks have grown on the venture radar. The reality, however, is that in each of these verticals, a brand champion has emerged after brutal competition to acquire customers. There is a best in class neobank, trading app, savings app, asset allocation app, etc. Sporting millions of users, these single product companies are fattening out into a multi-product relationship. And the roboadvisor attack into that space has just gotten stronger.

Nutmeg, the leading but modest roboadvisor in the United Kigdom, has just received nearly $60 million of fresh funding from Goldman Sachs. To earn the honor, the company manages about $1.5 billion (compare to Betterment's $15 billion-ish) and makes 50 bps in revenue. This isn't Goldman's first rodeo either, with prior acquisitions of Honest Dollar and Clarity Money -- neither of which were cheap. Even more relevant is the entry by the company into the UK with Marcus, it's Lending Club clone for personal loans. Unlike Lending Club (or Funding Circle), Marcus is attached to a bank that can provide interest to customers, and therefore natural funding for loans through deposits. That can't feel good to Monzo, Revolut and other neobank friends. We expect Nutmeg to join this lightly integrated family of broad financial products pushed by the investment banking behemoth to retail customers.

The other piece of news is arguably even more sensational. Acorns, serving 4.5 million customers (compare to Robinhood's 4 million, or Coinbase's 15 million), of which nearly 400k have IRA accounts, has raised $105 million from a conglomerate of media companies like NBC Universal and Comcast Ventures. Acorns manages $1.2 billion in assets (compare to $1.5 billion at N26) and now has a $860 million valuation. How does this story make sense? Media and finance are inextricably linked, and in the American case the glue can be financial literacy. CNBC content in the app will drive engagement, the media marketing funnel will create engagement, PayPal provides the payments and bank rails, and the bet is customer stickiness and margin expansion over time. It's starting to feel a bit like Alibaba in there!

So where are the parts of digital financial advice that are still early and not winner-take-all venture bonfires? Most digital-first financial services were built by Millennials for Millennials, and therefore have a blind spot for older generations. Companies that use modern tech for the issues facing Boomers aren't getting picked up in Techcrunch, but have a similarly large opportunity. Examples include Vestwell (B2B robo for retirement), RightCapital (financial planning with focus on tax optimization and pensions), Whealthcare (financial caretaking as clients are no longer medically fit to make decisions), and Mike Cagney's Figure (home equity digital lending). Do good and do well. 

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Source: Companies House (Nutmeg), Mobile Payments Today (Acorns), Company Websites (RightCapitalWhealthcareVestwell)

OPEN BANKING: Newly-horned unicorn Plaid acquires data aggregator Quovo for up to $200 million

In another unicorn story, let's take a look at Plaid, which we discussed just a few weeks back when they raised $250 million at a $2.7 billion valuation. Plaid solved the problem of financial authentication. Some of you may remember that when you connected a third party service to your bank account in the Dinosaur Age, that service would send you a few pennies into the account as a secret pass-phrase. It would be a random number, which you would then tell to the provider as proof you control the account. A few billion dollars later, Plaid has replaced this for tech companies with a simple API call. They do other stuff too -- which, broadly speaking, can be said to encompass all of the "Open Banking" PSD2 regulation in Europe. They just do it in the US, regardless of the wishes of the banks.

So we were delighted to see that Plaid used some of its new money to buy Quovo, a strong player in the digital wealth data space for up to $200 million. Unlike Plaid's banking focus, Quovo is strong at understanding investment management data. Take for example the following -- credit card transaction data categorization (Starbucks is a coffee shop), and tax basis reporting for stock purchases (bought at $100). These are different problems and require different teams. Quovo had built a strong stack on the investments side, powered a meaningful amount of the account aggregation for folks like Betterment and AdvisorEngine. Still, the acquisition likely has (1) much of the consideration in the form of Plaid stock, since venture investors don't love funding acquisitions, and (2) revenue-based valuation earn-outs. The cash outlay in that $200 million, we suspect, is more modest.

But also, let's look back and compare. Quovo's closest analog would be ByAllAccounts, which Morningstar bought for $28 million. Someone wasn't good at selling! Plaid's closest analog would be Yodlee, which used to power Mint and was purchased by wealth platform Envestnet for $590 million. In turn, BlackRock has bought into over $100 million of Envestnet stock. These more traditional versions of the same business were way, way cheaper than the Silicon Valley equivalents, and were prescient moves by the incumbents. Yet these are early days for financial data -- we are rooting for the whole industry to open up and digitize. 

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Source: Envestnet (Yodlee), Investment News (Morningstar), RIA Biz (Plaid/Quovo)

2019 FINTECH PREDICTION: Collision of Fintech Bundles and Pivots to New Channels

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Unicorn fintech startups like Robinhood, Acorns, Revolut, Monzo, N26, Betterment, SoFi, Lending Club and others will all converge on the same multiple financial product offering across lending, banking, payments and investments. This is driven by the need to cross-sell new revenue in order to justify high spending on customer acquisition. Large financial incumbents will be following the same bundling playbook through their mobile apps, intensifying the progress of Goldman Sachs, JP Morgan, UBS, DBS, BBVA and Santander along this axis. Tech and finance (as well as incumbents and startups) will all be pursuing the same customer-centric solution for the digital consumer. Great for the customer.

As a result, customer acquisition costs will rise and the digital model will become more competitive as servicing costs commoditize at a cheaper price point. What we mean is that if everyone -- including large operating businesses -- will understand how to market to and serve Millennials, driving away the arbitrage opportunity Fintech companies have had to date. As a result, at least one unicorn will implode when the cross-sell does not materialize. Most likely this will look like a devaluation of the equity component in the capital stack, such that new money is raised to maintain profitable marginal operation, but the hundreds of millions already invested in the business are mere sunk cost.

New revolutionary entrants will use channels that are foreign to existing Fintechs and financial incumbents, like video, Twitch, Discord or AR/VR. One example would be credit-as-a-service, similar to Stripe payment-as-a-service, built into a B2B customer journey. Another would be native payment systems for digital experiences and environment. Yet another idea could be social currency within chat streams for video gamers. It will be foreign territory for many, and the key to success is correct market timing balanced with adoption.

Source: Images from Pexels, 2019 Keystone Predictions Deck

ARTIFICIAL INTELLIGENCE: Morgan Stanley, Yext and Chinese AI-first Apps.

A point is not enough. It takes two points to make a trend-line, at least in a two dimensional space. One of the muscles we try to flex often is to connect points in different sectors and themes to see the limits of the possible. Let's contrast the following: (1) Morgan Stanley partnering with Yext for financial advisor business pages, and (2) Andreessen Horowitz' commentary on Chinese consumer artificial intelligence applications on a path to capture the hearts of teenagers everywhere. Disparate, funky, and painfully obvious.

About ten years ago, "hyper-local" became a venture catchphrase. News would go from being general to local, video would go from main-stream to niche, and so on, contextualized by the GPS in our pockets. Yext is a company that won one of the battles for hyper-local content by building the retail knowledge graph that gets printed on Google Maps. Simply, if you see a business listing for a laundromat on your Maps app, likely the app provider is licensing local data from Yext. This data then scales up into pre-made business websites, analytics, and customer funnel conversion. Morgan Stanley inked a partnership with this scale content manager to give their 15,000 financial advisors a digital presence. Controlling and printing out that content at scale, with embedded compliance and into every Google/Apple phone, is hard and smart. And perhaps physical presence is the main value of a human advisor.

Now for Chinese AI. Unlike Americans, with their hand-wringing about privacy, choice, and human agency, Chinese apps don't care. The next generation version of Instagram and Snapchat is called TikTok, and the storied venture firm Andreessen celebrates them for taking away any human choice in what content a user would see. The algorithm is not a search support tool, it is the only and ultimate arbiter of where your attention goes. And it tends to make kids happy (unlike Youtube, which generally makes them into Twitter trolls). 

So let's mesh these things together. A financial services version of TikTok with a Yext overlay would be an app that is tied to the physical world, perhaps through Augmented Reality or just simple Maps, that would decide for you which financial provider to find. It would know that you still want to talk to a person for that emotional connection, and would find one that's closest geographically and a best-fit emotionally -- a two factor optimization problem for an AI. Yext financial advisor reviews, combined with a Morgan Stanley risk/behavioral client questionnaire could do this. Thus the TikTok aspect kicks in, with the human in the loop simply being a form of physical content marketing, gaming the algorithm with a meatspace presence. 

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Source: Finextra (Yext), Andreessen Horowitz (AI apps), FactorDaily (App downloads), 

ONLINE BANK: Killing the Banks softly with Robinhood and Good Money

But wait, there's more! Certainly all top-3 neobank champions by geography are hungrily eyeing international expansion . The US is looking delicious for Revolut and N26, Europe is interesting for Ping An as it invests over EUR 40MM into fintech venture studio Finleap, Fidelity wants to open a roboadvisor in the UK, and so on. Technology does not have borders. This is why we are particularly interested in Good Money, funded to the tune of $30 million by Galaxy EOS VC fund (remember EOS raised $4 billion). Good Money is a "banking platform" whose equity will be owned by users when they take certain actions, like opening an account, installing the app, or referring friends.

If that sounds like tokenized equity intermingled with Binance referral codes, you're right! One thing we've learned from the ICO mania, other than that some people are sharp-elbowed opportunists who will go to jail, is that human beings like being in communities, and that communities grow way faster and cheaper than "customers". By combining crowdfunding with account actions, this play has a chance to build viral loops, and pioneer a model where a corporate structure (equity) and utopian philosophy (communal ownership of money) have mutually-reinforcing benefits. The blockchain software progress of the last two years makes this possible. Whether it will work or not is another fun story. 

Last, but not least, is Robinhood and their announcment of banking service to their 6 million mobile-first customers. The products is called "Checking & Savings", will deliver a 3% interest rate (vs. Goldman Marcus at 1.85%) and rebated ATM access with a debit card. It is not a bank account and therefore not subject to FDIC insurance. In fact, the whole thing is old hat -- Schwab does this well now (albeit with lower rates on its money market funds), and every HNW wealth management shop ran such an offering for the last 20 years. But you know, Robinhood actually knows how to sell and position a product for its audience, and are willing to burn venture money to deliver a 3% return. Steve Jobs made a killing announcing previously existing products as inventions of Apple -- and he won, because Apple's re-inventions were better suited for the times. Who will you bet on? 

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Source: Cointelegraph (Good Money), TechEU (Finleap), Newswire (Good Money), Bloomberg (Robinhood)

ROBO ADVISOR: BlackRock's $120 million buy of Envestnet stock and Morgan Stanley's platform

We believe that most financial industry incumbents deeply misunderstand and miscategorize Fintech startups and their innovations. They think the small size of a particular roboadvisor at some time X, or the number of accounts of a particular neobank at time Y, hold any meaningful information about the future. The truth is that most of the consumer Fintech symptoms are telling you what the underlying cause -- digitization -- doing to your industry. In the case of investment management, the outcome is a re-forming of consumer preferences, which then gets reflected in the pricing of solutions (50 bps), which then require entirely new products and value chains within a digital chassis (hey there 6 bps SPDRs).

Case in point. BlackRock, which had paid $150 million for FutureAdvisor, as well as invested in European robo Scalable Capital, has now bought $120 million in public equity of turnkey asset management platform Envestnet. In the same turn, Morgan Stanley has praised a deployment of a BlackRock-powered digital wealth desktop dashboard, rolled out to 15,000 front office advisors, as a "4-year head start" versus competitors. While that's not factually true -- many other great wealth platforms exist -- it does show that finally investment distribution firms understand the operating efficiency of digital-native solutions. 

Watch carefully also what this does to asset managers, i.e., fund manufacturers. In order to get into client portfolios, which are mostly intermediated in the US, they provide technology solutions to the intermediaries, nudging the intermediaries towards their proprietary investment products. That's not nefarious, just surprising that the best way to sell iShares is to give Morgan Stanley some high quality roboadvice software.

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Source: SWFI Institute (BlackRock), Financial Planning (BlackRock), Morgan Stanley (wealth screens)

DIGITAL LENDERS: Our new keystone deck finds $100B in global originations, merely 10% of market opportunity

We are excited to share with you our latest keystone analysis titled “Digital Lender Evolution”, which expands on our 2015 white paper on digital lending. In the updated deck, we highlight the major drivers of the space across the US, Europe and Asia -- from venture funding, to addressable market sizes, to current origination volumes, as well as operating performance. Additionally, we highlight systemic risks and technological opportunities facing the sector today. 

A few key takeaways: despite the difficulty in the public markets, the digital lender model continues to raise $5 billion in annual venture capital investment, dominated by the US, with Asia becoming a close contender year-on-year. We find that the opportunity remains large and under-penetrated: (1) in the US, the addressable market is $250 billion in originations or $1 trillion in outstanding debt; (2) for Europe, including the UK and the continent, it is $150 billion in originations or $450 billion in outstanding debt; (3) for China it is $600 billion in originations or $2.7 trillion in outstanding debt (though the Chinese market is undergoing major crackdowns on fraud and the collapse of SME lending).

Digitization of the lending process shows clear cost advantages across onboarding and ongoing servicing (up to 70% reductions). However, platform economics are challenged -- marketing costs have been unable to scale lower than $250 per loan, the high cost of capital hurts pricing from being competitive with banks, and surprise expenses, like legal fees or new product development, have eaten into margins. Initiatives like digital identity verification or AI-based underwriting can add meaningfully to cost-saving, and perhaps improve the marketing conversion funnel as well. We were also surprised to see that large global banks have begun to track digitally active or mobile-first customers as a KPI, going from <20% to 40%+ digital penetration at some of the key institutions.

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ROBO ADVISOR: $40 Billion Per Month Goes from Active to Passive, But Robo Performance Mixed.

One part of the digital investment management story is the shortening of the value chain in wealth and asset management. As active asset managers (fund manufacturers that pick investments to create alpha) face compression driven by asset flows into passive products -- indexes packaged in ETFs -- one answer form asset managers have been to build out their own distribution channel, where they control asset allocations. This is why roboadvisors have primarily gained traction with manufacturers (revenue sale) and not distributors (efficiency sale). So let's highlight a few relevant data points.

First, Autonomous asset management analyst Patrick Davitt just put together our October sector data, which is highlighted below. Looking at over 9,200 active funds and $9.3 trillion in assets, a full 63% under-performed their benchmark in October. Out-performance in a down-market is supposed to be the reason active management exists! As for 2017, there was a 50% chance of out-performance, a coin flip on whether it's better to hold an active fund or just the index. In terms of actual assets, regardless of market environment, about $20-40 billion is flowing out of active funds and into passive funds. Hard to find a more clear example of a secular shift. Part of this story of course isn't fair to fund managers. When bad things happen in an active fund, you can blame and fire the fund; but in a passive index, you blame the market and hope it recovers. This is a permanent, psychological disadvantage.

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The second part of the story is the fantastic Backend Benchmarking Robo Report (link below). The analysis follows the performance of 24 roboadvisors, with several over a 2 year horizon, which we partly highlight. Notably -- Merrill, TIAA, Zack's and Morgan Stanley are all listed as incumbent robos. Our estimate of $600 billion in the strategy feels increasingly correct. In the charts below you'll see 2 treatments of the data: (1) annualized returns vs standard deviation, sized by Sharpe ratio and colored by incumbent/startup status; and (2) an upside and downside capture ratio plot, which shows how good an allocation is at capturing alpha during market momentum. In the first analysis, incumbents like FidelityGo and Vanguard look stronger than the independents in terms of the unit of return per unit of volatility. In the capture category, TD Ameritrade, Personal Capital and Wealthfront stand out. Merrill Edge is the worst on capture, and FutureAdvisor has the worst 2-year performance. What's most telling perhaps is that 77% under-performed their benchmark (as set by this third party) in Q3, and 82% under-performed over a 2 year period. Hard to fire the whole market.

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Source: The Robo Report (download here), Autonomous NEXT (robo AUM), Autonomous Research (flow data)

ROBO ADVISOR: Titan startup mimics hedge fund trades, repeats mistakes of the past

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It's 2018 and startups like Titan are still launching B2C roboadvisors claiming to invent the "modern, mobile version of BlackRock". Did we forget that FutureAdvisor, a modern, mobile version of a money manager, was bought by BlackRock in 2015 for $150 million, and is now being deployed both B2C and across financial institutions? Or that SigFig (previously WikiInvest) has gone through the same pivot, and is now powering financial advisor platform CoPilot for Citizens Bank, backed by UBS. Or that HSBC just signed Marstone as its provider of similar software? Or that WisdomTree did the same with AdvisorEngine, or Invesco with Jemstep?

Titan scrapes hedge fund filings data in order to mirror their purchases into a basket of 20 stocks for the price of 100 bps per year, which is 2-4x more expensive than most roboadvisors. This was also done before. Remember AlphaClone, or Covestor (sold to Interactive Brokers), or Motif (now sells IPOs), or Kaching (now Wealthfront)? The idea that there is a "pro-sumer" audience that wants to delegate investing a little bit, but still retain control to pick directional themes, has been repeatedly proven wrong. Having raised $2.5 million and grown assets under management to $20 million does not change the underlying issue -- the market does not exist at scale.

If you think we're being too critical, here's what appealed to token Millennial Matt Low from our team: "We are all human and succumb to peculiar logical blindness when the words “hedge fund”, “algorithmic trading” and “Mobile BlackRock” are placed together in the same article. This was particularly the case when reading up on Titan, which appeals to my mindset of supporting anything but the glass tower financial monoliths of Wall street and Canary Wharf". Fair point, Matt. But there's only so many of you to go around. To make Titan actually work, you'd need to funnel in $100 million of growth capital to acquire customers, cross-market banking, payments and insurance products, and then sell the whole mess to BlackRock.

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Source: TechCrunch (Titan), Wealth Management (SigFig), Company Websites

CRYPTO: Surprises from the Dallas Digital Assets Strategies Conference

We chaired a unique event in Dallas this week, and a few key takeaways are worth mentioning. First, something that really stuck out was the audience itself. We informally surveyed about 150 attendees, of whom 50% were financial advisors allocating assets for retail and HNW investors. Further, 70% of the audience owned Bitcoin, 50% owned ETH, and about 15% participated in an ICO directly. Two people, not including Lex, had the unfortunate pleasure of buying Crypto Kitties. The largest financial advisor in the United States, Ric Edelman, who runs $200 billion across 85,000 clients, stayed with us for the full agenda. Just a year ago, the overlap between the wealth management and crypto communities would be a null set. 

On the fund manager side, we had Tuur Demeester from Adamant, Sean Keegan of Digital Asset Strategies, Kyle Samani of Multicoin, Mat Hougan of Bitwise, and Bart Stephens of Blockchain Capital. We were impressed by the very variety of investment strategies on display. For example, Tuur primarily runs a Bitcoin investment strategy, using leverage on/off BTC to amplify alpha.  Similarly, the custodian Xapo only custodies BTC, backed by a reserve of coins -- $10 million worth bought in 2014. Others run index funds -- with Bitwise creating passive indexes and Digital Asset Strategies trying to deliver smart beta on the same baskets. And of course, Multicoin and Blockchain Capital both take fundamental venture-style bets on direct projects. We were reminded again of the BCAP token offering, a security token that Blockchain Capital launched as a unit in its fund. 

We can't do justice to all the conversations (i.e., custody, regulation, markets), but another one that stuck out for us was an asset allocator panel. Paul Pagnato of PagnatoKarp, a wealth advisor to large family offices, sees crypto living inside the venture capital allocation slice. James McDonald of Vishnu Wealth Management talked about building a 10-15 coin basket with the largest liquidity, while protecting for downside exposure. And we'll end on the perspective of Tyrone Ross Jr., who never wanted to put his clients into crypto assets. Instead, his clients just started disclosing to him their over-exposure to digital holdings -- so he had to design hedges and diversification strategies that would balance out the idiosyncratic risk. He also had to start reading white papers and websites to figure out what his clients were talking about. Advisors with such an appetite will retain their clients relationships, while those like Noriel Roubini will be drowned out by the winds of time.

Source: Tyrone's     Video    , DASS     Twitter    , Lou Kerner on     Nouriel Roubini    .

Source: Tyrone's Video, DASS Twitter, Lou Kerner on Nouriel Roubini.

ROBO ADVISOR: Are robos managing $1 trillion of digital wealth yet?

The center of gravity for digital wealth in the US is the In|Vest conference, and the update this week from its publishers is excellent. Let's call attention to the following phenomenon. All of a sudden, everyone wants to claim to have roboadvisor / digital wealth assets, and to get rewarded from a valuation perspective for understanding the future customer. As soon as JP Morgan started bragging about its YouInvest free trading app to compete with Robinhood and Schwab, Bank of America released an update on how much asset under management sit inside of Merrill Edge, its online investing division, and its digital strategy. So here are a few interesting numbers on the size of the robo market, broadly speaking. 

For incumbents, Merrill Edge now has $200 billion in assets under management. This is, end of the day, the small client channel. But after combination with Bank of America, Merrill gained a retail footprint in the form of bank branches. The firm is planning to put 600 new investment centers into those branches by 2020, for an omni-channel digital client experience. Another examples is Ric Edelman's post-merger mega RIA, composed of Edelman Financial, Financial Engines (formerly FNGN, the original 401k roboadvisor), and the retail footprint of the Mutual Fund Store. That's $176 billion in AUM, plus 125 physical locations, plus Ric's own $15+ billion. Let's add to that Schwab ($33 billion) and Vanguard ($112 billion). Fidelity, TD Ameritrade, Capital One Investing and others also have a similar service, so let's round that up to $10 billion generously.

On the disruptor side, we have Betterment ($15 billion), Wealthfront ($11.3 billion), Personal Capital ($8 billion) with the most assets, and maybe another $3 billion from players like SoFi, WiseBanyan and the others. Let's be kind and say micro-investing services (Acorns, Stash Invest and the rest) have $2 billion between them. That's not a knock -- those apps have millions of users, but they don't optimize for AUM. For good measure, let's throw Coinbase into the mix as well, with $20 billion in custodied crypto assets managed in a digital app. The tough part remaining is the B2B2C players in the form of SigFig, AdvisorEngine, Jemstep, FutureAdvisor, Trizic and Envestnet. We'd be willing to bet on $50 billion in total true digital delivery. Sum all that up, and we get to $650 billion. Now, these are very loose definitions. You could still add in (1) quite a bit in asset allocated crypto assets, (2) the Asian fintech digital investing numbers (e.g., Ant Financial), (3) the digital bank arms of the Europeans (e.g., BBVA, Nordea) and then get pretty close to a trillion. Do we still think roboadvice is a failing theme? 

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