With a plethora of new companies and business models already threatening the core services provided by retail banking, we are now witnessing early signs of disruption of the services offered by investment banks and private wealth management firms.
Much has been written about the disruption of retail banking. While we surely will see savings and loan banks around for many years to come, companies and initiatives like PayPal (EBAY), Square, V.me (Visa), Dwolla, Payoneer, Goggle Wallet, Apple Passbook, and many mobile operators in developing countries are already displacing many of the typical functions provided by retail banks. Peer-to-peer lending companies such as CommonBond, Lending Club, and Prosper are also quickly displacing many of the remaining services that we would expect from a typical thrift, and one might become rather bearish on the sector. Granted, these forces are massive, but one must also remember that most of these initiatives (possibly with the exception of mobile payment platforms) are currently focused on retail consumers and small enterprises, as opposed to medium and large enterprises, and it will be some time before any of these or future challengers will displace retail banking as we know it.
At the same time, we are also seeing massive threats to the incumbent Investment banking conglomerates. In private equities, companies such as SecondMarket and SharesPost, which recently signed a joint venture with NASDAQ OMX, are disintermediating investment bankers and brokers in secondary transactions, and may very well give institutional investors additional ways to enter the private market. I don't think Sand Hill needs to be worried anytime soon, but they are taking notice, and are actively looking for ways to handle this shift in power. Institutional investors with crossover funds are becoming especially active in this space, and are fueling a growing secondary direct market. Market makers such as Knight Capital Group and others are also dabbling in this market, and I believe the day is fast approaching when private companies voluntarily adopt disclosure policies to allow for more active private trading, as executives are looking for ways to control both the process and the flow of information. Outside of the tech sector (in the widest sense) there are very few companies for which such platforms have been relevant, but we may see wider adoption after the early adopters, the tech sector, pave a successful path. There is also no reason to believe that typical investment banking and sales and trading for medium and large enterprises can't be disrupted. I could easily get on board for a call to end roadshow-mania, as technology can provide far better means to perform most of the due diligence anyway. That being said, it isn't going to happen soon, and it is also unclear how much of this is a U.S.-centric phenomenon.
Private wealth management is also being disrupted. We have already seen a massive shift to ETFs and other basket-oriented funds and financial instruments, and there is little or no proof that active management in public equities can yield a greater after-fee return than its benchmark index; on the contrary, studies show exactly the opposite. Popular culture has used such studies to discredit active management as a whole. However, as investment professionals know all too well, public equities are only part of the story. Once your portfolio starts diversifying into medium and low-cap securities, distressed debt, or any more exotic investment avenue, such as hedge funds and private equity funds (again, in the widest sense), active management becomes crucial, as the top quartile managers significantly outperform their peer group. As Erik Hirsch from Hamilton Lane recently said to Wharton MBA students, "investing in venture capital during the last ten years was worse than going to Vegas." For institutional investors who, for diversification reasons, will be investing in most asset classes and are not typically engaged in actively managing their funds, selecting active managers is their only real task, and they often outsource it.
Many wealth management firms are beginning to take on more of an advisory role, whereby they now pitch asset allocation, manager selection, and monitoring to their high net-worth clients, rather than management of the funds directly. I believe we will see this trend continue, as similar services are offered by numerous firms to their institutional clients. In this paradigm, success is measured by successfully choosing the proper allocation among and within the asset classes, and selecting the most successful managers within such asset classes. My bankers at Bank of America-Merrill Lynch (BAC) and Barclays (BCS) will excuse my saying this, but I'm pretty sure that big data platforms are far more equipped than they are to answer that question, and if not now, surely they will be in the very near future. TechCrunch reported this week that Wealthfornt has secured $20 million in venture funding, in a round led by Mike Volpi of Index Ventures, Chamath Palihapitiya of The Social+Capital Partnership, and Reid Hoffman of Greylock Partners -- not lightweights, to say the least! While Wealthfront is really a retail investor platform at this time, I can see it, or other ventures, moving into the institutional investor space as well, just as soon as they can prove their model on early-adopter, retail investors.
Retail and investment banks, as well as private wealth managers, to the extent that they are different, are going to have to find a way to play nice with these models. While they may not be ready to admit it yet, it is clear that there are massive forces that are slowly disintermediating them, and are threatening their core competencies and services. Some of these models can, and will be, adopted and integrated by the Street, and will allow them to overcome competition. However, other models will completely catch them by surprise, and will have achieved too high adoption rates to ignore. PayPal and Square, despite issues of quality control and regulation, have clearly proved that they are in that group of companies that cannot be ignored, and the list will surely grow. It is an interesting time for the financial sector, and I hope that it can learn to evolve with the adoption of these challenging models, as it has no alternative.
Additional disclosure: I am employed by Greencrest Capital, which is affiliated with Knight Capital Group.