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James Levy
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I am an international investment advisor and and financial services entrepreneur with over twenty years of experience in private banking focused on the High Net Worth and Business-Owner segment. I began my career in 1991 at Merrill Lynch International Private Bank in Madrid, Spain as a... More
My company:
P2P Finance, S.L.
  • Will Open Source Asset Management Disrupt the Mutual Fund Industry? 2 comments
    Jun 14, 2010 10:05 AM
     
     
    Wikipedia, a well known example of the open source model, defines open source as ¨practices in production and development that promote access to the end product´s source materials.¨ An open source model permits concurrent yet different agendas and differing approaches by contributors to achieve a common goal. Two basic rallying cries of the open source movement are that ¨information should be free¨ and that the user should ¨only be charged for convenience¨. This concept has proven to have enormous power and potential, particularly when enabled by increasingly sophisticated and inexpensive internet based communication and collaboration tools. Open source is the mirror image of the centralized ¨command and control¨ model which is still the organizational basis of almost all companies since family farm and artisan based production methods gave way to centralized mass production with the advent of the industrial age. Open source can be seen as a bottom up liberation philosophy which elevates the role of the voluntary collaboration of the sovereign individual, participating freely following their own agenda and motives, rejecting the top down command and control model where the ¨worker¨ is a cog in the machine who must simply fulfill a designated role, and must be tightly monitored and controlled along with levels of inventory and defective parts percentages.
     
    Increasing numbers of talented individuals seek the autonomy and personal freedom of the open source philosophy for application in their professional lives and their consumption decisions. For example, Seeking Alpha itself can be defined as a Software as a Service (SaaS) open source application, where some users choose to contribute content free of charge, each for their own reasons, with the result being that their skilled labor in the generation of quality content for the site contributes to the Seeking Alpha community goal of building and maintaining a first rate investment resource for all users.
     
    The open source model has already disrupted several industries, among them most notoriously software development (think Linux and Apple Apps) and newspaper (and encyclopedia) publishing. One enormous and highly lucrative industry which has recently seen the first green shoots of potentially disruptive open source based competition is the mutual fund industry.
     
    A disclosure is in order here. I have earned a reasonable living for the nearly 20 years of his professional life largely from receiving a share of the marketing fees charged by his clients’ mutual funds companies and I am well acquainted with the benefits and drawbacks of mutual funds. The benefits are very well known, and there is no need to repeat them here. Not surprisingly, less attention is given in the financial industry sponsored press to the drawbacks of mutual funds. First and foremost, it makes no sense whatsoever to pay 2% per annum or more just for Beta exposure to a market or benchmark which can be acquired much more efficiently through the pertinent ETF. Though this is obvious to investment professionals, we also know that even today a very large percentage of all mutual funds in existence are either openly or covertly nothing more than trackers (with more or less tracking error) of an index or benchmark.
     
    If retail investors choose active management in order to seek alpha, that is, achieve risk adjusted returns superior to those of a benchmark or index which can be replicated through an ETF, then a mutual fund is usually their only available choice. Invariably, the investor is drawn to the historical returns of the fund in question, rather than the risk adjusted returns. Additionally, the investor is usually assured that the fund is managed with a ¨team approach¨, and for that reason the investor need not be concerned if the track record of the fund is built under different asset managers, or if a star asset manager leaves a fund to join a competitor (or start a hedge fund, if indeed the manager has star quality). However, despite these drawbacks, for the large majority of retail investors, high minimums for segregated accounts or sophisticated investor requirements to purchase a hedge fund leave them with no other alternative than mutual funds to attempt to benefit from successful active management.
     
    That is, until now. Within the past year, the first small steps have been taken to introduce a new business model in the mutual fund industry through the emergence of an Open Source Asset Management (OSAM) alternative. The new model uses web based technology to offer a platform to provide retail investors with additional sources of alpha through the automated replication of the trades of chosen alpha generating money managers who offer their investment acumen through the platform. In order to be chosen to participate in the platform as a model to follow, a money manager must have provided a publicly available, transparent, verifiable track record of their investment performance for a reasonable time period. In line with open source tenets, the participating money managers provide this information as well as the full transparency of their brokerage account free of charge to the platform, and only collect a fee for their work if investors select them as their model to follow in their own platform linked brokerage account. These alpha generating money managers linked to the platform may or many not be professionals in the financial services industry. They may lack the academic credentials or self promotional skills necessary to climb the rungs of an asset management company, or may simply have chosen a different path for their lives. What does unite them is a passion to compete and succeed in generating alpha in the model account which determines their ranking and prestige among peers in the open source platform. This is particularly true considering that in most cases these managers have a significant part of their own net worth invested in their own publically viewed model account.
     
    To the best of my knowledge investors currently have only two green shoots to choose from in a field which may one day become a lush garden of open source asset management alternatives. These two platforms are both in their very early days with a limited but growing offer of talented investors to follow. Despite the short time elapsed since their launch, these two platforms are already beginning to fulfill the promise of becoming a virtual meeting place where investors and talented asset managers both benefit tremendously. The first of these shoots is kaChing (www.kaChing.com) whose objective is ¨connecting smart investors with outstanding professional investment managers¨. kaChing offers investors a platform where they can open an Interactive Brokers LLC brokerage account in their own name, and then choose among a list of kaChing approved Registered Investment Advisors (RIAs) to find the one with a track record, investment style, and risk level which best matches their own investment needs. They can then enter into a contract with kaChing to have their own account managed as a clone of their chosen RIA´s account. Orders are executed automatically in the investors own account. Measures are taken to insure that there is no ¨front running¨ and that all investors receive an equal treatment. In keeping with the open source philosophy, the investor pays for the convenience of the automated trades. The investor pays a fee for this service which is shared between kaChing and the investment advisor, and kaChing provides a host of value added services to both investors and the registered investment advisor to facilitate comparison of advisors through standardized analytics as well as communication tools between investors and advisors. Launched in October of 2009, the kaChing platform has grown slowly, and currently has captured approximately $11 million of investor assets while offering 15 kaChing approved registered investment advisors.
     
    The second of these green shoots is Covestor Investment Management (www.Cv.im), an offshoot of the popular Covestor.com investment site. Covestor Investment Management shares several of the same open source inspired goals of kaChing, but goes about achieving these goals in a way which I believe will prove to be more successful in the long run. Covestor traces their origins to: 
     
    ¨a group of entrepreneurs who believe that salaried fund managers have no monopoly on investment talent and shouldn't have a lock on the rewards that come with investment success. Coming from the financial services and online world we trust our networks more than our brokers. We believe in democratizing the investment management industry and helping proven self-investors around the world compete with the large institutions
    In order to execute their open source vision for the asset management industry, Covestor Investment Management has built a platform where the company itself is an RIA which executes trades generated by designated sub advisors chosen from among the most talented investors who participate in the popular Covestor (covestor.com) site. In this way, Covestor Investment Management is able to leverage off its existing base of monitored money managers to be able to offer a much longer list of ¨models¨ to follow. All models are based on a publicly available, and Covestor analyzed, universe of 67 RIAs and non-professional investors who have satisfied Covestor Investment Management´s screening process. Covestor Investment Management comes closer to a true open source model than does kaChing, as the aspiring asset manager does not need to be a RIA to achieve success on this platform.  
     
    The Covestor Investment Management site leverages off the talent pool available in covestors.com and provides a means for the most outstanding investors, whether professionals or not, to gain broad recognition and begin to receive an income stream in return for their open source sharing of the fruit of their labors. The Covestor Investment Management platform offers investors accounts in their own name with either Interactive Brokers or TD Ameritrade. These dedicated brokerage accounts hold the funds which are managed according to the model or several models chosen by the investor. Each model is a clone which replicates each trade of their selected Covestor contributor. As is the case with kaChing, Covestor Investment Management offers a wide range of value added services both to investors and model managers, which facilitate the analysis of investment performance as well as communication and transparency. The fees are similar to those of kaChing, but in any case lower than those of a typical equity mutual fund.
     
    What are the real advantages of these platforms as opposed to mutual funds? These open source inspired technological platforms offer numerous advantages both to investors and money managers, particularly aspiring money managers who have not yet achieved name recognition. For investors, the advantages include much lower fees due to disintermediation. There are no teams of marketing people on payroll nor payments to private bankers such as myself. Additionally, the investor benefits from total transparency as to exactly what assets they are holding in real time, as well as the security of holding the assets in accounts in their own name. In this way, the investors are not subject to the fine print of an unread, online, one hundred page mutual fund contract, which can allow for the fund to suspend redemptions (and block the investors funds) under a wide range of circumstances. Additionally, in the case of Covestor Investment Management, the investor can specify securities they do not want to hold, an advantage of segregated accounts which can provide important tax benefits, satisfy a particular investors ethical investing requirements,  as well as avoid regulatory complications of corporate insider trading of their company's shares during prohibited periods.
     
    There are great advantages to the open source approach to asset management for individuals or small firms with proven investment ability but no marketing budget, distribution platform, regulatory compliance professionals, or desire to build a full asset management firm to compete with the established players. Using these open source platforms, a person who has demonstrable talent for active asset management need not spend a career climbing the rungs of a mutual fund management company before perhaps being designated a fund manager and thus making that talent available to retail investors. The open source approach allows people who have demonstrated their capability to provide alpha to investors to focus singularly and exclusively to that end, leaving to the platform the functions of marketing, advertising and certifying the results. In this way, the platform provides a channel for retail investors to benefit from the decisions of yet undiscovered investment managers.
     
    Though I have no financial or personal stake in Covestor Investment Management or kaChing, I wish them and their future competitors success in their endeavor to disrupt the mutual fund industry through applying an open source approach to asset management. In the end, the successful search for alpha in active management always depends on the skill and intelligence of individual people matching their wits with Mr. Market. Very few people are known to have been able to meet this challenge for sustained periods of time, but we do not know how many individuals never had the chance to achieve recognition for their investment prowess beyond their circle of ¨friends and family¨ due to the obstacles to entering the asset management industry discussed above. The emergence of a thriving open source asset management industry will lower the barriers to entry sufficiently to enable very talented individuals from all walks of life to earn a living from asset management, providing retail investors better choices at a lower cost. In my opinion, the disruption of the ¨fat and comfortable¨ mutual fund industry by open source asset management inspired platforms such as kaChing and Covestor Investment Management is only a matter of time.


    Disclosure: Author holds no positions or financial relationship with any of the companies mentioned in this article.
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Comments (2)
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  • David Byrd
    , contributor
    Comment (1) | Send Message
     
    Interesting Article. While these platforms are a good way to change the mutual fund industry, I think that they are only a step in the process. Last week I started an open source software project called open midas(code.google.com/p/open.../). It is an actual trading system. It should be done next week, but it will only be a pre release that will show the basic principles and potential of such a system. The trading system is modeled after that many proprietary algorithmic trading systems that investments banks use. Strategies include pairs trading, ETF arbitrage, and dual listed company arbitrage. If you add fixed income price and currency feeds you can do convertible arbitrage and triangular arbitrage. The idea is that a member of the open source community can just download the file, fill in the necessary fields to connect to their brokerage account, and their money will be managed by with sophisticated, proven strategies. I think that my project will not accomplish this, but discount brokers will build their own algorithms that you can use for free. This is because the frequent trading would more than cover development costs. Hedge funds like Renaissance technologies,DE Shaw, and Goldman Sachs' Global Alpha have out performed traditional investors using computer driven strategies for years, I think its time the average investor had access to this alpha.
    30 Aug 2010, 12:10 AM Reply Like
  • Periclesp
    , contributor
    Comment (1) | Send Message
     
    This doesn't really seem to qualify as an open source model for investing since for such a model to actually operate, there would need to be participation from contributors outside of the investment manager to the investment model construction, probably with some form of consensus decision making function. What's described here is the ultimate in transparent asset management, but not an open sourced solution.
    7 Oct 2013, 07:35 AM Reply Like
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