Here's The Web Based Investing Solution That Cuts Out The Middle Man

Billionaire technology visionary Jim Clark, hero of Michael Lewis’ The New New Thing, and founder of Silicon Graphics, Netscape and Healtheon stumbled when it came to realising his dream to liberate individual investors from the sometimes predatory, certainly expensive, hands of financial planners, investment advisors and private banks.

MyCFO Inc. was founded by Clark in 1999 to fuse the power of the internet with the best professional advisors to enable, at least, the ultra rich who populate Silicon Valley, to control their own financial destiny and escape the clutches of the professional investment industry. It was another great idea, but the promise of accessing more resources than leading Wall Street fund managers was coupled to a minimum account size of $10 million, and, ultimately, even this elitist venture to give individuals the tool to manage their own affairs floundered. Amidst problems linked to tax shelters, the dream dissolved in 2002 when certain assets of MyCFO were sold to Harris Bank, reportedly for about one third of the funding raised by Clark since inception. Harris myCFO survives as a family office solution provider.

But what about the holy grail of liberating the individual investor from the endless ranks of middle men?

Of course, a self-reliant international investor can pick the best funds worldwide using sites such as Credit Suisse’s Fund Lab – see https://fundlab2.credit-suisse.com/ — first launched in 1999 and now covering 5000 funds from 100 investment houses across the world. However, you’ll still need advice and Fund Lab prompts you to consult with one of their advisors.

For the younger generation nurtured on the Net and distrustful of bankers after the Global Financial Crisis, a pure internet solution remains essential.

As a result, one ancient Swiss private bank, Wegelin, in May, launched Nettobank, enabling internet fans to set up on-line accounts and then construct a portfolio selecting from amongst what is still a relatively limited choice of investment funds. This was a brave departure given the history of e-banking ventures in Switzerland. Vontobel, a Zurich-based institution which has since recovered, shuttered a disastrous e-banking venture in 2001 after sustaining massive losses trying to launch a similar business.

However, it seems improbable to find internet-inspired personal investing liberty amongst the bricks and mortar of traditional banks; they’ll always fret about the on-line offer cannibalising lucrative profit margins in their legacy business. Pure internet players in the financial services sector are different; they have nothing to lose.

A glimpse of the holy grail of taking control over our investment futures can be found on the shores of Lake Geneva, nestling in quaint Gland, home to both the World Wildlife Fund, and Switzerland’s leading on-line broker, Swissquote. The firm serves more than 150,000 customers and has grown into an internet bank capitalised around $600mio on the Swiss stock exchange. Its platform also accesses more than 7,000 mutual funds.

Swissquote was founded by Swiss engineers Marc Bürki and Paolo Buzzi in the 1990s. Both were graduates of EPFL, the Ecole Polytechnique Federal of Lausanne, a university close to the mushrooming entrepreneurial firms along the Geneva-Lausanne corridor in French-speaking Switzerland, a symbiotic relationship resembling that of Stanford University and its host of hi tech offspring clustered around the likes of nearby Palo Alto, California. After graduation, Bürki headed off for the European Space Agency while Buzzi did a techie apprenticeship in Silicon Valley before both returned to their Alpine home to launch what was initially merely a share price provider. That raw site blossomed into a on-line broker, first in Swiss shares, then going international before moving recently into FX. And yes, their website — www.swissquote.ch – is in English amongst other languages. 

Chief Technology Officer Paolo Buzzi had this to say. “While our core services were aimed at self-directed investors, we knew there were many people out there with whom we were not dealing who wanted to invest, but didn’t necessarily want to master it all themselves and didn’t want to spend all their spare time following the markets. We set out to try and capture those clients.”

The result, after four years of R&D by a quant team of six physicists and mathematicians, led by Dr Serge Kassibrakis, was the debut at the end of July of ePrivate Banking.

“Paolo always wanted to democratize investment for the individual investor, but doing that turned out to be heavily mathematical,” said Dr Kassibrakis.

“Serge’s team tested the validity of our portfolio management product by launching a long equity fund in January 2009 towards the tail end of the GFC. That fund, using quantitative methods, has earned 13% in Swiss Francs for investors since its launch which makes it one of the top 3 funds in its class in Switzerland,” noted Buzzi.

However, the real objective was handing individual investors the tools to construct their own portfolios and then devising how to automatically manage those portfolios using the models built by the Quant team. Today, the product is a pure equities portfolio, but bonds will be included by the first quarter of 2011, bringing together the classic building blocks of the balanced portfolio.

Dr Kassibrakis took the writer through a demo recently. “First, we ask the new client to complete a risk profile before using a cursor on-screen to define his maximum risk level. Since mathematical terms like ‘confidence levels’ are meaningless to a private investor, we use graphics to show the investor what this means in terms of potential performance and how he might go too far into the red if he’s not careful.”

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“Once they’ve digested the risk involved, we ask them on the next screens to fix the investment strategy, whether to measure in dollars, francs or euros, then what he prefers in terms of industry sectors and geographic markets. The client simply uses the cursors to choose or prohibit sectors and markets and vary the weightings in each one. He then moves on to set the minimum cash level, what are his ‘must have’ stocks or shares to be avoided — the white and black lists —  so to speak, and finally how often we should optimise his portfolio.”

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Buzzi added: “Re-allocation frequency is key. Daily would be fine, but the costs would be prohibitive. We are charging 0.50% of the value of the portfolio as an annual account charge and 0.10% for brokerage so quarterly seems reasonable, but it’s up to the client to choose.”

At the heart of the re-allocation process is CVaR, “Conditional Value at Risk,” a particularly conservative quant tool that seeks out an investment strategy constructing a portfolio of securities with a lower overall risk than any particular share; a mathematical form of diversification. The tool then re-allocates the portfolio, as this changes, optimising the risk/reward. Of course, human intuition is missing but then again the programs can do 100,000 analytical runs overnight testing various parameters. That’s asking a little too much of any Wall Streeter.

Using CVaR means the portfolio is tested weekly to ensure the portfolio remains within the client’s risk level. If not, whatever re-allocation frequency was chosen by the client, the portfolio will be re-allocated automatically. In crisis conditions this may require increasing cash to safeguard capital.  That is a key to saving a lot of money. It’s a far cry from the  reality of savage bear markets where many human portfolio managers freeze like rabbits in the headlights while their client portfolios melt into oblivion.

The weekly testing also avoids the risk of a re-allocation being wrongly triggered by the intra-day “Flash Crash” on Wall Street some months ago.

“The client can immediately see what his preferred portfolio, based on his choices, looks like, as his strategy is simulated and then back tested for the longest possible period based on what data is available,” Dr Kassibrakis added. “And that includes all fees as well!”

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Investors can play around with the cursors to check both risk and performance against various market indices and move backwards and forwards modifying their inputs to check out how various changes affect the outcome. Once they’re satisfied, it’s simply a matter of clicking on “Select Strategy” and Swissquote generates the optimal share portfolio from their universe of 2,000 liquid blue chips. The client can check out various analyses of the portfolio by sector, geography and currency. Execution occurs within 48 hours of pushing the button on the portfolio and uses institutional dealing disciplines to get the best prices. Reporting is on-line and the client can modify his portfolio strategy at any time.

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It may be early days, but ePrivate Banking seems something new in financial services both in Europe and the U.S. Given the expected demand for the service, you might be wondering where Swissquote will find the quant geniuses to flesh out the product range. Well, they’ve taken out insurance and endowed a chair of Financial Engineering at their alma mater EPFL down the road. It’ll be a short commute for upcoming graduates.

You can feel the shivers shuddering through the ranks of investment advisors across the world as they imagine their worst nightmare: investors finally free to cut out the middle man. That should put a smile on the face of Jim Clark.

Richard H. Schweizer is the pseudonym of a Swiss banker with more than 25 years of experience managing money and trading markets.

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