After a rough start for financial markets that persisted from the first quarter (Q1) and escalated at the end of Q2 from Brexit, the second half of 2016 (H2) has begun on a calmer note with equities recovering from recent volatility and just off new record highs.
Digital wealth managers have continued to gain traction from the first half of the year, along with the adoption of new payments and lending technologies that consumers are using from emerging and mature fintech companies including finance-related solutions for investing.
One significant trend appears to be the ongoing shift from active to passive investing, as portfolios are rebalanced less often against longer term targets – when compared to higher turnover from active managers that aim to capture short-term market moves or frequently adapt to underlying benchmarks.
(1) Financial Planning / Morningstar Data]
Shift from Active to Passive investing
The ongoing trend towards passive investing appears to reflect a number of drivers, including the idea that active turnover is linked to increased trading costs – which reduces net returns – along with the argument that outperforming a benchmark over time can be achieved with rebalancing on a more passive basis or less often.
Such views on passive investing in low-cost ETFs were expressed in Anthony Robbins latest book titled ‘Money Master the Game,’ after he had interviewed some of the largest fund managers globally.
The crux of the passive premise is that buying equity indexes on dips can lead to above average returns on the assumption that the price of the index eventually recovers – rather than trying to time the market on shorter-term moves, along with diversifying via the use of medium term and longer term bonds and commodities.
However, real diversification in these scenarios can be challenging for investors to achieve because of how correlated electronic markets are, which can create a contagion effect within a portfolio even if its various holdings are well spread across traditional assets.
With the US elections coming up next quarter, geopolitical uncertainty surrounding the outcome is likely to cause further volatility in equity markets and making alternative investments an attractive choice for investors to diversify ahead of Q4.
Robo investing and fintech
Robo-advisory firms such as Wealthfront, Betterment, SigFig, Future Advisor, and traditional brokers such as Charles Schwab and Vanguard, and others that use automated processes known as robos to provide digital advice, continue to push forward.
Most recently, E*Trade and Capital One had each announced a robo-related offering, whereas in other parts of the world such as Australia and the UK – regulators have already drafted proposed guidelines for regulating automated investment advice as new solutions emerge from brokerages and technology providers in major financial centers.
Actively timing the market can be hard even for the pros, while following a plan such as maintaining a target holding distribution in a portfolio that is readjusted to the markets ebbs and flows only at pre-determined intervals is far easier and less costly.
This is primarily what robo advisors try to achieve, while making the customer acquisition process scalable for online brokerages to onboard customers digitally, yet what are the real returns that clients will achieve and what is their overall portfolio risk?
The answer to both of these questions is less certain, when compared to a structured product with a target-yield that is based on an asset-backed security.
Industry growth and consolidation
As trading costs continue to decline, so do the fees that brokerage firms earn – which consequently can lower their earnings and create broader industry challenges for financials, as the value that brokerages offer becomes narrowed to other services such as research or other services that clients may pay for or consider to be of premium value.
Over time, this trend can lead to a consolidation in the industry where only a handful of the largest companies that provide nearly the same services to the masses will remain, while the emergence of a new set of solutions and tools including alternative asset classes become mainstream.
Estimates predicted by an A.T. Kearney model using an adoption rate based off the percentage of investable assets into robo advisory services suggest a compound annual growth rate (CAGR) of 65% through 2020 in the US.
This particular estimate would bring the nearly $300b of Assets under Management (AuM) in robos up to a projected amount of $2.2trillion by 2020, according to the report’s forecast.
A recent report by Technavio in July estimated that the market for algorithmic trading in the Americas was forecast to reach $19.21 billion by 2020, growing at a CAGR of 10.46% from $11.68 billion from last year.
Thanks to related convergences in technology and finance, which is helping to bring alternative asset classes to the market via regulated offerings, investors now have more to choose from than just low-cost ETFs and robo-advisors.
Emerging alternative assets
Such solutions, known as Alternative Investments, are products that are typically available only outside of traditional brokerage and banking institutions although are slowly becoming adopted at mainstream venues as well.
New innovative products continue to be launched and the emergence of alternative investments has been enabled by financial technology (fintech) startups and new platforms/products that bring hard assets to the digital realm in the same way that robos aim to digitize investment advice online.
These new products have created more available options for clients to choose in their portfolio, yet learning how such investments operate may require even sophisticated investors take a step back to learn and understand how Alternative Investments can have their place – to produce both yield and diversify portfolio risk.
Alternative financing boom
According to a report from PeerIQ that tracked marketplace lending securitizations for Q2 2016, volumes rose 15% from the prior quarter, with consumer, student, and SME loans represented across P2P lending platforms.
PeerIQ 2016 Q2 Marketplace Lending Securitizations tracker]
While these markets typically represent credit-based assets and not assets secured by collateral, overall, it still represents a growing portion of Alternative financing. Moreover, the secondary markets created from these assets present investors with alternative investment opportunities.
For example, a milestone during last quarter came from SoFi, after it received an industry first ever AAA rating from Moody’s on its first rated unsecured consumer loan deal for a student loan transaction.
Alternative Assets in Litigation Finance
For example, litigation finance, also known as legal finance, has emerged as a new viable alternative asset even for institutional investors such as pension funds.
A Wall Street Journal article published on May 15th 2016 titled ‘Litigation Financing attracts new set of investors’ had highlighted that even pension funds participated in investing in a portfolio of lawsuit settlements as part of the structured alternative investment product.
More recently, LawCash has brought several portfolios of packaged settlement cases to alternative investment platforms such as YieldStreet with nearly a dozen such structured deals made available to investors.
In these deals, LawCash acts as the originator and because of its consistent track record and risk-management process, investors risks are broadly diversified across a large number of cases so that their returns are not entirely dependent on the outcome of one specific case.
In terms of experience, LawCash is a leading provider of litigation finance including in pre-settlement financing nationwide, and is an original founder of the American Legal Finance Association (ALFA), and has helped finance over 90,000 individual cases with funding in excess of $425m.
Disrupting to acquire new and existing market share
Moving into new areas of interest, disruptive technologies and business models such as AirBnB and Uber have created a new landscape and marketplace, in the same way that Facebook, Twitter and LinkedIn had changed social media. However, businesses like AirBnB and Uber represent underlying assets and not just paper-backed social statuses and resumes.
Brian Hughes, a partner for KPMG in the US, and National Co-Lead Partner of KPMG Venture Capital Practice, commented in statement published on his firm’s website on July 19th, “There’s a lot going on, with uncertainty dominant in every market. Many investors are holding back to see how these uncertainties shake out, while others are focusing on companies they see as having a solid foundation and growth plan – like Uber, Snapchat and Didi Chuxing.”
In the above example the number of taxi-medallion sales declined in Chicago, this can also reflect that the existing market-share is acquired by ride-sharing fleets or vehicle operators that cater to both existing riders and new entrants that adopt the use of products such as Uber.
Such socially-friendly businesses help unlock efficiencies within local communities while reflecting changes in consumer trends on a macro level nationwide.
With the right registered investment advisor, and technology, finding a portfolio that represents such an investment in emerging businesses and disruptors can provide yield while ensuring that underlying assets are secured as collateral in case of risk.
YieldStreet screens alternative assets for opportunities across portfolios where the overall holdings of each deal are inherently diversified so that risk isn’t concentrated – yet at the same time these investments have little to no correlation to the stock market.
With a rejection rate over 90% only select opportunities that meet YieldStreet standards are presented to investors, adding valuable diversification to almost any portfolio (compared to a portfolio of only ETFs – even if those funds represented various asset classes).
Therefore, while robos could have their place in the future of traditional finance, alternative investment platforms which are currently finding high-yielding returns for investors, can be a prudent part of a medium-to-long-term portfolio and complement client’s returns and diversification needs.