The Disruption of Finance

  • Jim Lee
Depositphotos 54085067 l 2015
As a futurist, I spend much of of my time thinking about "what happens next?"  In this article, I'll share an insider's view of the finance industry. Much has changed in the past 25 years, and it's been exciting to watch.
Let's start with the existing trends first, followed by some of the new stuff:
1) Rise in popularity of index investing. There is extreme price compression going on in commoditized asset management. It truly is a race to the bottom. Some index funds now carry annualized fees as low as 0.04%. This is beginning to translate into fee compression for traditional active managers.
This is also translating into so-called "economies of scale" - bigger companies are getting more competitive, in part, because they can charges lower fees.
Meanwhile, conventional mutual funds are bleeding assets, while the bulk of new inflows are going to a handful of Index providers, primarily those offering Exchanged Traded Funds (ETFs).
Index and Ownership
Source:FactSet, P&I and Simfund as of 03/31/2018.
The irony here, is that big fund companies such as Vanguard and Blackrock may be the ultimate beneficiaries from the rise of robo-advisors (which tend to rely heavily on index funds). The top ten asset managers now own roughly 30% of all the companies represented in the S&P 500 index.
2) Because of the dominance of indexing strategies, stock selection is going somewhat out of favor for the general public. Investment management is becoming more about understanding and tracking the exposures that your companies correlate to, and less about the companies themselves. Think about that.
For sophisticated investors, privately managed equity portfolios continue to offer tax efficiency, along with the ability to customize accounts according to individual preferences.
3) Automation disrupted the investment research world a while ago. I run into quite a few former analysts / portfolio managers that were outsourced to algorithms. A regional bank a few blocks away from the StratFI office almost entirely liquidated its staff of analysts back in the mid 2000's.
Just last January, the AI Powered Equity ETF (ticker: AIEQ) was introduced, using IBM's Watson to actively manage stock selection. This will be fascinating to watch.
4) Indexing -> smart indexing -> active management of smart indexing strategies
A few years ago, we saw a boom in smart beta ETFs, which focus on various "factors" (value, momentum, quality, etc.) that appear to provide superior performance characteristics over time. As any expert would tell you, these factors come and go out of favor.
Cropped Multifactor
So, the new, new thing would be strategies that actively switch between those factors. Oppenheimer funds started its own Oppenheimer Russell Dynamic Multifactor ETF (OMFL) and Vanguard is following up with its own multifactor ETF (VFMF).
These strategies blend active management with algorithmic enhancement to traditional indexed strategies. How "meta" is that?
5) The headaches of regulatory oversight are contributing to a decline in the number of publicly-traded companies within the U.S. These figures peaked shortly before the adoption of Regulation FD (2000) and Sarbanes-Oxley (2002).
It is much more appealing to be a privately owned and funded company now, especially with an abundance of venture capital. Easy money, less regulation, what's not to like?
Many companies are waiting much longer before having their IPO, with initial public offerings now more of an exit strategy than a funding mechanism. The result is a narrower set of opportunities for public investors. 
Listed U S Company Count
6) Blockchain technologies pose a competitive threat to traditional financial institutions. Blockchain/crypto-currencies already provide alternatives for funding, trading, and cash transfer. Financial intermediaries run the risk of becoming disintermediated.
Initial Coin Offerings (ICOs), those bizarre love children of crowdfunding and IPOs, have already raised more than $9B this year. While crypto-currencies boomed in a "Wild-West" environment, further adoption will necessitate some further regulatory oversight.
(Trends #6 and #7 highlight the problems of "too much" vs. "too little" regulation, and the complexities of managing change.)
7) When the stock market (eventually) goes into bear mode - index funds are likely to get sold first. It is how flash-crashes happen. Many ETFs are not going to be as liquid as people think, periodically trading at steep discounts to net asset value. This will create a counter-trend opportunity for active managers.
8) The future of advice. You'll want to be sure that your financial advisor can keep up with the times.
The trend seems to be moving towards bigger money managers offering a less personalized experience. Some financial advisors are going into full "robo" mode, while others are more focused on "soft" services such as life coaching. At StratFI, we provide leading-edge investment advice with personal access.
Our offerings continue to evolve rapidly. Feel free to give us a call or send an email if you'd like to learn more.
James H. Lee, CFA, CMT, CFP®
(302) 884-6742
Disclosure: Information contained herein is for educational purposes only and is not to be considered a recommendation to buy or sell any security or investment advice. The advisor may hold shares of OMFL and AIEQ within client accounts. Securities listed herein are for illustrative purposes only and are not to be considered a recommendation. 

Lessons from Vacation

  • Jim Lee
Moab Trail Resized
Earlier this month, I took a two-week vacation to Moab, Utah. What’s in Moab? Dirt, rocks, and some of the best mountain biking in the world. What used to be a burned-out uranium town is now a world-class destination for people who enjoy the outdoors. Moab is the home of legendary trails such as Porcupine Ridge, Slickrock, and Bull Run.
We just keep going back....
After biking for twenty years, I learned a few things along the way.
  1. Where you focus is where you lean
  2. You are less likely to have an accident if you are well-balanced
  3. Everything is easier with momentum (except for making turns!)
  4. Over-steering is like micro-managing. It only slows you down.
  5. Keep your hands off the brakes, and let the hills do the work for you.
  6. Everyone learns faster when leadership is shared.
  7. Keep your eyes on the trail at least 20 feet ahead of you. More time to react.
  8. Switch gears before absolutely necessary.
  9. Everything is better with friends.
  10. The best views usually follow the longest climbs.
Some of these lessons have useful analogies for investing. As I get older, I’m beginning to learn the value of avoiding injury. Sometimes, winning means simply being able to hit the trails again the next day.  
Investing (like staying fit) provides it's own rewards and sense of achievement. If you want to get better, the key is to push yourself just a little while still playing it safe. It's OK (and even fun) to take a few small risks. Just keep them survivable so that you can wake up tomorrow and do it again.
Work hard, have fun, be excellent - and enjoy Memorial Day weekend!
James H. Lee, CFA, CMT, CFP

Thinking Fast and Slow

  • Jim Lee
I’ve been doing a lot of research lately on the future of real estate. This is an easy and popular topic – so much of it is tangible and visually interesting.
One thing really stands out. We’ve had some radical shifts in how we think, act, and organize. Yet, our physical world has been relatively unchanged for decades. We have the same streets, the same buildings, and the same forms of transportation. Cities change slowly. Parts grow, parts fade away. Yet the “bones” often remain across the generations.
Understanding why change doesn’t happen is almost as interesting was why it does.  One of my favorite explanations comes from Stewart Brand, of the Long Now Foundation. He writes about this in his book How Buildings Learn.  
Brand noticed that while collective change is now a given, not everything adjusts at the same rate.
Pace Layers
This is a layered view of the world that we live in. Brand refers to this as "pace layer thinking."
  • Fashion and technology move very quickly.  Every few months, there are trendy new lines of clothing, movies to watch, and music to follow. Our language is surprisingly adaptable.
  • Commerce and businessdo their best to keep up with the times, rolling out new offerings and updating existing ones. The start-up period between idea and reality is quickening, but it can still take years to introduce an entirely new product.
  • Infrastructure projects take significant planning, and often require a decade or more to build out. Part of this relates to the red-tape involved in obtaining approvals, and the need to raise massive amounts of capital.  
  • At the layer of governance, building codes and zoning regulations can last a century or more. 
  • Culture is not so much about fashion as it is about core values and traditions. The time frame for change can be hundreds (if not thousands) of years.
  • And in the end, nature has the final word. It will last longer than civilization.
Between each of these layers, you’ll have an element of turbulence and friction. This is where public discussion frequently happens. The faster moving layers get all the attention, while the slower moving layers have the power.  
Pace Layers 004
Pace layer thinking explains why cities and our built environment tend to change slowly over time. It provides insights to why the market for hydrogen fuel is so small (infrastructure), or why crypto-currencies might not hit ever reach the mainstream (governance). Cultural considerations are also significant. We may have some of the technology needed for genetic engineering, yet are reluctant to embrace it.
So, next time you encounter a new investment concept, take some time to consider why it might work out (or not). Think fast. Think slow.  
Jim Lee CFA, CMT, CFP® 
Founder, StratFI.
Disclosure:  Information contained herein is for educational purposes only and is not to be considered a recommendation to buy or sell any security or investment advice. Securities listed herein are for illustrative purposes only and are not to be considered a recommendation.

Trading the Hype

  • Jim Lee

Riding the Hype Cycle

You'll find the second and third floors of our house completely loaded with books. My wife and I both just love to read. For Steph, it is mostly literary and historical fiction. I'm an avid reader of business books, trends, philosophy, and sci-fi. Maybe 40-50 titles per year for each of us.

As a professional investor, it feels like 2017 was a year of tremendously hyped stories. Artificial intelligence, autonomous vehicles, blockchain, immuno-oncology, and marijuana legalization all had their moments in the spotlight.

Billions of dollars were made, billions of dollars will be lost.

But how do you analyze a speculation with no history and no profits? There are some explosive opportunities in the markets, and many of these defy any reasonable financial analysis. (I run into this problem with biotech stocks all the time.)

This month, I'll outline a process for evaluating some of these "story stocks."

What is the story? Why is it compelling? Is it easy to explain? If you can, write down a synopsis of why this is the next big thing.

How big is the story? What's the upside here? Will this be just a niche market, or is it a technology/service/product with broad implications? Also, what is a size of the company relative to the opportunity?

Is it real? Would this story be shelved in the "fiction" or "non-fiction" category? Do the main characters (an organization, its founders, and key personnel) appear to have both depth and realism?

Who knows the story? Some stories have been around forever. Others are comparatively new. The fresher the story, the higher its conversational value. The best stories are often unknown to most people.

Are there alternative narratives? What is the competition? Are there more compelling stories out there? What could go wrong?

When does the climax happen? Are there expectations leading to a key event, such as an FDA approval, a big earnings report, or legislation? Key events can add to the hype and excitement, only to be followed by realism. As the saying goes, "buy the rumor, sell the news." By the time that news becomes completely public, the best opportunity may have already passed.

How does this story end? It is usually a good idea to determine this before making a trade. What is your exit strategy? Do you have an upside target price where you'll take profits? Also, do you have a stop-loss to limit your downside and signal that you need to move on?

Position sizing is important here. That means not making any big bets when there is a lot of risk involved. (I prefer to keep my mistakes small.)

When done well, understanding the story behind a speculation can take just as much time and effort as research done using a classic textbook approach.

Jim Lee, CFA, CMT, CFP®
Founder, StratFI

Disclosure:  Information contained herein is for educational purposes only and is not to be considered a recommendation to buy or sell any security or investment advice. Securities listed herein are for illustrative purposes only and are not to be considered a recommendation.


What the Trump Tax Plan Means for You

  • Jim Lee
Depositphotos 11602565 original
The end of the year is always a busy time for folks in the investment advisory business.  There are charitable gifts to make, IRA distributions to send out, tax-loss harvesting for portfolios, and last-minute retirement plan contributions.  
This year is even more complicated, because the rules of the game are changing. 
Earlier this week, Trump's tax reform bill was approved by the Senate.  It will go back to the House for further review before going to the President for his signature within the next month.    
Here is a brief summary of what appears to be happening:

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Getting Realistic About Trends & Cycles

  • Jim Lee

There is something irresistible about doing things that people say can't be done. Like trying to beat index funds, or timing the market.

With interest rates coming off all-time lows, bonds are looking less and less attractive for diversification. Real estate is also at risk, particularly if Trump's tax reform plans go through. Meanwhile, stocks have been the "best game in town" for a long, long time. This bull market has been going on since March of 2009 and is the second-longest on record.

Clients are happy with their recent gains, but are beginning to ask me "how long can this go on?"

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