Covestor and VesTopia: Winners and Losers from Peer to Peer Investing

Two innovative startups are about to change the face of the financial industry. Today sees the launch of Covestor, and over the next few days we'll see the emergence of VesTopia. Here's how they work:

Anyone with a brokerage account can sign up for Covestor. After sign up, Covestor gathers data about your portfolio and trades in one of two ways. Either Covestor pulls data in real time via account aggregation service Yodlee, which interfaces with the big five online brokerages (Ameritrade, E*Trade, Scottrade, Fidelity and Schwab). Or, investors can manually upload trades to Covestor themselves. Reported trades are later verified by cross checking against the investor's brokerage statements.

Covestor begins to track your performance, and then ranks investors by performance. Visitors to the site can view investors by style, portfolio type and a range of performance statistics, including risk-adjusted performance (Sharpe Ratio). And once a visitor has found an investor with consistently great performance, the visitor can pay to "subscribe" to that investor's trades. Covestor shares the fees with the investor.

VesTopia is very similar: after an investor with an online brokerage account signs up, VesTopia directly pulls information about your portfolio and trades, using a desktop client that automatically scans the pages of the online brokerages' web sites. Like Covestor, it works with all five leading online brokerages. Visitors can pay to view investors' trades and portfolios, and VesTopia shares the fees with the investors.

The differences between Covestor and VesTopia are mainly in initial target investors and degrees of transparency. Covestor encourages everyone to sign up, allowing individuals with outstanding performance to bubble up to the top via Covestor's performance rankings. VesTopia, in contrast, will highlight a carefully vetted group of high performing investment professionals, though it plans to widen its service to individuals soon after. Covestor allows pseudonyms and anonymity, betting that performance is all that matters, not someone's name. VesTopia promotes finance professionals with real names and biographies. Covestor allows investors to mask the actual size of their porfolios by reporting only percentage allocations, whereas VesTopia also provides actual position sizes and the dollar size of portfolios.

Covestor and VesTopia are the eBay of money management. Just as eBay allowed anyone to become a store owner, these peer-to-peer investing sites allow anyone to make money from being a great stock picker. You no longer need to set up a hedge fund; just trade as you always would, and watch as the number of paying subscribers to your successful ideas grow.

Both services may even allow hedge funds to outsource research. If you're looking for an analyst to cover Chinese stocks, why not just subscribe to the stock picks of the top stock picker of Chinese stocks on Covestor or VesTopia?

Now, I'm certainly biased: I'm personally friendly with founders of both Covestor and VesTopia, I own a small stake in Covestor, and both companies are potential partners for Seeking Alpha. We held back from offering portfolio games or shared portfolios on Seeking Alpha because we saw real portfolios and real track records on the horizon. Who cares about stock picking competitions and socially-networked play portfolios when you can rank investors by their real trades with real money?

There are challenges. Covestor and VesTopia need to convince investors that there's no risk of online brokerage accounts being compromised. Both claim that they have that nailed, but perception and reality are different things.

Who benefits from the rise of peer-to-peer investing? This could be good news for the online brokerages, including Ameritrade (AMTD), E*Trade (ETFC) and Schwab (SCHW), because it raises the potential profit of having an online brokerage account.

Who might lose? In the long term, by facilitating the discovery of great stock pickers and providing a new economic model for them, Covestor and VesTopia may end up challenging mutual fund companies (which are already facing an onslaught from ETFs), such as Legg Mason (LM), Blackrock (BLK), and T. Rowe Price (TROW), and even hedge funds like Fortress Investment Group (FIG).

And full service brokers who offer investment advice, like Merrill Lynch (MER), Morgan Stanley (MS), Ameriprise Financial (AMP), and Citigroup's (C) Smith Barney, may now face increased competition.

Full disclosure: I own stock in Covestor and have personal friendships with founders of both Covestor and VesTopia. My children own ETFC; I have no other position in any other stock mentioned here.

Comments

[Ralph F]

I think you're right: the biggest hurdle will be to get people comfortable with the security aspect of giving access to your account to a startup. How are they handling that?

[Frank Li]

V. interesting. Another potential loser from this: TSCM, which acquired Stockpikr and does socially networked "play" portfolios. (I'm short the stock, and this isn't my real name.)

How much money do these services offer for each subscriber to your stock picks?

[Ralph F]

Love the idea, but couldn't they have chosen a more Web-2.0-ish name? How about:

StockTradr
StockWinnr
StockManagr

:-)

[RikkiTahta, CEOCovestor]

Security is completely central to our offering (see here www.covestor.com/secur...) which is why we partnered with the company that manages inter-banking passwords for the leading 100 global financial institutions, why we went through ISO 27001 certification, why we only have read-only access to data post-trade and precisely why we took so long to launch. (Although I also have to blame our head of Operations, who built similar systems in the institutional world for Goldman and GAM, for his obsessive testing over the last three months with security and audit companies)

I did like Covestr - but one of my colleagues pre-registered it and is holding on to it in exchange for a window office

[Ralph F]

Hi Rikki,

Great to have you on Seeking Alpha! What's your role in Covestor, and is there anything in the article that wasn't mentioned that's important for us to know?

What do you think are the greatest strengths of your product?

Ralph

[Guy Hirsch,CEO VesTopia]

Great post David,

It’s true that there are differences between the companies. However, as the CEO of VesTopia, I’m excited to take part in introducing a new breed of investment concept to this very traditional market. And I’m sure that Covestor are too.

Our ability to attract highly talented, experienced and professional Investors to expose their real portfolio holdings and transactions, in real-time, indicates that something in the market is drastically changing. Investors are eagerly looking for more than the traditional advice, and they expect the expert to put his/her own skin in the game.

Guy.

[DavidJackson]

Hi Guy,

I mentioned in the article that most people's concerns focus on the security issues. Rikki addressed Covestor's approach to that in his comment above; can you talk about how VesTopia is approaching security?

David

[RikkiTahta, CEOCovestor]

Hi Ralph

I'm one of the 3 co-founders and acting CEO. There are tons of issues we haven't touched on - particularly that elephant in the room - regulation. Its also mind-numbingly complicated to treat an individual account like an institutional hedge fund and maintain a normalised approach (ie take out cash flows for buying a car or getting a bonus) and maintain standardized performance metrics inline with GIPS. But that doesn't make for very compelling reading.

The only other important factor is maintaining privacy - all data is normalized to percentages and members can have screen names. So while the track record you build is auditable and verified a participant can remain anonymous to other users and not reveal their net worth.

Cheers Rikki

[SA EditorEli Hoffmann]

This is a brilliant idea. How long did it take you (both) to navigate what surely was an ocean of red tape until you were able to convince brokerages to release this information to you in real time.

One potential item of confusion I can foresee is that active investors often combine long-term trades with short-term or even day trades. Looking at their portfolio from the outside, it might be quite difficult to get to the bottom of what they're actually doing. Will investors be able to annotate their moves?

[RikkiTahta, CEOCovestor]

Hi Guy, great to virtually meet you

TOTALLY agree with you about how this world is changing. Its a $18 trillion dollar industry that is amazingly opaque. 10 years ago the fund management industry enjoyed scale economies - better access to information, better tools and better pricing. Thanks to REG FD, tools that brokers like E*Trade provide and new commission free accounts like Zecco, the playing field has been leveled. In fact its de-scaled as there are 50,000 investable equities worldwide and there are strategies a $5m portfolio can do that that $500m portfolio can't.

It's great you're out to prove the same and I really look forward to us both giving the fat-cats in their panelled rooms in Boston and Zurich a run for their money.

Cheers Rikki

[Guy Hirsch,CEO VesTopia]

David,

VesTopia takes security extremely seriously, and we’ve invested a lot of time & money in this issue from day one. Our unique technology enables us to monitor each and every trade that Investment Directors make in real time – all the time, but with this comes great responsibility.
Naturally, I can’t delve into deep technical details, but no sensitive information, including the usernames and passwords to the brokerage accounts of the Investment Directors is kept on our servers or transmitted to any 3rd party.

Guy.

[RikkiTahta, CEOCovestor]

Hey Eli

Presenting normalised statistics that accurately reflect what is going on is a real thorny problem. We want to present a simple "tear-sheet" like Morningstar or the funds marketing departments so people can gain a quick snapshot that is directly comparable to other funds or portfolios - eg click on my name above for an example. Needless to say none of the mutual funds, hedge funds or money managers willingly subject themselves to more than that scrutiny.

But we're tying to go beyond that down to a sectoral or stock level to gain an insight for instance as to who has the best timing on a stock, or which ideas (paired trades or themes) might work. We're far from finished and we'll improve over time - we worked with the Finance Department of Columbia Business School in NYC to help us on some of those metrics - but (sorry if this is boring) in some issues there are a couple of performance measures one can use that are equally valid. Interestingly we interviewed a bunch of fund of funds in London to figure out how they required their reporting and the institutional world is frighteningly lax on standards. GIPS is the main standard, but even there people can cherry pick a little to present themselves in the best light.

So in short its work-in-progress. We've decided in the short-term on a simple snapshot of the critical metrics and then an option to download data so you could run your own analytics over someone's past record while we improve.

Hope that helps - should be in our help sections

Cheers Rikki

[SA EditorEli Hoffmann]

Thanks for responding Rikki. Looking at your user profile on your site, it seems to me that while I can track your holdings, and individual trades (once I register), I have no way of knowing whether you're a heavy-handed investor or a 'piker' flipping 100-share lots.

Why does that make a difference?

Well for the same reason that David in his erudite post expresses reservations about tracking investors trading fantasy portfolios. Part of what makes a great investor is the ability to keep cool in the face of big-money swings. If my Covestor portfolio can be assembled using 100-share lots, is it all that different from a fantasy portfolio?

[Guy Hirsch,CEO VesTopia]

Rikki,

I’m glad to virtually meet you as well, especially on David’s platform.

There’s still a long road ahead of us, and the burden of proof is on our shoulders, yet I share the same anticipation and vision: the market is leveling, and the change has to happen.

Cheers, Guy.

[RikkiTahta, CEOCovestor]

Hi Eli

Quick comments and feel free to email me [rikki at covestor] and I will send you an invitation code to sign up and you'll see how the tracking works to account for portfolio size.

Real money is always different to fantasy regardless of size - you can't have multiple real money porfolios running different strategies under different names, regardless of size - the SEC won't allow you to open a fake named brokerage account

and see what happens with fantasy - contests.cnbc.com/mill...

cheers Rikki

[SeekingAlphaEditors]

Great to have both CEOs responding to comments!

Can you both discuss how much money you think a top-ranked investor could make on your respective sites?

Thanks,
Ezra

[Josh, CFOVesTopia]

Hi Ezra, this is Josh from VesTopia - Guy's close partner. Naturally, our financial arrangements with our Investment Directors is confidential. It does, however, reward performance in a major way. We do this because we want the best talent out there, and that comes with price tag. We know that we are doing a good job if we line their pockets, and that's exactly what we aim to do. The concept was so compelling to a couple that they even checked their day jobs at the door, and became our partners.

[Ralph F]

Josh, you wrote: "Naturally, our financial arrangements with our Investment Directors is confidential. It does, however, reward performance in a major way." It's not "natural" at all not to publish what the fee arrangement is. You'll have to approach fund managers directly every time, pitch to them, and negotiate with them. Rikki's approach of providing transparency about fees and automating the sign up seems much more scalable.

[Josh, CFOVesTopia]

Hey Ralph ... our sourcing capabilities are soon to be much more automated, and hence more scalable. We like to learn from everyone, and continually improve processes. However, the model that we are focusing on at the moment stresses quality, and not quantity. It would be nice to see both over time, but it takes just that – time. Meanwhile, we’re happy to roll up our sleeves a bit to get what we want. Our pipeline is very cool. Stay tuned.

[RikkiTahta, CEOCovestor]

Hi Ezra,

I honestly don't know.

Figure the amount someone can make is going to be a function (however loose) of their popularity and their performance.

In the offline world a registered investment advisor will charge somewhere between 1.5 - 3.5% of assets annually and a hedge fund will charge 2% of assets and 20% performance fee. You can't exactly replicate that on our platform as regulation will dictate how you can charge based on the location of both parties. However the best way to imagine it is, if I was an offline fund manager with 1,000 clients who each gave me $25,000 to manage, I'd be commanding fees of about $0.5m per year before any performance bonus.

It's probably going to be south of that number in the above example. But the great thing about the internet is you can scale. In the offline world an investment advisor can't easily manage 100s of clients so will generally have a $250,000 minimum.

Regardless - before any money changes hands - the one thing everyone needs first is a real track record.

Have a look at our thinking here and the direction we are moving towards www.covestor.com/how/f.... This is a highly regulated issue so it is of neccessity work-in-progress.

Cheers Rikki


Regulatory disclaimer: please note Covestor is a real-trade sharing service. Neither Covestor nor its members are offering personalised investment advice and Covestor does not offer the opportunity for unregulated participants to advise each other directly. The above example is only a hypothetical example for a registered investment advisor managing client funds.

[Michiel deBoer, ZeccoDir. ofProd Dev]

Zecco.com, the company that introduced access to $0 stock trading last year, is actually offering a similar and free service to its members, called ZeccoShare.

With ZeccoShare you can put your mouth were your money is by sharing your actual portfolio holdings, as well as recent trades with other community members.

You are all invited to check it out in Beta.

Michiel

[Ralph F]

Michiel, do account holders get paid for effectively sharing their stock picks on Zecco? Or is this just a "you can see mine if I can see yours" arrangement?

[Michiel deBoer, ZeccoDir. ofProd Dev]

Ralph, the use of ZeccoShare is free, and we do not pay users to share. When you sign up for ZeccoShare we currently offer you the following options: 1) set your personal profile and investing style 2) share your actual portfolio holdings and recent trades 3) search for and connect with investors who share interests, investing styles and real trading behavior 4) use public as well as private communication tools to interact with others. All based on the idea of putting your mouth where your money is. Every month we are rolling out additional features and functionalities, also based on the great user feedback we have been gathering so far. In fact, we are launching the partnership with a well-known stock rating site within a couple of days. So, please join in and check it out.

[Ralph F]

Michiel, don't you think that because Covestor and VesTopia allow good stock pickers to make money, that all the best ones will migrate to them, and you'll be left with a community of poor performers sharing ideas with other poor performers for free?

Seems to me that the best thing about Covestor and VesTopia is that they allow people to make money from stock picking, and as Rikki says above -- there's real scale on the Internet, so that could produce large sums.

[Michiel deBoer, ZeccoDir. ofProd Dev]

Ralph, here are a couple of thoughts, not meant to be conclusive since there most likely is room for different models. ZeccoShare is based on total equality, not so-called pros versus amateurs or such. Everybody that has access is in the same starting position, and actual user behavior and performance will show who are the “real” pros. So the proof is in the pudding, so to speak. What we don’t want to do is limit access by requiring people to pay money. Our view of community is people coming together and helping each other to become better investors, and in the process, creating powerful user data and content. Think of Wikipedia – hundreds of thousands of volunteers have created something much more powerful than could ever be imagined by an individual company. And there is no payment motivation whatsoever.

[Frank Li]

Couple quick questions to all three of you (Covestor, VesTopia and Zecco):

1. Let's say I'm signed up for your services, and I'm buying an illiquid stock that takes me a few days to buy. Are you going to publish my trade immediately before I've finished assembling my position?

2. Is there a risk that people could use these services to manipulate stocks, say by assembling a great track record, getting their friends to buy a micro cap stock, and then buying that stock and publishing the trade, so all the followers would then go and buy the stock?

[Josh, CFOVesTopia]

Hi Frank. Good questions:

1. At VesTopia, our policy is absolute transparency, which is built into our technology. Every executed trade is published immediately, so liquidity of a stock is a consideration for our Investment Directors. There is no running or hiding with us.

2. There is always that risk. That being said, since we have close relationships with our Investment Directors, we have built into our contract with them a "code of ethics" so to speak, which affirms the highest ethical standards in the business. The scenario you laid out would obviously be forbidden, as would every other game one could play. Also remember that since our Investment Directors are really out there, their picture is up, their name is up, their story line is up, etc. Accordingly, if one were to act unethically, apart from breaking contractual obligations with us which would have serious consequences, they would also be jeopardizing the rest of their career in the business. I do have worries, for sure, but this is not one of them.

[SeekingAlphaEditors]

FYI: Because we have the CEOs of Covestor and VesTopia, the CFO of VesTopia and the Director Product Management of Zecco in the discussion, we (Seeking Alpha editors) have added job titles to their names to make it easier to understand who's saying what.

Please check out the nested comments as well: you can respond directly to questions and points by clicking on "reply here" below their comment.

[alpha24seven]

I see a bigger problem. The brokerages you've chosen to participate. ALL the serious traders that I know that put up real numbers use Interactive Brokers (short of prime brokerage relationships) I'm sure there are some good maybe even great traders at Schwab et al -- but if you REALLY want to see performance you need to include IB.

[ing_rivera]

This is the most absurd idea that I've heard.

[MichaelGoode]

I'll second alpha24seven. IB is where the best trade.

[Lisa]

Interesting to see how these sites are doing. According to Compete, Vestopia is now massively bigger than Covestor:

siteanalytics.compete....