Tech­nol­ogy’s ef­fect on in­vest­ing

Montreal Gazette - - FRONT PAGE - MARTIN PEL­LETIER

“Com­pu­ta­tional power isn’t just chang­ing the old lit­era­cies of read­ing and writ­ing. It’s cre­at­ing new ones.” — Clive Thomp­son, Smarter Than You Think

There is no hid­ing from tech­no­log­i­cal dis­rup­tion these days which has spread quickly into ev­ery sec­tor from health care, oil and gas, con­sumer dis­cre­tionary, real es­tate, bank­ing, in­sur­ance, le­gal, ac­count­ing — even to the in­vest­ment in­dus­try.

The level of con­nec­tiv­ity in de­vices is the rea­son why this pe­riod of tech­no­log­i­cal dis­rup­tion is dif­fer­ent from prior pe­ri­ods such as the 1990s tech bub­ble. In par­tic­u­lar, the sub­se­quent build out of the in­ter­net of things has re­sulted in the ac­cel­er­a­tion and rapid adop­tion of new tech­nolo­gies that are us­ing data to ef­fec­tively drive down prices of prod­ucts and ser­vices for con­sumers.

In the in­vest­ment world, this level of con­nec­tiv­ity has sud­denly al­lowed equal and full ac­cess of in­for­ma­tion to the many char­tered fi­nan­cial an­a­lysts out there will­ing to do the re­search. As a re­sult, the level of ef­fi­ciency in the mar­kets has in­creased to the point where it is be­com­ing nearly im­pos­si­ble to con­sis­tently out­per­form pas­sive bench­marks — es­pe­cially one in which there is lit­tle to no vo­latil­ity. Look­ing ahead, imag­ine what will hap­pen when more of these CFAs start us­ing cog­ni­tive com­put­ing and ar­ti­fi­cial in­tel­li­gence to start an­a­lyz­ing all of this data.

It isn’t sur­pris­ing to see ex­change traded funds (ETFs) do very well in this en­vi­ron­ment. They them­selves have been a very pow­er­ful dis­rup­tive force to the high-fee mu­tual fund in­dus­try. Sud­denly, the av­er­age in­vestor can own the mar­ket at a sub­stan­tial dis­count to an ac­tively man­aged fund that is strug­gling to de­liver al­pha due to higher fees and greater broader mar­ket ef­fi­cien­cies.

While the fund in­dus­try is try­ing its best to adapt by low­er­ing fees them­selves, it is be­com­ing a race to the bot­tom hav­ing to com­pete with ETFs that charge as lit­tle as 10 ba­sis points. More so, it is com­pet­ing against the banks and even in­sur­ance com­pa­nies who have both the size and scale to be a low-cost and prof­itable man­u­fac­turer of ETFs.

In­ter­est­ingly, ETFs have a lot in com­mon with the net­work ef­fect be­ing used in other in­dus­tries. This is where a prod­uct or ser­vice is nearly given away at cost to build out an in­ter­nal dis­tri­bu­tion sys­tem which ad­di­tional higher mar­gin prod­ucts or ser­vices are then lay­ered on top of. This makes it tough for a sin­gle-ser­vice provider such as a mu­tual fund firm to com­pete against a mul­ti­ser­vice fi­nan­cial in­sti­tu­tion.

Then there are the in­vest­ment ad­vis­ers who have fi­nally be­gun us­ing ETFs them­selves in order to pro­tect their mar­gins in an en­vi­ron­ment where reg­u­la­tory and ad­min­is­tra­tion costs are ris­ing and in­vest­ment fees are fall­ing. From a value-add per­spec­tive, their role is still im­por­tant in re­gards to as­set al­lo­ca­tion and ETF se­lec­tion.

How­ever, even this role is fast be­com­ing dis­rupted with roboad­vis­ers of­fer­ing au­to­mated as­set al­lo­ca­tion so­lu­tions and ETF se­lec­tion for a frac­tion of the cost. To make mat­ters more com­plex, these robo-ad­vis­ers are about to be dis­rupted by ETFs them­selves who are of­fer­ing tac­ti­cal re­bal­anc­ing strate­gies within a sin­gle ETF. We’ve even seen ETF’s uti­liz­ing ar­ti­fi­cial in­tel­li­gence to re­bal­ance hold­ings and weight­ings.

That said, these strate­gies have yet to be stress-tested given the mar­ket has gone up a record amount of time with­out a cor­rec­tion. A ma­chine also can­not talk an ac­tive in­vestor out of re­turn-chas­ing, such as an over­al­lo­ca­tion to eq­ui­ties at mar­ket highs or loss aver­sion with an un­der-al­lo­ca­tion at mar­ket lows — at least not yet any­way.

Ad­di­tion­ally, there are some ex­cel­lent ac­tively risk-man­aged strate­gies out there that will out­per­form dur­ing pe­ri­ods of ex­cess vo­latil­ity. We think these funds are go­ing to have to scrap their stan­dard two-per-cent man­age­ment fee and 20-per­cent per­for­mance fee though, in order to sur­vive un­til the next cor­rec­tion. That said, it wouldn’t sur­prise us to see more of these funds be­come au­to­mated, es­pe­cially those that are quant-based thereby driv­ing their costs down so they can con­tinue to com­pete.

In con­clu­sion, while lower fees and ETF dis­rup­tion are no doubt a great de­vel­op­ment for in­vestors, it shouldn’t be the sole fac­tor driv­ing one’s process. In­stead, we think pair­ing tech­nol­ogy with as­set di­ver­si­fi­ca­tion and pro­fes­sional ad­vice is and will con­tinue to be a pru­dent long-term way of man­ag­ing money.

Fi­nan­cial Post Martin Pel­letier, CFA is a port­fo­lio man­ager and OCIO at TriVest Wealth Coun­sel Ltd, a Cal­gar­y­based pri­vate client and in­sti­tu­tional in­vest­ment firm spe­cial­iz­ing in dis­cre­tionary risk-man­aged port­fo­lios as well as in­vest­ment au­dit and over­sight ser­vices.

PETER J. THOMP­SON/FILES

The dis­rup­tion of new tech­nolo­gies in all in­dus­tries is un­prece­dented today com­pared to prior pe­ri­ods, such as the 1990s tech bub­ble, says Martin Pel­letier. The wise way to man­age money in these daunt­ing high-tech times, he ad­vises, is to pair tech­nol­ogy with as­set di­ver­si­fi­ca­tion and pro­fes­sional ad­vice.

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