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(In)efficient markets

Pretty much anyone who has been involved in financial markets for any length of time and has some success knows that these markets are not efficient. And thank goodness. Well sort of. Thank goodness from the point of view of an investor, because this creates the ability to generate excess returns. But most investors don’t, most because quite frankly – although rarely admitting it – they’re not even trying.

There are many reasons why markets are not efficient, most with roots in the fact that markets are by definition complex adaptive systems which have constantly changing dynamics and local equilibria. But one of the key drivers contributing to the dynamics of this system is the psychological biases that have been effectively embedded in the DNA of the modern “industrial” asset allocation paradigm. The natural and instinctive herding mechanism that is built into the way humans think.

For most people, there is no way to switch this off; the best one can hope to do is have high self-awareness and try to compensate for this bias. Interestingly, some people are physiologically missing these mental pathways. As an example, think of people afflicted by Asperger’s Syndrome. I’m not a doctor but some of the most (consistently) successful traders who I have had the privilege to meet or work with over the past couple decades certainly seem to have personality and behaviour traits that line up with (at least mild) versions of the Wikipedia definition of this conditions. I’m pretty sure this is not coincidence.[1]

But generally, most people (and thus the institutions they represent) make (investment) decisions locked inside a Keynesian Beauty Contest – trying to guess what everyone else thinks is pretty, not searching for intrinsic prettiness. And this is often a reasonable strategy, ie they are not behaving irrationally. Although it will never produce consistently strong returns – certainly not on an absolute basis, it will for long periods avoid consistently poor relative returns and even if absolute returns are poor (or even catastrophic) there is significant and very real safety in having fallen (jumped?) off the cliff in a herd. People like covering their ass. Wrong together rather than successful alone. Loss aversion. It’s a rational survival strategy.

And this behavioural framework applies through the whole asset allocation food chain – LPs to Funds to Companies – which means a couple things:

  • the big tend to get bigger (buy IBM)
  • there is an extremely high energy barrier to new entrants (at every level of the food chain)
  • an actor’s ability to raise capital is the most important factor in their ability to raise capital (recursive)
  • and for asset managers their core business becomes gathering (not investing) capital (tail wags dog)[2]

Which creates a big opportunity/risk pair[3] (or set of fractal pairs):

  • (for individual actors) an opportunity: for those that can break away from this cognitive and behaviour framework to make outsized excess returns if their convictions are fundamentally sound
  • (for society) a risk: that intrinsically value creating investments (funds, companies) are starved of capital, while many mediocre “me-too” investments are overcapitalised

In my opinion there is no precise, fundamentally “right” optimal balance in this pair, or certainly not one that is consistent in all environments but I suspect that our current state is quite far from a potentially optimal range. It’s great for a (very small) number of actors that may have the skills and good fortune to take advantage. But collectively poor for our societies and economies. Systemically brittle. From this societal point of view, I think it is important to at least try to redress this balance. I don’t have a magic solution for doing so, but as suggested above, self-awareness can be quite effective in helping to mitigate (at least a good portion) of our systemic biases. It won’t eliminate the Keynesian Beauty Contest paradigm, but it will at least dampen it.

Lest you think I’m exaggerating the extent of this herding behaviour baked into the world’s capital allocation system, let me share some of my first-hand experience of this. For almost a decade I was a syndicate manager. For those of you not familiar with investment banking jargon, my job was to manage the process of raising capital (in an industrialised, repeatable process.) While my focus was fixed income (bonds) (meaning that each year I was involved in managing hundreds of deals – ie my data set give me a decent sample size), the capital raising process – whether you are raising a seed capital round from angels, doing an IPO or selling a bond issue – is fundamentally the same. And if I were to draw a graph of the first questions investors asked during the marketing of a new issue of securities, it would have looked something like this:
Investors' first question

(Yes, sadly Virginia this is how too many of the traditional managers of your savings frame their decisions…)

But, for the smartest investors (defined by those who consistently delivered better returns, who – during my tenure as a syndicate manager – were mostly a small number of hedge funds) this graph was inversed. It’s not that they didn’t care at all how big the book was or who else was investing, but that these were structurally second-order, tactical questions for them. First they made up their mind whether or not they thought the investment was compelling and only then did they factor in the deal dynamics in their bidding tactics.

I was reminded of this and inspired to write this post (in the hope of contributing to increasing the systemic self-awareness alluded to above) by a couple posts that I stumbled across in my bedtime reading last night that highlighted the biases (failings?) of investors in the venture capital food chain (LPs and VCs.)

In “How to Convince Investors”, Paul Graham highlights the behaviour I’ve described above:

If you can make as good a case as Microsoft could have, will you convince investors? Not always. A lot of VCs would have rejected Microsoft. Certainly some rejected Google. And getting rejected will put you in a slightly awkward position, because as you’ll see when you start fundraising, the most common question you’ll get from investors will be “who else is investing?” What do you say if you’ve been fundraising for a while and no one has committed yet?

While Eghosa Omoigui of EchoVC talks about the risk/opportunity pair that arises from the “Trough of Conviction” that LPs and VCs are prone to get stuck in:

Conventional wisdom has always been incredibly seductive. Particularly as it requires little to no intellectual effort. I am slowly forming a hypothesis that pattern matching in VC is showing similar characteristics, oddly enough.

Today’s VCs are falling prey to the minefield of so-called axioms masquerading as truisms. So sticking to the ‘x for y’ or ‘a for b’ pitches is simple, believable and thus fundable. I have no issues with this framework. It helps entrepreneurs to tell a story and VCs love to fund storytellers. But it implodes when faced by disruptive innovation, which I have seen recurrently present itself as an undiscovered versus unmet need.

…So all this boils down to the apparent calcification of pattern recognition (formulaic VC?), and the departure from the two-sided risk-taking marketplace (entrepreneur AND venture capitalist) that was always a key part of early stage venture. A fulltime dependency on pattern-matching when unaccompanied by thesis formation means that you will miss the big winners. As the venerable Tom Perkins declared, ‘If there’s no risk, you’ve already missed the boat.’

And he goes on to quote Elon Musk:

“I think it’s important to reason from first principles rather than by analogy…The normal way we conduct our lives is we reason by analogy…

We are doing this because it’s like something else that was done..or it is like what other people are doing…slight iterations on a theme…

“First principles” is a physics way of looking at the world…what that really means is that you boil things down to the most fundamental truths…and then reason up from there…that takes a lot more mental energy…

Someone could –and people do — say battery packs are really expensive and that’s just the way they will always be because that’s the way they have been in the past…”

Now perhaps by endorsing this view I myself am suffering from confirmation bias, after all, the DNA of Anthemis Group is entirely thesis-driven (both in the businesses we support with capital and in how we’ve organised Anthemis and our approach.) Although it is too early for me to definitively say our thesis is proven. That said (self-awareness!), this framework is the same one that informed my biggest previous (investment) successes – Betfair, Markit, Weatherbill, Zoopla – that have vastly outweighed the ones that didn’t work out. (Interestingly, one example of a poor investment I’ve made was in a company called GnuTrade. And although GnuTrade didn’t succeed, a company formed at almost the same time with the same vision called eToro[4] has succeeded spectacularly. Thesis confirmed, backed the wrong horse.)

So my “call to action” is that anyone reading this who has responsibility for making investment and capital allocation decisions fights harder against their biases to simply follow the path of least resistance – the crowd – and to develop and embrace real conviction, arising from a robust cognitive framework, and to act on this. Even if only at the margins. Let’s move the needle. We owe it to our children to try.


[1] I was somewhat surprised that I couldn’t find any research that had been published on this topic that might prove/disprove this correlation…
[2] Some venture-backed companies can also fall into this trap…
[3] I believe that opportunity and risk are like fundamental particles that only exist in the universe in pairs, two different sides of the same coin so to speak.
[4] Anthemis is proud to be a small investor

Blueleaf: a trillion dollar market opportunity

A billion dollars isn’t cool, you know what’s cool? A trillion dollars.

A bit more than a year ago, my friend Fred introduced me to John Prendergast who was in the very early stages of conceptualizing a platform called Blueleaf to help people better manage their savings and investments. As Fred knew, this kind of thing is right up my alley and so I set up a call with John to learn more about his plans.


As many of you know, for over a decade – since first discovering the enabling power of the internet and Moore’s Law – I have been very excited by the prospect of revolutionising the way 99.9% of people manage their personal financial balance sheet. (With the first 80% of this revolution being simply to help people recognise that they have a personal balance sheet and that it should be considered holistically and in the context of each person’s circumstances, constraints and aspirations.) I called this PALM – personal asset-liability management (but am not so naive as to think that this is the nomenclature one would use to popularise the notion…unsurprisingly most folks aren’t super aware – or inclined to be – of the importance of robust ALM…)

Indeed of all the various innovative ideas and companies I’ve looked at and invested in over the past decade, this concept of PALM is the one that actually lies in the Paul Graham vector of solving problems you encounter yourself. Indeed, I cannot wait to have a robust, networked, intelligent asset-liability management dashboard to help me manage my family’s increasingly complex balance sheet. And for once, I am also in fact part of the key or core demographic for this type of product (which is not often true!)

Although I would argue that people should start managing their personal balance sheet from the time they enter higher education or the workforce, the reality is that it isn’t until the 30s and 40s that real complexity typically starts to creep into the balance sheet: mortgage(s), other secured and unsecured loans, multiple savings and investment accounts including pension plans and other tax-driven structures, more complex compensation mixes (including equity and options), children, and the awakening realisation that they can’t count on the state or their employers to secure their financial future.

Adding to this complexity is the fact that financial products are almost always sold (and bought) in isolation – with at best limited regard to the consumer’s overall balance sheet – and choices are often driven by non-financial considerations (changing jobs, marriage, divorce, etc.) You might expect me at this point to go off on a rant about how awful this is and that our financial institutions are failing us by cynically selling us individual financial products rather than holistic financial solutions and that this needs to change. Surprise! I don’t have a problem with financial institutions selling products. That’s what they do. Worrying about that is like wishing the sky was a different colour than blue. Misdirected energy.

Ironically, most financial institutions actually spend a lot of time, money and energy pretending to and trying to convince you that they are looking at you “holistically”, that they are looking at the big picture but in order to do so, they need to control more or ideally all of your balance sheet. In other words, sell you more products. Well I don’t know about you, but whether your balance sheet is $50,000 or $500,000,000 – I think it is pretty intuitive that (a) it’s pretty much impossible to do all your financial business with just one institution and (b) even if it were possible, it is highly undesirable to do so. Pre-2008 this was obvious to me (as an ex-banker and someone with high financial literacy); post-2008 I think this is increasingly obvious to everyone.

The solution in my mind was an intelligent (online) wealth management / ALM platform that would allow individuals (and families or other self-determined groups) to aggregate all of their financial commitments – assets, liabilities, cashflows – and then allow them to risk manage (scenario analysis, simulations, rebalancing, etc.) and optimize their personal balance sheets according to their changing needs and circumstances. Mixing a high level of automation in terms of the basic record-keeping, data management and transaction processing with an intelligent user-interface allowing the user and/or their advisor(s) to make well-informed, contextual decisions. In essence, a meta wealth management intelligence layer that put the information advantage squarely with the individual, where it belongs.

I dreamed about building this…


So I remember when John started to describe his vision for Blueleaf to me on that first call, he had me at hello. The vision, the product, the approach all aligned with my vision of using 21st century technologies to bring institutional strength risk management tools to individuals. A few months of refining, learning, due diligence and progress later, and I was convinced that John and his team could deliver on their vision and I was delighted for Anthemis to become the lead seed investor in Blueleaf just in time for Christmas 2010. (And the cherry on the icing on the cake is that now I have a good reason to visit the great city of Boston every 2-3 months or so.) As you might imagine, building the technology to deliver this vision is not trivial and it’s been impressive to see them bring Blueleaf to life.

Blueleaf banner In closed beta since last fall, and by focusing on providing financial advisors with an amazing platform to help them help their customers, Blueleaf has (very quietly) already gathered over $1 billion (yes, billion…) of assets on the platform, including a significant number of multi-million dollar accounts. Often when people hear this, they are surprised – why would advisors trust a new start-up like Blueleaf with all the details of their clients net worth? I think it is relatively simple. First and foremost, because by doing so, they can derive real – measurable and material – value for their customers by using their platform, and secondly because it makes much much more sense for individuals and independent financial advisors to share a complete view of someone’s finances with an independent 3rd-party platform provider like Blueleaf than with any individual financial institution.  In other words, it makes advisors look like rock stars and gives individuals a quantum upgrade from the still all-to-common wealth management user interface of a kitchen table covered in account statements… And the wealthier and more sophisticated (and older!) you are, the more you are likely to realise this is true. There are very good reasons to have multiple banking, insurance and broking relationships. The problem is that today, to gain the advantages of multiple relationships one has to pay a real cost in increased complexity that arises from having to manually manage and aggregate these accounts.

And just in case there are any private bankers reading, I think you will agree – if you are honest with yourselves – that almost none of your clients have given you all of their assets to manage. Is it because they don’t trust you? Well yes sort of, but (hopefully!) not in a toxic way. Let me explain: they know (and know that you know, that they know, etc.) that you need to sell them products. Perhaps you can take a long term view of this (which is good) but sooner or later, you need to book some revenue against each of your client relationships. Like scorpions, this is your nature. They also know that having all your eggs in one basket is generally not an optimal strategy. And they know that you might not be at that institution forever and – in a bit of good news for you – their relationship is almost certainly more with you as an individual than with the institution (despite the enormous sums your firm spends on brand marketing.) Hell that’s one of the reasons they have assets spread amongst 4 different banks: some of those assets followed you with your previous career moves…

In fact, I am convinced that the most enlightened private bankers, insurance brokers, financial advisors will embrace and celebrate a platform like Blueleaf as it will make their customers more intelligent, better informed and less paranoid and allow them to do their jobs better and build even stronger relationships with their customers. Of course the weak ones – who really add no value other than shuffling reports around and hoarding information – will hate it. But the clock is ticking on them in any event…

John’s vision for Blueleaf is to have $1 trillion of assets on the platform in the next 5-7 years. Yes TRILLION. Think that’s crazy?Think again:

  • That’s 1 million accounts of $1 million each (c. 34% of US HNWIs, 10% of Global HNWIs)
  • or c. 9% of US HNWI’s investable assets of $10.7 trillion (or 2.5% of global HNWI investable assets)
  • or 10 million accounts of $100,000 each (c. 25% of US mass affluent households)

Source: Cap Gemini / Merrill Lynch World Wealth Report 2010

Don’t mistake ambition and vision for hubris: it will take a lot of hard work and an amazing product and value proposition to get there, but the size of the market opportunity is clear. Equally importantly, I think the time is right to introduce a Blueleaf approach to the market: a combination of shifting demographics, increasing familiarity and comfort with web-based financial management products and the fundamental shift in private investor mindsets in the wake of the global financial crisis are all aligning to drive an increasingly holistic, transparent approach to investing and wealth management. Some of the key learnings from the 2010 World Wealth Report back this up:

Post financial crisis, HNW investors are now much more engaged in their financial affairs. HNW clients are re-evaluating their current wealth management provider relationships and moving assets to firms that can clearly demonstrate a more integrated approach to meeting their needs.

Three unequivocal demands HNWIs are making of their wealth management firms today are:

  • ƒSPECIALIZED ADVICE: As clients become more educated about their own investment choices, they increasingly expect ‘Specialized’ or ‘Independent’ƒinvestmentƒadvice, and are re-validating advice from their Advisors/Firms through other sources, including peers, the Internet, and other research alternatives. They also expect the advice to be aligned with realistic and appropriate goal-setting, based on their actual risk profile.
  • ƒTRANSPARENCY AND SIMPLICITY: HNW clients want increased ‘Transparency ƒandƒ Simplicity’ and ‘Improved ƒClientƒ Reporting’ so they can better understand products, valuations, risks, performance, and fee structures. HNWIs are reviewing product disclosure statements and investment risks before even conferring with their Advisors. They also value better reporting and more frequent updates after being blind-sided during the crisis, when they lacked a real-time view of what was happening to the value of their investments. And increasingly, the type of products they seek out are the ones they can understand.
  • ƒEFFECTIVE PORTFOLIO AND RISK MANAGEMENT: The vast majority of clients see ‘Effective ƒPortfolioƒ Management’ and ‘Effective ƒRisk ƒManagement’ as important after the crisis. As a result, they increasingly want and expect scenario analysis on proposed allocations and products that is aligned to their individual goals and expectations, and in-depth research around all types of products so they can better understand the risks. For instance, many wealthy clients are very concerned about their exposure to markets and want to limit their downside risk. At the same time, they know they need to diversify and have global exposure, particularly to fast-growing markets. As a result, they want evidence through risk-scenario analysis to facilitate investment decisions that meet their goals while remaining aligned with broader volatility and risk-appetite limits.

These are a pretty darn good articulation of Blueleaf’s mission statement; it’s great to see this kind of independent confirmation. Now enough talking and back to work. Lots to do and $999 billion more assets to bring on to the platform. (And if you’re reading this from the US and are an early adopter type person or financial advisor, please request an invite. I think you’ll like it.)

I do have one complaint however:  I just wish they’d hurry up and launch in Europe too!


See it in action:
Blueleaf Advisor Demo Videos
Blueleaf Client Demo Videos


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Are (traditional) financial markets broken?

I don’t have much invested in traditional public equity markets, just a handful of relatively small positions in my (self-directed) pension fund. I haven’t done any robust analysis but my intuition tells me that my average holding period for these positions is probably around 2-3 years, with perhaps a bit of trading (lightening up or adding to existing positions) one or twice a year. And watching the markets from the sidelines over the past month or so certainly hasn’t made me regret this modest, passive allocation. When massive, mature companies trade up and down by 10 or 20% in a period of days – with no or little company specific news, confidence in the market’s ability to set prices in an orderly fashion clearly goes out the window. Indeed, the (public) equity markets are dangerously close to losing their ability to provide one of their key benefits: price discovery. And if/when this comes to pass, there will be serious knock-on effects on their other prime (and beneficial) function of capital allocation (and providing access to capital to companies and access to companies to investors.)

The risk is that a tipping point is reached at which the traditional public equity markets cease to be relevant venues for raising capital or investing. As many people have recently remarked (Kill the Quants Before They Kill Us, Beat high-frequency trading machines by not playing their game, etc.) possibly the key driver of this trend is the relentless increase in algorithmically-driven machine trading (high-frenquency or otherwise.) Now don’t get me wrong, I am neither a luddite, nor am I fundamentally opposed to these trading strategies; rather all other things being equal I would probably consider myself a proponent. In moderation, these types of trading strategies add both liquidity and heterogeneity to the market and as such help create a more robust trading ecosystem. But recently, the equilibrium of this system has come unstuck. Anecdotally, it is now assumed that upwards of 60% of trading volumes on the main public stock exchanges are accounted for by algorithmic/machine-directed trading. On some days and in some stocks, I understand that this can be as much as 80+%.

And most of these strategies don’t involve any judgement as to the valuation per se of a company; basically, as the Onion put it so brilliantly many years ago: they are just “trading” a “blue line”.

Blue Line Price History

NEW YORK–Excitement swept the financial world Monday, when a blue line jumped more than 11 percent, passing four black horizontal lines as it rose from 367.22 to 408.85.

So nobody is actually setting the price! (…or more accurately, the “price-setters” in the markets are mostly being overwhelmed by the trend-trading machines.) This does have the side effect of creating real trading and investment opportunities for on the one hand a small number of smart nimble day traders and on the other hand a small number of very long term investors (who have the luxury of having deep pockets and patience) but for the vast majority of investors (professional or private) the market dynamics and extreme short term volatility make participation more and more painful. This is particularly the case in a low-return environment such as today. Clearly execution (entry and exit points) have always been important, even to long term investors, but never have they been make or break like they have been in August: who cares if you have a carefully crafted investment thesis that predicts a 20-40% appreciation over 2-3 years in Company A when depending on the day of the week on which you entered the position, the thesis is rendered somewhat moot by a 20% swing in the share price.

And it’s no wonder that strong, growing private companies are often loathe to have their shares listed: what right-thinking CEO wants to deal with that insanity???

So what’s the solution? I don’t pretend to have an answer, but I do have a couple suggestions that perhaps point in the right direction for smarter people than I to develop into actionable plans:

  • design structural dampeners (through exchange rules and regulations) that limit the volume of algorithmic trading to some maximum proportion (to be A/B tested to find the optimal point – 40? 50? 60? percent?); this could also be a dynamic number, for example increasing or decreasing with intraday volatility to damp same
  • encourage the continued development of private secondary markets (SharesPost, SecondMarket and others) and help to develop them as real alternatives (and complements) to traditional public equity markets.

It’s really important that our global capital markets operate robustly and efficiently. In fact it’s never been more important. I believe that reasonable, robust solutions exist (or can be developed.) But I fear that the inertia and prejudices of entrenched incumbents (exchanges, banks, regulators, governments and investors) will make finding these solutions exceedingly difficult. I hope I’m wrong. Until then, be careful out there (and think about re-allocating some of your capital to the private markets; you’ll sleep better at night!)

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You better, you better, you BET(terment!)

Yesterday, our latest investment was announced to the world.  It’s in a super exciting NYC based company called Betterment.com who, in their own words, have created a “better way to save money.”

Betterment ticks the box on so many of our investment themes and fits so well into our vision of digitally native 21st century financial services that they had us at ‘hello’…but the clincher was the amazing team and impressive execution to date.

When asked, I often tell people that we invest in the “emerging Apple’s of financial services”,  ie that we look for companies who use technology to create powerful, intuitive, user-friendly customer experiences by essentially abstracting complexity away from the user (not ignoring it, but managing it – with skill and dexterity – behind the scenes) rather than exposing it in all its glory to customers with the implicit goal of profiting from then managing (exploiting?) their confusion and disengagement.  Of course the Apple analogy is not perfect but probably can’t be beat in terms of a pithy soundbite summary of our approach.

So with this in mind, think of Betterment as having a Jobsian approach to savings and investment:  combining a intuitive and powerful user interface with a robust back-end execution platform, Betterment allows anyone to quickly, easily and without mystery manage asset allocation and risk budgeting using a simple, multi-asset class portfolio.  No hassle, no time wasted, no blizzard of trade confirmations.  The first time I saw it, I immediately wanted to be able to manage all my cash balances using their platform.  (Unfortunately they are currently only operating in the US so not super-practical for me personally but you can bet we’re keen to help them expand their horizons…) Say goodbye to the money market account.  Indeed, if you are based in the US and have a bunch of your savings tied up in money market accounts or CDs, you should definitely take a very serious look at replacing these with a Betterment account.  Have a look at their product tour:

But the most exciting thing about Betterment is that they have only just got started and it’s scary (good) to think what Jon, Eli, Kiran and Anthony, can and will do over the next couple years.  And it’s a great fit with our nascent but growing ecosystem and we look forward to helping them work with other great digitally native financial firms like BankSimple, Blueleaf, FX Capital Group and others as they grow their business in the months and years to come.  And the icing on the cake is getting the opportunity to invest alongside guys like Rob and Eric at BVP who bring a lot more to the table than just capital.  Congratulations guys and thanks for inviting us along for the ride.

And was just thinking this might be the right track for their inaugural global marketing campaign…

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