It may shock those of you reading this on your phones, tablets or new smartwatches, but much of the world’s financial capital is still tracked in spreadsheets. Crazy? You bet. But that doesn’t prevent many pensions, endowments, foundations, family offices and other long-term investors from managing their capital with business, risk, and information technology systems that are obsolete or lacking in critical functionality, redundancy, and security.
This lack of sophistication should worry everybody. Why? Because these investors sit at the top of the capitalist food chain; they are the ultimate source of capital that keeps our economic system — and all the financial intermediaries — running. Do you want the Principals in the long chain of Principal-Agent relationships that allow our economy to function to be operating so blindly? I don’t.
Moreover, I’ve been particularly frustrated by this lack of technological sophistication because it has served to disempower these investors. Rather than leveraging their scales and varied time horizons through aggressive investments in their own processing power, they allowed the “fee machine” to perpetuate itself through significant investments in technology. Indeed, with the computing revolution, the private financial services industry has accumulated and consolidated its economic power. It should not be surprising, then, that more than one third of all corporate profits today are captured by finance companies.
But there is good news: things do appear to be changing. I’ve begun seeing a new generation of technology entrepreneurs focusing their sights on helping Giants better do their jobs. So I’m hopeful that a new generation of technology companies will emerge and empower institutional investors. Naturally, this raises questions as to where the next generation of finance and investment companies are going to come from, and who is going to help them grow.
While the venture capital industry has become infatuated with “fintech,” most VCs seem to think of finance as payment processing, crypto-currencies and robo-advisors for individual investors. While those advances may offer some interesting opportunities, that’s not really what we’re interested in here. What we need instead is a generation of “invest-tech” companies that truly empowers investors. So should we expect the VC crowd to back a generation of companies that will put their own partnerships out of business? Hmm. And given the fact that many VCs don’t understand how to run their own businesses, I’m not sure we’d want to trust their vision for how tech companies can interface with investment management organizations.
The broader community of institutional investors will thus need to nurture the nascent ecosystem of investment-related technology companies so as to facilitate an invest-tech boom that empowers institutional investors. As such, with this post, I’d like to offer my views on how invest-tech companies are going to build technologies that change the business of investing.
To me, there are four distinct functions that we can expect to see; I refer to them as The Four Ds:
Disintermediation: Technology is changing the way companies access capital. What AngelList has done for high-net-worth individuals, new platforms will soon be doing for institutional investors. Powerful matchmaking and correlation engines will soon help Giants connect with unique and thoughtfully identified investment opportunities (i.e., companies that match up with the Giants’ comparative advantages, networks, geographies, and so on). Those companies and individuals that made their money in financial services because they sat at the intersection of networks (see brokers, bankers, and even some asset managers) should be nervous. In the future, it will be hard to extract rents based on these sorts of information asymmetries, as technology will inevitably shine a bright light on these networks, and the opportunities and investors therein. Think of it this way: what technology has done to travel agents, it will soon do to an entire segment of the financial services industry.
Dissemination: Data begets information, which begets knowledge. Better access to reliable data facilitates the rapid communication of information and the development of knowledge, which can be used to enhance performance (if it is communicated effectively within the organization). It’s for this reason that proprietary information and data-processing systems have become key competitive differentiators for investors; better systems provide better data, which in turn drive better investment decisions and performance. There are some obvious and major challenges here. Building the sorts of backbones required for these types of analyses is time consuming, expensive, and painful — though my hope is that the time, expense and pain will decrease as technologies get better. Moreover, getting data from one risk or asset engine or service provider to talk to other engines and providers is extremely difficult (requiring an “information bus” of some sort). Can you build these types of systems using spreadsheets? No. The sample sizes are way too big and the processing power required to chug through the complex equations would crush your laptop. Isn’t this just Bloomberg? No. This is about intelligently overlaying a fund’s proprietary portfolio data on top of market and third-party data to develop unique investment insights that are truly real-time and bespoke. Significantly, new companies are emerging to help investors clean, normalize and manipulate their portfolio data in creative ways (which is forcing Bloomberg to respond). I think many investors forget how useful their own data can be, as it provides multi-asset, multi-geography insights. But extracting those insights requires a big investment in technology and system architecture. And, yes, it should be viewed as an investment and not an expense.
Democratization: When the computational revolution really kicked off three decades ago, hedge funds and savvy asset managers accumulated power because they had technology that nobody else had. Today that authoritarian control of computing power — which was reinforced by egregious management fees — is being democratized. The processing power that cost $100 million in 1980 now costs around $1,000. So while, in the past, only the most sophisticated asset managers (i.e., hedge funds) possessed the tools required to manage complex global portfolios, soon the most sophisticated systems on earth will be budget-friendly for all Giants. And, inevitably, this will lead to a major shift in the way Giants think about capital deployments and how they use external service providers. As a result of the drop in the price of computing, there are already companies emerging to provide “black boxes to the masses.” And I expect more companies will look to sell access data and insight platforms on a license model rather than offer asset management services using those platforms with a hefty management fee.
Dispensation: You can think of this as the scale economies of technology. As institutional investors adopt innovative technologies, they will have the power to dispense with antiquated rules in the investment industry. And the rule that seems most prone for dispensation is that which says asset managers should get paid a percentage of its assets under management. Managers would like us to believe that moving money is similar to moving dirt in trucks from point A to B; that it requires a constant fee that escalates in parallel to the escalation of total assets under management. But, as it turns out, moving a nine-digit number from computer A to B is as costly as moving an eleven-digit number. Yes, I do understand that big trades are harder to place and certain investment strategies have capacity constraints, which may warrant the higher nominal fees. That’s fine. But in these exceptions the service provider should be forced to justify the basis-point fee. It should not be the standard upon which all investment contracts are based. Anyway, there are new companies emerging to help investors identify these “historical artifacts” and figure out ways to bypass them through technological innovation. I think many people fail to realize how many of these “rules” continue to exist across the range of financial intermediaries. Spotting these rules and then developing technology to break them seems to be a new trend.
Ultimately, technology will help Giants streamline and strengthen operations, manage and distribute knowledge, access unique —and heretofore expensive — markets, and level the playing field with the private financial services industry. What’s more, the companies that need capital to grow will welcome the chance to partner directly with patient, long-term investors. So this should be an exciting and promising new space for investment.
BUT — and yes, there’s a but — accelerating this invest-tech phenomenon will demand the support of the Giants. In order for these companies to have a strong hope of success, the community of institutional investors will need to invest in their own technology, data management and infrastructure (on a massive basis) and be willing to serve as pilot clients to new companies in these domains. I’d like to see the Giants engage with technologists like they engage with financial service providers. And if they do, I think the geography of finance and investment will get very creative — and very destructive — for mainstream players.
