Originally published on LinkedIn
Today some of the investment strategies which are most in-demand by investors throughout Asia-Pacific have a thematic approach at their core. Thematic portfolios offer exposure to certain economic, social or technology trends, such as the increasing pressure on potable water supplies, the surging use of robots or the rise of social media.
But choosing the right theme in which to invest is, of course, only part of the equation. Selecting the right stocks too can make a tremendous difference in capturing the value of the global trends that are attractive to invest in. And in this regard, financial institutions in Australia who are looking to build or enhance a robo-advice offering for their clients, can benefit from offering quantitatively managed portfolios.
A quantitative methodology in robo-advice services is a viable and cheaper alternative to traditional human-made portfolios. Investment specialists, such as Quantifeed, develop the rules of a quantitative portfolio. But after the rules have been defined, there’s no room for human misjudgement during the execution.
Here’s how we do it. Every time we construct a thematic index that can be used by our clients, we first conduct thorough research into a specific theme. We look at what defines this theme and what are its economic drivers. Next, we aim to identify stocks that are impacted by the factors central to the theme and, finally, we decide how to weight these stocks.
Let’s look at the theme of social media. To select the components of this theme we consider companies that can be described as social media networks. These are the platforms that individuals use to keep in touch with friends and share content with a global audience. The theme itself is highly attractive to invest in. There are currently over 2 billion people using social media channels in the world today and the number is expected to reach 3 billion by 2020.
To select the potential winners within this theme, we first select stocks from a universe of US-listed companies with a market capitalization of over US$50 million and a daily liquidity greater than US$5 million. Given that a third of global internet users are based in Asia, we include ADRs in this universe of companies as well.
To identify relevant companies within this theme, we look at the general company profile, as well as specific business revenue segments. We then select up to 20 stocks from those relevant companies based on their valuation and the popularity of their platform. In order to select companies with strong financial position, we then screen out any company with no or negative earnings in the remaining selection.
The rules-based system makes the selection of the relevant group of stocks a systematic process. Our methodology in this example picks companies that derive more than 20% of their revenue from at least one business segment relevant to the social media theme.
Integration with technology
Our index design also integrates with the digital capabilities of our technology. Because users trade the individual securities comprising an index, an important aspect of design is the tradability of stocks. The number of index components and their weights are other important variables. To improve diversification, we equally weight our indices or utilise factors such as volatility or dividend yield to determine the weighting of stocks. Interestingly, the application of such weighting methods often leads to outperformance and improved risk/return characteristics relative to a traditional market-cap weighted index.
As a further point of differentiation, our white labelled B2B platform allows financial institutions the flexibility to adapt the index to their own requirements, for example to facilitate a very low investment amount across a reduced number of stocks. Our technology can generate these changes automatically, or enable the user to modify the index composition by eliminating or adjusting the trading order before submission for execution.
If you’re in an Australian financial institution looking to build an engaging robo-advice offering for your customers, let’s meet! You may contact me on email@example.com
Since the Fintech industry started to take off a couple of years ago, there’s been a lot of discussion about how disruptive these new types of businesses are. Headlines have been filled with this idea of a new generation of companies that are defying the status quo and reshaping financial services. But while the innovation that Fintech companies bring to the industry is very real, these companies are much less disruptive than what you’ve been told.
The narrative that supports this concept usually confronts Fintech companies against the incumbents, much like the story of David vs Goliath. But the truth is that, by leveraging technology, a lot of fintech firms today are not really disrupting existing industries. Instead, they are filling gaps among the population who have typically been underserviced by the traditional service providers. In other words, they are expanding the industry.
This is the case for robo-advice, which has been both loved and criticised since its first appearance in Asia Pacific. The most recurrent argument against it is that an online and automated service can never replace a human adviser.
But this point of view ignores that robo-advice is, in fact, servicing a segment of people who don’t have access to in-person, high-quality advisory services because they don’t have the financial assets to justify the cost. We call this the ‘mass affluent’ market segment.
Until now, financial institutions in Asia Pacific have struggled to provide a low-cost, low-touch advice model to this customer segment. But thanks to digital wealth management technology, provided by fintech firms like Quantifeed, financial institutions in the region can now tap into this additional customer base, which has traditionally been beyond their reach. And this is a clear example of how Fintech firms and traditional financial services institutions are actually working together.
The good news for consumers is that although scalable, an automated service doesn’t mean one size fits all. Today’s technology enables digital advice to be personalised and engaging.
Digital services are driven by demand
Besides the mass affluent segment, there’s also another layer of customers who are now being serviced by robo-advice solutions. Customers defined more by attitudes than by the size of their portfolios. These are customers who plainly prefer not to go to a bricks-and-mortar office to receive a service. Consumers increasingly want to get all their services online including their wealth management.
It’s clear that the wealth management industry is catching up to the broader trend of digitisation, which has already transformed other industries. Customers now feel that if they can’t be serviced online, anytime, anywhere and on any device, then they are not being serviced properly.
It’s important to remember that robo-advice has developed in response to demand. And as the middle class is quickly moving up the scale of wealth in the region, this demand will only grow with time.
From the supply side, wealth management companies today have much to gain by adding robo-advice to their existing offering. A low-cost and highly scalable solution can help them to service an important segment of customers, who at one point in their lives may also reach the critical size to be serviced in person – if physical offices continue to exist, of course.
When cooking a meal, great importance is placed on the right ingredients. It’s not much different with index construction. Here too, the right stocks make the difference. At Quantifeed, we are transparent about our index design. In this article, we discuss some of our recipes.
Currently, some of the investment strategies most in-demand have a thematic approach at their core. Thematic indices offer exposure to a certain economic, social or technology trend. Examples are the rising use of social media or the increasing pressure on global potable water supplies.
Our index design process starts with research. What defines the theme and what are its economic drivers are some of the questions we ask. Next, we aim to identify stocks that are impacted by the factors central to the theme and to decide how to weigh these stocks.
Take the example of the water theme: the strategy comprises companies that are likely to gain in business and value in an environment of increasing water scarcity. The increasing shortage of potable water is a development which plays out over decades. The companies involved in helping to alleviate water scarcity are dispersed over many sectors. To identify relevant companies, we look at the general company profile, as well as specific business revenue segments. Companies active in areas such as water supply networks, water treatment and purification, flow control, measurement and diagnostics technology are considered for the strategy. We also devise a mechanism to exclude companies which should not be in the index. For example, some energy and electrical utility companies do report revenue from water- linked activities, but their share price is driven by factors outside the theme.
Importantly, the process described above is governed entirely by rules and doesn’t require any judgement. We are confident that it systematically selects a relevant group of stocks. Our methodology selects companies that derive more than 90% of their revenue from at least one business segment relevant to the water theme. The index is diversified across sectors, from utilities to industrial companies and health technology.
Our index design integrates with the digital capabilities of our online platform. Because users trade the individual securities comprising an index, an important aspect of design is the tradability of stocks. The number of index components and their weights are other important variables. To improve diversification, we equally weigh our indices or user factors such as volatility or dividend yield. Interestingly, the application of such weighting methods often leads to outperformance and improved risk/return characteristics relative to a traditional market-cap weighted index.
As a further point of differentiation, our online platform allows users the flexibility to adapt the index to their own requirements, for example to facilitate a very low investment amount across a reduced number of stocks. Our platform can generate these changes automatically, or enable the user to modify the index composition by eliminating or adjusting the trading order before submission for execution.
Our strategies are based on themes and factors, such as income or growth, or even dynamic models. Sometimes, we mix things up and combine different approaches to achieve a whole new strategy profile. But that’s the topic of another newsletter.
I always found jogging dull. But a little app on my phone has changed that. It is called “Zombies, run!” and simulates a pack of hungry zombies chasing me during my run through the deep dark forest. The app creates a whole new experience: I find jogging much more engaging – and I also run a bit faster.
What virtual zombies can do for a runner, digital wealth management might be able to do for the mass affluent that lack personal advice. Creating an engaging and stimulating experience, and accompanying the customer through her investment journey.
A good example of how such a piece of technology can help is when considering the process of investing in life goals. Customers often save for specific near-term or long-term goals. We all save for retirement. In addition, some people might save for a holiday, a car or a home. Education, too, can be a worthwhile goal saving for. There are many examples.
Digital wealth management can offer a tool to the customer to understand the funding needs and time horizon of her financial ambition. However, simply putting money into a savings account might not accumulate enough money to reach the goals within the desired timeframe – especially in times of record low interest rates. We cannot save ourselves to prosperity, we need to invest. But how?
Common wisdom recommends more equity at the beginning of the period and a gradual shift into bonds towards the target date – without much more specifics than that. However, technology takes a step further and specifically quantifies the optimal asset mix and the risk of not reaching the goal (shortfall risk). While sophisticated Monte-Carlo simulations run in the background, the customer is guided through a friendly and engaging user interface to intuitively understand the dynamics involved in asset accumulation through investing.
Once parameters, like initial and monthly contribution and goal horizon, have been decided on, the plan is put into action seamlessly. At the push of a button the customer can make an initial investment on the same platform. And that is not the end of the story.
Interaction takes place over time: once an initial investment is made, and regular contributions are made, the customer can check her progress. What if a few payments are missed, or what if markets drop sharply? The goal-based investment tool may present the customer with different options on how to get back on track. Be it higher contributions, a longer time horizon, or an investment with a higher risk/return profile. Again, changes to the allocation can be implemented directly on the platform. This interaction is an experience, and a journey that a financial institution can take with its client towards a financial goal.
Of course, a human advisor can interact and offer good advice too. But he cannot scale across hundreds of thousands of clients with accounts too small to warrant a sustainable relationship. A human could not provide the appropriate level of attention to each customer, and react in time when change is necessary. Only a digital wealth management platform provides the stability needed for an ongoing profitable relationship. A prospective customer with the intention to invest in a life goal represents an opportunity for the financial institution to successfully convert a banking relationship into a long-term wealth management relationship. A relationship that can be profitable for both parties.
To learn more about how goal-based investing can enhance the wealth management experience of your customers, contact firstname.lastname@example.org.
Einstein dies and goes to heaven only to be informed that his room is not yet ready. “I hope you will not mind waiting in a dormitory and you will have to share the room with others” he is told by the doorman. “See, here is your first roommate. He has an IQ of 180!” – “Why that’s wonderful!”, says Albert. “We can discuss relativity theory!” “And here is your second roommate. His IQ is 120!” – “Why that’s wonderful!”, says Albert. “We can play Go!” “And here is your third roommate. His IQ is 80!” – “Why that’s wonderful!”, says Albert. “Say, where do you think the market is headed?”
Excelling at investment strategy would seem to be a low bar for an artificially intelligent machine: Earlier this year, a machine trained by deep learning beat Lee Sedol, one of the world’s best and most experienced players, at the ancient board game Go. Yet, digital wealth managers, or robo-advisors, are not beating humans at the investment strategy game; they are not even playing. And here is why:
Today’s digital wealth management solutions are based on the same investment principles and models used for the past three decades. 21th century technology is using 20th century concepts to decide on asset allocation and portfolio diversification. And there is nothing wrong with that – those models are based on timeless insights. Technological advance can refine them and bring more computing power to the table but the core concepts remain the same. It is telling that Wealthfront, a leading digital wealth manager, has Burton G. Malkiel serve as its chief investment officer. Dr. Malkiel is an 84 year old finance professor, best known for his book “A random walk down wall street”, first published in 1973.
So, if not in investment strategy, where did the digital revolution take place in wealth management?
Technology has made it possible to efficiently roll out portfolio management solutions to a large number of accounts. This brought down cost, resulting in low fees and a reduced minimum deposit requirement. Thus wealth management can be delivered to a client segment that did not have access to such services under traditional wealth management offerings.
In addition, cleverly designed investment tools and easy-to-use interfaces create a user experience rivalling and even surpassing that of a human advisor. What the ATM has done for bank branches and online banking to off-line money transfer is now being done for wealth management: a service that’s available anytime, anyplace and on any device. And while risk tolerance questionnaires, low cost diversified investments, such as ETFs, and immediate market access through online brokers have existed for at least a decade – it is only with digital wealth managers that all these elements are integrated on a single platform.
There is another area in which robo-advisors can outperform a human investment manager: digital wealth managers rely on rules-driven investment decisions, governed by mathematical formulae and quantitative criteria. While a human advisor consults similar models, automation brings discipline to the table. Human bias is taken out of the equation and decisions are consistent and unemotional. Nobel-prize winning psychologist Daniel Kahneman notes in his book ‘Thinking, fast and slow’ that, in general, formulae trump human judgement. And digital wealth managers rely on formulae.
Low cost, an integrated user experience and discipline are forecasted to attract up to US$ 300Bn* in assets by the end of the year to firms such as Betterment, Wealthfront, Motif and Personal Capital. This success lays the ground for further sustained technological advance in the sector. Digital wealth managers are already beginning to experiment with the application of artificial intelligence (AI) to their marketing (if not their investment) strategy. Salesforce already applies AI to customer relationship management. Their product is called Einstein.
*Source: AT Kearney
Now and then a paradigm shift occurs that can totally change the landscape of an entire industry.
A recent example of this was telecommunications in Indonesia. Until the 1990’s, Indonesia had one of the lowest levels of telephone connectivity in the world. Now, Indonesia is one of the most connected nations on the globe. Put simply, mobile telephones allowed the nation to leapfrog the stage of land-line connections and now it has the most number of mobile phones per head in the developing world.
Another paradigm shift is occurring that will bring huge benefits to the millions of people living in the developing world – the availability of high speed internet accessed through mobile and smartphone devices. Both Google and Facebook are currently working on projects to beam high-speed internet from low-level satellites or drones to areas of the population which are not currently supplied by regular telephone and internet service providers.
Smartphones have a computing capacity today many times that of a personal computer just five years ago. These mobile devices are replacing laptops and PCs as the access point to the world of information available on the internet.
These changes in technology have an enormous democratizing effect on people living in the developing world. Education, health information and legal services will be available online, hopefully lifting millions out of poverty. The most positive outcome may be that millions of unbanked people in the developing world, who have no access to payment services, capital, financial advice or who suffer at the hands of unscrupulous non-bank lenders, may receive financial services for the first time.
Many of these people may in fact by-pass the stage of ever going to a bricks-and-mortar bank, as technology enables them to freely access a variety of financial services at any time and on any device. Not only will they benefit from the access to financial services and advice, but the competition from digital financial service providers will drive down the cost.
New digital financial services in Asia
Online loan marketplace
For people with no or little credit history, getting a short term loan to cover something as necessary as a child’s school fees or a family emergency can be an uphill battle. Millions of such people in Asia fall prey to loan sharks and opportunistic money lenders.
A new company based in Singapore, Onelyst, has turned the tables on this situation. By creating an online marketplace for borrowers and licensed non-bank lenders to meet, their technology levels the playing field – allowing price discovery for the borrowers and encouraging lenders to compete. The marketplace enables borrowers to quickly identify the cheapest loan from potentially hundreds of possible lenders. The competitive environment created by this market place forces the lenders to show their best offers. It also simplifies the marketing process and enables lenders to reach customers at lower cost.
Philippines-based Coins.ph is meeting the needs of another unbanked section of the population. The company enables people with no bank account or credit card to be able to deposit money into a digital wallet and pay utility and other bills on their smart device. This might seem rudimentary to many of us who have bank accounts but in countries where over 50% of the population have no bank account these services fill an important void.
Digital wealth management
Wealth management may not be a concern for the world’s poorest communities but an entire generation is emerging that will be the first to save for their own retirement. Wealth is growing faster in Asia than anywhere in the world and it is growing fastest in the emerging and mass affluent sectors.
Until recently, these two sectors – characterised by lower account values – have been underserved by traditional wealth management providers. In the past, it simply wasn’t profitable for financial institutions to provide them with a face-to-face service.
This situation is about to change. Companies such as Quantifeed are enabling financial institutions to offer powerful wealth management solutions on digital devices. These applications enable the investor to self-direct an investment experience. The online investment journey takes the client from an assessment of their goals and needs, through to the recommendation of a suitable portfolio. After an investment is made, it can be reviewed and managed. Financial institutions across Asia now realize that by deploying digital wealth management services, they can profitably service customers with smaller amounts to invest. This connects with a new generation of tech-savvy consumers that expect to be able to get their wealth services online.
Services for the mass affluent will be high-quality and affordable as banks compete in an increasingly transparent market to offer wealth management services that were previously only available to those in the high net worth bracket.
Onelyst, Coins.ph and Quantifeed have all recently graduated from the OCBC Open Vault Fintech Accelerator programme, which took place between May and August in Singapore. Eight companies from across the globe were chosen from over two hundred applicants, with the purpose of helping entrepreneurs build promising Fintech companies of the future, faster and more efficiently.
Costless, secure and instantaneous financial transactions. That’s the future. Seems too good to be true but that’s exactly what blockchain technology will herald for the financial services industry.
Automated investment services, aka robo-advisors, seemed like a distant destination just a little while ago. Yet financial institutions globally, and no less in Asia, are travelling that road faster than any of us might have expected.