November 15, 2016
Written by Matt White, CFA®, Investment Analyst
Despite the vast complexities of our interwoven financial world, the objective of the financial profession is quite simple: Invest wealth efficiently to generate the highest possible return for a given level of risk. Over the last two decades, new technologies have fundamentally altered not only how the world works, but also how our profession goes about investing in it. In this quarter’s newsletter we focus on how today’s emerging technologies are further transforming the financial world, creating new connections between investors and investments, and how MRA Associates is utilizing some of these changes to drive results for our clients.
One significant development we see happening is the rise of alternative lending platforms. These platforms are online peer-to-peer networks that connect borrowers with investors who are looking to lend to them. The alternative lending model is a major disruptor to traditional consumer banking, providing lower rates to borrowers and higher yields to investors, by compressing the spread typically charged by banks. This lower spread is achieved by using technology to automate and realign processes that are much more burdensome for banking giants.
By removing banks as the middle-men, borrowers have more resources to drive innovation in their business or spend in the global economy and more return can be provided back to investors. To capitalize on this paradigm shift in lending, MRA Associates has begun evaluating investments in loans made to high credit quality borrowers through select alternative lending platforms. By displacing traditional consumer banks there is potential to capture part of the lending spread and earn competitive returns from a diversified source in portfolios.
Another large thematic change occurring in finance is the explosion of big data, which is the collection and analysis of unstructured information (think satellite photos, Facebook posts, and audio newscasts). Big data matters in finance because it improves how market participants gather and analyze information, thereby making our financial markets more “efficient”. As markets become more efficient they incorporate new information into prices faster, making it more difficult to actively time markets. In context, a current rule of thumb pegs 80% of the world’s information and data as being unstructured, which means there are a lot of insights big data can provide and a lot of efficiency to be gained. For the greater part of modern history, having an informational advantage over the stock market required teams of research analysts and stock pickers to compile and give meaning to all this unstructured information. However, new technologies like optical pattern recognition, machine learning, and cloud computing are eroding the upper hand these traditional teams have enjoyed because computers are doing the same research faster and, in some cases, with greater accuracy.
In contrast to these traditional methods of investment selection, MRA Associates utilizes a systematic approach to the stock market, relying on decades of academic research demonstrating that active market timing is difficult and markets are mostly efficient. Instead of looking for investment managers that claim an informational edge, we invest with teams that identify biases and factors showing evidence of outperformance over long periods of time in efficient markets. With big data ushering in a new era of greater market efficiency, strategies such as the ones we employ should continue to provide advantages over the old guard of active stock-pickers.
A subtler, but important, shift technology is bringing to finance is the transformation occurring in payment processing. While it is not top of mind for most people, payment processing is at the heart of everything we do, from trade settlement across international borders to swiping a credit card (or iPhone) to pay at your local grocery store. The enigmatic emergence of Bitcoin is one example of the changes taking place in transaction technology. Essentially, Bitcoin can be thought of as a digital payment system, similar to PayPal. The difference is that PayPal exchanges fiat currencies (US Dollars, Euros, etc.) between banks whereas Bitcoin is an actual currency that relies on a decentralized ledger network, called Blockchain, to handle transactions. While the jury is still out on Bitcoin’s viability as a currency, the Blockchain technology that underpins it has major potential to change how our world moves money.
Blockchain is a distributed system of “ledgers” that records and stores all transactions on the network in order to validate the legitimacy of participant account balances. Each time a transaction occurs on the network these ledgers are consulted to verify the payer actually has those funds to send. As the transaction is completed it is broadcasted back to the network, updating the balances of the payer and payee. This self-verifying algorithm removes the current need for central payment processing companies like Visa or MasterCard and even certain functions of sovereign monetary authorities. Groups like UBS and JP Morgan are working on applications for the technology to re-tool the global payments system and improve payment transparency. The potential value of Blockchain integration into the global payments system is widespread, ranging from reduction in money laundering activity to improved identity theft prevention. MRA Associates currently employs numerous methods to defend our client accounts against identity theft, such as verbal confirmation of money movements. New technologies in payment processing, like Blockchain, will provide us even more tools to protect our clients’ critical account information and privacy.
Our world today is connected by a vast ocean of smart phones, social media profiles, and an army of WiFi-enabled toaster ovens otherwise known as the internet-of-things. We are living in the age of the algorithm, where supercomputers transfer money across the globe faster than the blink of an eye. However, as advisors it is not lost upon us that at the heart of all this are people – with real lives, dreams, and concerns. Among all the links in our increasingly networked world there is one connection that still reigns above all others . . . and that is the human connection.