I planned on posting an update to LPHI today, but the situation has turned out to be a little more complex than I first thought it would be. I still have some questions I need answered. So instead, I'm posting this interview I had with Dan from Learningmarkets.com. The interview was done in mid December, but unfortunately Dan hasn't had a chance to finish off his story. I put a lot of time into these responses, I don't want it to go to waste, and I think this should help my readers better understand what I do at kaChing, so I'm going to post the raw interview here today. Hopefully Dan will finish his story soon so I can update this with a link. Enjoy!
Hi Jeff,So to give you a little context, I'm working on a story about kaching and covestor -- but it's a broad story about financial services and companies trying to reinvent portions of the industry. It's not a specific review of kaching's services or a comparison of kaching to covestor. So I am looking for a few insights from someone actually managing money with one of the services that might reflect on the broader implications in financial services. (That's you.) I'm assuming you can also give us some insight into how these new services affect advisers and their businesses.
I'll answer these two questions together because the answers are related. The best possible outcome is that kaChing becomes popular and I'm able to legitimately consider this as a long-term career alternative. KaChing's brokerage account clients who mirror me pay kaChing 3%, of which 2.25% is passed on to me. As a baseline reference point, at $3 million, I'd be making $67,500/year. So based on this, you can get a sense for what I would need to be content. That being said, at the moment I'm researching companies and managing my portfolio on a full-time basis. I'm giving this the best effort I can.
The question of how big I think I can get is a function of time. If I maintain good performance and I do this for 10 years, I have no doubt that I'll attract sufficient assets to live comfortably. But 10 years is obviously far too long to go before earning a reasonable living.
I didn't choose kaChing, kaChing chose me because of my performance and research quality. I'm not at all familiar with the platforms offered by Schwab or Fidelity, but I can take some educated guesses on what the differences are and why kaChing is a better solution for me.
I'm not an RIA and I do not plan on registering as one. I'm a supervised person of kaChing, meaning that they are responsible for managing relationships with clients, determining suitability, and establishing (and enforcing) policies and procedures to protect their client's interests. I manage a model portfolio, and only make money when kaChing and its clients decide my portfolio is a good model and fit for them. I'm not responsible for actual trading, rebalancing, marketing, managing anything on the back-end, or responding to client inquiries. I respond to questions left on my kaChing wall as best I can, but I don't even know if those questions are coming from kaChing clients or just casual website users, and my responses are monitored by kaChing. My only job is to generate the best returns I can. I would imagine that working with Schwab or Fidelity would transfer RIA responsibilities to me that I'm not equipped to handle, the most important of which is finding clients to start my practice.
My relationship with my followers is exactly what I want it to be. KaChing is fully responsible for managing the client relationship, and I'm free to respond to questions on my wall, generally regarding companies I've researched and investment rationale. When someone asks me a question on kaChing, I'm not aware of whether or not they're mirroring my portfolio. I might be responding to followers, brokerage account clients, or just random people interested in what I'm doing. The relationship is indirect, and sometimes unilaterally anonymous. As I mentioned above, I'm not registered as an investment advisor, so the indirect nature of these relationships is an important protective barrier for both me and kaChing's clients. I wouldn't feel comfortable without it.
I have not back-tested my strategy. My strategy is in no way technical, and not back-testable. I usually spend a significant amount of time researching a company (reading 8 years worth of annual reports, quarterlies, sell-side research, conference call transcripts) and modeling it in Excel before I make an investment decision. Working full-time, I might find one interesting opportunity per month, and I generally expect to hold positions for a long time. So for me to back-test, I'd have to limit my access to information, excluding the most recent 5-years (especially stock price performance), spend about a month researching it, and then somehow do this enough times to have a statistically significant backtest. And then even that probably wouldn't cover enough different economic environments to be meaningful.
The question that concerns me is not about maintaining my genius status, but my investment performance. The Investor IQ score seeks to find good managers without overemphasizing performance, and I totally agree with this mentality in the short to medium term. Even Berkshire Hathaway has been down 50% peak-to-trough 3 times in it's history, so there's no doubt that this will happen to even the best investors. But over the long-term, all that matters is performance. If my long-term performance is good, I have no doubt that I'll be able to weather a storm. Even if my future doesn't involve kaChing, good long-term performance and investment rationale will always attract assets.
To be considered a "genius", Genius investors must maintain an IQ score of at least 140. If you fall below, you have 60 days to recover before brokerage account clients mirroring your portfolio have their accounts liquidated. During the time I was below 140, my portfolio was closed to new investors, but there was no interruption to existing clients. So in this particular case, my followers were not affected, and I didn't loose my income. I believe my score dropped because my performance score was initially based off 6-months of data, but when I passed my 1-year anniversary, my performance score reflected 12 months. Somehow a 70% year isn't good enough for full-credit on the performance component of my IQ score!
What kaChing has done is extremely innovative. They've created a community where people from all over the world can create model portfolios, share investment ideas, and use a history of good returns to attract real assets. I sincerely hope that kaChing will continue to innovate, and the investor IQ score is the obvious place to start. What's great about real IQ scores is that you can be tested when you're 10, 20, 30, 40, or 50 years old, and your score really shouldn't deviate much. The fact that kaChing's investor IQ scores are non-stationary indicates to me that the formula might not be quite right yet. That being said, I would have no idea how to score a diverse group of investors using an automated or quantitative process. The challenge is daunting. Not surprisingly the IQ score has been renovated in the past and I can't imagine that not happening again in the future.
In my particular case, I'm classified as a "value" investor, meaning my IQ score is in part based upon what percentage of my portfolio or what percentage of my gains have come from stocks classified as "value". If two companies are the same size, have the same capital structure, and are reinvesting earnings in projects that generate the same rate of return, they should be priced equivalently. But if one of these companies is reinvesting in tangible assets like production facilities, it will have higher earnings (and a lower P/E) than a company reinvesting in R&D because R&D is expensed. Because the tangible assets depreciate, the low P/E company will have lower earnings growth. Both companies will have the same top-line, and should be worth the same to investors, but one will be considered "growth" and the other "value". I generally prefer "value" stocks because low prices are more apparent. But for me, separating the market into "growth" and "value" stocks isn't useful, and I would enjoy the freedom to consider "growth" stocks for my portfolio without being penalized.
A suggestion I made to kaChing was to create a research-based IQ score, which would calculate my IQ just as it does now, but substitute companies I've written research on for companies categorized as "value" by kaChing's algorithm. This would allow investors like myself who thoroughly research companies but who are agnostic in the "growth" vs "value" debate to defend their positions on a case-by-case basis. It would also stimulate the community to produce more and better investment rationales.
I've been investing since I was an undergrad, but what I'm doing now bears no resemblance to what I did then. At the beginning I just picked some companies I liked without doing any sort of financial statement analysis. I did exceptionally well, but I closed my portfolio in 2006 when I started to realize how little I actually understood. After finishing my MBA, passing the first two CFA exams, and spending about a year at a hedge fund, I opened a brokerage account and bought some of the companies I was most optimistic about.
Currently my portfolio is very small, extremely concentrated, and it includes some very risky stocks including micro-caps too illiquid to trade in my kaChing account. I'm comfortable taking far more risk with my portfolio than I ever would actually managing a fund because I view my portfolio relative to the income I expect to generate over the course of my life. If I were wiped out tomorrow, I'd be sad, but it's not something I couldn't recover from... emotionally or financially. I manage my kaChing portfolio more in line with the way I would manage my retirement savings. Because of regulatory requirements, my ability to freely trade in my PA is limited. Eventually I'll be transferring at least a portion of my portfolio into a kaChing account where I'll be mirroring myself, but I'm not ready to reduce my exposure to some risky positions yet, and I'm also hesitant to recognize short-term capital gains for tax reasons.
If there were issues on the back-end, I wouldn't know about them. I don't see the individual portfolios, I don't see the actual trades that are placed, and I have no responsibility for managing them.
I manage a blog where I share investment ideas and Excel models, so it's not uncommon for people to leave comments or questions there, but I make it clear that I'm not giving any personalized investment advice. kaChing's policy regarding questions from kaChing clients which I receive outside of kaChing is for me to redirect those questions to my wall where responses can be monitored. KaChing has made it very clear to both the Genius investors and brokerage account clients, that kaChing is the investment advisor, responsible for managing accounts and customer relationships, and that the Genius investors are little more than a data feed. I haven't really had a problem with clients asking me awkward questions yet, but the policies and procedures seem to be in place in case that happens.
For anyone out there interested in following my career as well as my investment ideas, I was interviewed by Hiro Takei from Behind the Spread this weekend. We spoke about my involvement with kaChing, my background, and my investment strategy. For anyone not familiar with kaChing, basically I've been managing a fantasy portfolio there for about a year, and they just started allowing investors to open brokerage accounts that mirror my trades. So far there's about $200k mirroring me!
kaChing has been making waves with their official launch. Dan Carroll and Andy Rachleff made an appearance on CNBC yesterday. They were also covered in the New York Times, Blogging Stocks, the Broker News Blog, Business Pundit, Fast Company, Forbes, the Huffington Post, Newspost Online, Reuters, and 9 other news sites... I'm sure you get the point.
Zack Miller recently interviewed me for his blog "New Rules of Investing". The blog discusses how new technology, web 2.0, and investor preferences are impacting individual investors and investment professionals alike. Given the tools we have available, the importance of making the right financial decisions, and the risk of trusting the wrong people, I find it hard to imagine a world in which people don't continue to take more control of (and responsibility for) their financial situations. Even if the optimal solution for most people is a passive long-term investment in index funds, this marks a profound change in the world of finance.
Thank you to Zack for introducing me to his audience. I appreciate it very much!