The 5 Digital Investing Trends of Our Generation
There are almost as many reasons for why Millennials are the least invested generation in history as there are digital investing apps attempting to address those reasons. Most are missing the point and most haven’t delivered the right product-market fit, even with a race to the bottom in fees and to the top in gamification and user interface. Why? The problem of Millennials not investing is only getting worse and it does not matter how free and accessible investing becomes.
Five meta trends shaped the digital investing or robo-advisory industry over the past 10 years and were meant to address the problem Emcee is solving.
1. Digitization of Portfolio Management
The first was the advent of technology that digitized the investment process and democratized wealth management for the masses by reducing advisory fees to a marginal cost. Wealthfront (oringally KaChing.com before it pivoted) and Betterment were pioneers in robo-advising. They automated portfolio management theories from the 1950s, such as Modern Portfolio Theory (not so modern anymore) and charged next to nothing for doing what financial advisors were charging wealthy people high fees for.
The name of the robo-advisory game is asset allocation — giving everyone access to a diversified portfolio that is suitable to an individual’s financial background. It’s like a putting some of your eggs in a basket of stocks, some in a basket of bonds, and some in commodities. This is a lot easier to do if you have baskets that track thousands of stocks or bonds at the same time (i.e. ETFs). Today, robo-advisors use some variant of portfolio management theory that is designed to track the broad market and achieve diversification that is barely customized to the financial background of that individual. The new flavor of Robo is goals-based investing — pairing asset allocation with specific goals, like buying a Tesla in five years or taking a vacation to Turks and Caicos.
The problem with selling asset allocation is that it is a commodity. You can replicate virtually any portfolio that these robo-advisors offer in an Excel spreadsheet as an undergrad Finance major. No wonder it sells for next to nothing (~.0025 of assets under management). It is great for the consumer but bad for business. In fact, since the birth of the robo-advisors hundreds more have popped up in the U.S. alone and the larger financial institutions such as Charles Schwab and Vanguard took a promising lead after entering late in the game.
To be fair Betterment is now offering a hybrid digital and human based service and is on a mission to “grab coffee” with their customers. Just keep in mind, under the hood it is all the same engine.
2. Freemium Trading
The second trend was the removal of trading and transaction fees which crowned Robinhood as the free trading app for Millennials with over 4MM investment accounts, 80% of which are Millennials’. In the Freemium model only a basic service is free, which limits the user to a lot of trading restrictions but is perfect for the first-time trader who wants to learn at no cost. After that you can open margin accounts, get unlimited trading, trade crypto and options, and do anything else most brokerages offer at competitive prices. See Jason Yum’s article about how Robinhood makes money, but be careful; you might not like what you find. Remember that there is no such thing as a free lunch, or as Jason puts it:
“If you don’t see the product, you’re the product.”
3. Thematic Portfolios
The third trend is the gamification of digital investing by aligning investment decisions with personal beliefs and interests, creating theme-based portfolios. This notion popularized environmental, social, and governance (ESG) investing among socially-conscious Millennials.
Turns out investing can make a social impact, and robo-advisors like Swell Investing and OpenInvest are literally banking on it. Align your investments with beliefs such as socially responsible investing, anti-tobacco and firearms, and diversity in the workplace. Create your own thematic portfolios on platforms like Motif with up to 30 stocks — they will charge you at least $5 a month for it. Not so appealing anymore? Didn’t think so.
It is safe to say the verdict is out on ESG investing: you can have your cake and eat it too. The quants at Arabesque seem to think so anyway. The most major criticism of ESG investing is centered around how information is collected on companies that fit the description and even how terms like diversity are defined across thousands of different companies.
Companies like Swell Investing and OpenInvest run into the same problem as the vanilla robo-advisors such as Betterment and Wealthfront — what is their defensibility? They are also selling asset allocation but in a packaging that is meant to touch the hearts of Millennials they are trying to acquire as users. In fact, most robo-advisors are riding the trend and offering ESG portfolios as well.
Stash Investing takes this value proposition to the next level — with thematic portfolios around themes that engage Millennials such as marijuana, supporting female CEOs, anti-Trump portfolios, etc. They are fighting the battle of hearts over mind and at the moment winning. But I thought that is what ETFs are for? Turns out you can just reuse stocks by putting them into a lot of different portfolios with different names so don’t be surprised if Apple, Netflix, Amazon, and Google show up in a lot of your Stash portfolios.
4. Social Investing
The fourth is social investing, where communities of investors share investment related information with one another, similar to the experience of posting on a social media platform. Emcee is part of the next generation of social investing and financial content sharing apps.
Social investing (on digital platforms) has failed in the past but today there are leaders in the space such StockTwits, eToro, and Sum Zero. Wealthfront was KaChing prior to pivoting which was an innovative social investing platform ahead of its time. Covester was a social investing platform that democratized wealth management before getting bought out by Interactive Brokers and pivoting to a professional marketplace over 7 years ago.
So why is now the time for social investing? Because technology, the financial services and brokerage industry have never been so connected as they are today. Behind the scenes, multi-broker APIs allow communities of investors to trade together like never before. The emergence of alternative trading systems allows platforms like eToro to group trades together from multiple traders who want to copy the same trade and electronically trade the group as one block. Fractional shares allow less wealthy investors to proportionally mirror wealthier investors regardless of portfolio size.
Social investing apps come in many flavors designed for different types of investors with different experience levels. Sum Zero is for value investors in a professional community with a deep (no pun intended) understanding of stock valuation. On the other hand, StockTwits shares news about stocks through a Twitter-like feed. eToro allows advanced traders to copy each other’s trades. Emcee enables users to mirror portfolios and investment accounts of their peers in private groups or mirror a professional on the marketplace. We take social investing one step further by embedding the right incentives into our platform to activate peer leadership. We have higher engagement and retention because our leaders are incentivized to teach their peers about investing, not just help them get started but hold their hands until they are ready to do it themselves.
5. Accessibility of Unique Asset Classes
The fifth and latest trend is the appetite for unique and alternative asset classes offered as digital products such as cryptocurrencies, private placements, and music royalties. The adoption of the JOBS Act and Regulation CF in 2015 empowered average Americans with the same investment opportunities as Accredited Investors (i.e. Net Worth > $1MM). Technology is giving access to everyday Americans to asset classes never imagined before. Today, on different platforms, one can invest in cryptocurrencies, startups, real estate, and tokenized assets most of which derive their value entirely on speculation (i.e. Dogecoin).
However, unlike public markets, a Vanguard or even Schwab is yet to emerge, and far from it. Though problems still do exist. Secondary markets are sparse, even nonexistent for most alternative investments, lacking liquidity and fungibility, the key ingredients to a successful marketplace. The silver bullet for this problem does not exist yet, though blockchain seems to be promising.
Certain provisions of the JOBS Act, which were implemented in 2013, gave birth to a crowdfunding industry for private placements and in 2015 allowed non-accredited investors to participate in the process. Since then, dozens of platforms have struggled to amass deal flow, and none have created fungible secondary markets, a great use case for blockchain technology. Blockchain is disrupting this industry by streamlining private placements, democratizing alternative investments, and can create fungible secondary markets. No one has yet found product market fit, but there are very new initiatives to try and an ecosystem is forming around these use cases:
Vezts vs RoyaltyExchange — Performing Rights Royalties
The music industry royalty distribution system is ripe for disruption, albeit with huge challenges. Most artists do not own most of their own performing rights and did not have any commercially standardized avenues to sell their royalties, besides selling rights to another individual directly. Along came RoyaltyExchange, a new entrant a few years ago in the private placements space which started out as an online platform that auctioned off royalties to the highest bidder. We spoke with the CEO and founder Jeff Schneider about some of the challenges they faced with that model. In their second iteration they securitize royalties through a master fund and then IPO the fund to investors, very similar to the way REITS work. Their highlight was their Eminem IPO (minimum investment during the IPO is $2,250 for 300 shares) through their “Royalty Flow” fund. However, deals and offerings on their platform are relatively scarce, don’t have secondary markets, and are only offered on an irregular basis.
On the other side of the spectrum, there is Vezt. Vezt (still in beta) can disrupt the nascent music royalty investment industry by creating a peer-to-peer platform for artists to directly sell (or finance) their established or potential royalties to their fans. They are democratizing financing and investments for artists and fans. In short, they do this by tokenizing royalties as an asset class leveraging the Ethereum blockchain and its smart contracts. Through their “initial song offerings”, investors buy Vezt coins which gives them rights to an artist’s royalties. The coins can then be traded on a secondary exchange, with limited liquidity. It is unclear how each coin tracks what specific royalty and how one would know exactly which royalty asset a coin is valued under when trying to purchase on a secondary exchange (i.e no fungibility). Their success remains to be determined but it seems to be a practical application of blockchain to disrupt a traditional industry.
CrowdVest vs FunderBeam — Crowdfunding in Private Placements
CrowdVest (similar to Republic and Seed Invest) is an emerging crowdfunding platform, leveraging the JOBS Act to give access to non-accredited and accredited investors to startups for as low as $500. Yet they face the same problems of illiquidity, lack of secondary markets, and no fungibility. It is difficult to scale, and while other platforms like it have harnessed more deal flow to provide more liquidity, it is a slow process. Part of the problem is a steep education curve. Most ordinary investors are not aware of private placements nor their access to it, not to mention investing in private companies is much riskier and less transparent than investing in public ones.
FunderBeam, founded in 2013 and operating in the UK, is attempting to disrupt the nascent crowdfunding industry by tokenizing syndicated deals individually. Investments are tokenized at the syndicate level and then can be traded on their secondary exchange. Therefore, there is a quick path to liquidity for sellers and frees investors from having to keep their investment for years.
Emcee is eyeing alternative assets in the social investing framework as well. One could argue investments in private placements requires a strong domain expertise than public investments due to lack of publicly available information and complexity of private placements. Therefore, mirroring someone who is already involved in a specific private placement is a strong value proposition. AngelList has a similar concept with their syndicates.
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