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Stalled innovation (part 1)

Rative: a Canadian Fintech that could not be built

· Fintech

This is the story of my first attempt at launching a Fintech (a company in financial technologies) in Canada. I wish I could say that I failed, and moved on, but I was not able to build it in the first place.

Usually, it goes like this, an entrepreneur has an idea, builds a proof of concept, collects evidence from the target market that the product is viable or not. Then if both the concept and the market responses are positive, the entrepreneur may raise funds to develop the full concept. But when it comes to Fintech’s, there is a significant roadblock access to data.

This is the story of a project that could never be built because data access has been blocked by financial institutions. Even if the project has offered to “work within the walls’’ and with anonymized data, major financial institutions have answered in unison: no. The product was not for them, it was for their customers.

Rative’s mission was very simple; to empower retail investors with a tool to help them assess if the performance of their investment account is excellent, average or mediocre versus a population of other investors who have a similar profile.

Generally speaking, and marketing nomenclature aside, there are typically five investor profiles: conservative, balanced, growth, max growth and income. Some investment policy statement can also be formulated as goals based (ex. target 4% or inflation +2%).

Let's illustrate with Robert, a retail investor who filled the investor risk profile questionnaire requested by his advisor, Eric, and who has been put in the ‘’balanced’’ investor profile. Eric’s compliance department will monitor his work and as long as the investments chosen for Robert fall roughly within 60% equity and 40% bonds (the industry standard for a balanced profile), Eric is doing his job.

But is Eric doing a good job? According to his firm (the investment dealer), Eric is a superstar. He is measured by gross revenues (the fee he makes on Robert’s money) and sales (how much new money he manages). Eric has trophies in his office that he received at the President’s club to testify for his “performance’’.

But is Eric managing money well? The statistics that would support such assessment are not available. Worse yet, they are not even computed. But at the end of the year, Robert gets a statement with fees paid along with the rate of return on each of his accounts. But there are crucial elements that are missing. First, the fees on the investment products used by Eric are not included and there is no measure of risk available. A measure of risk is essential, otherwise it is like saying I weigh 145 pounds. My shape will be much different if I am 5’2” or 6,2” tall. A similar concept applies for investments. Robert know he made 4% and paid 2%. That’s it.

For institutional money managers, the story is much different. They have all sorts of statistics and metrics to compare their net of fees, risk adjusted returns versus other money managers. Retail investment advisors just don’t have any. For example, we know that robo-advisors are cheap. But are they good? We don’t know. There are no performance statistics available to compare.

I wrote earlier that Robert is not seeing the fees on the products used by his advisor and that he is not getting metrics to compare the performance. I will demonstrate this by looking at investment products that are very popular in Canada: mutual funds and exchange traded funds (ETFs).

Standard & Poor’s (S&P) produces on an annual basis a comparison between index and active management. Below are the staggering % of equity funds who did worse than their benchmark (December 2018)[1].

USA - S&P 500 (1, 3, 5 years): 64,49%, 78,98%, 82,14%

Canada - S&P TSX Composite (1, 3, 5 years): 76,92%, 94,37%, 90,28%

Europe - S&P Europe 350 (1, 3, 5 years): 85,65%, 86,01%, 80,21%

This is not a new phenomenon and these statistics have been consistent since at least 2004 (when S&P) started tracking them. It is an indication that ETFs which track a diversified and broad benchmark index such as the S&P500 and the S&P TSX Composite, have an 80% probability of being the best investment choice when compared to active management.

Is there perhaps a difference in fees? Yes, there is. Pure index-tracking ETFs are on average ten times cheaper than comparable mutual funds (i.e. mutual funds that do not pay commissions to advisors).

Great, there are investment options available to Canadian investors that are ten times cheaper and better 8 times out of 10. Robert, our investor, should expect his portfolio to have at least 80% index funds and the rest in actively managed products. Once again, let’s look at some actual Canadian statistics[2];

Total mutual funds net assets (June 2019): $ 1,423.1B

Total ETF net assets (June 2019) : $ 156.6 B

Yes, there are for every $1 in ETF, $9 in mutual funds. This ratio should be the exact opposite.

After spending over ten years interacting with full service investment advisors and demonstrating these statistics year after year, the ETF net assets number barely budged.

When products are 10x cheaper and the best option for end customers 8 times out of 10, you would expect the business to be flourishing. Nope. We, non-commission based ETF sales person, did not have the right lubricant for business. We did not have trailers (commissions for advisors), gifts, money for charitable donations or golf tournaments and fancy lunches. We simply had the best investment product for portfolio construction for the end customer. But this was not sufficient. Because the retail investor does not see it. He does not have means to compare. He does not know if he has products that are 10x more expensive and underperforming. It does not show!

After spending over ten years explaining this to investment advisors, I simply could not accept that some of them could manage money like superstars and be out shadowed by wheeler dealers and good story tellers with no accountability to the retail investor. I had to tackle the issue differently.

I had to do something radically different if I wanted to make sure advisors were awarded business based on their merits of dutifully managing money and doing it well.

So, I invented Rative: Rate + Objective.

Part 2 will explain what I have tried, the responses I got, and how I ended up focusing on Bitcoin instead. Stay tuned.

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