| 19 October 2009

Goodbye virtual portfolio, hello real money. Today kaChing announced that its members can invest their money in what was once but hypothetical territory. Started on Facebook and now thick with more than 400,000 investors, kaChing fed a social crowd that was content to set up virtual portfolios and fight for the right to be named an investing "genius."

Now, however, every move made by a genius can trigger actual orders at Interactive Brokers (IBKR) and these once-virtual geniuses are becoming real-world money managers. (Both kaChing and the managers make money by charging a fee, which can range anywhere from 3% to 0.25% of assets under management.) 

Founder Dan Carroll and Chief Executive Andy Rachleff (also a co-founder of Benchmark Capital) have their sights set squarely on the mutual fund industry. “The mutual fund industry is a $10 trillion industry that has seen no innovation for 25 years," said Rachleff in a New York Times interview. "The Internet has had no impact,” Mr. Rachleff said. kaChing, they hope, will shine a bright light on what was otherwise a very dark hole.

Aside from a lack of understanding or clarity the biggest challenge investors face with most mutual funds is cost. And the situation isn't getting any better. We tackled the problem of costs in our analysis of target-date mutual funds. John Bogle himself, whom some would say is the father of the mutual fund industry, has suggested that the Supreme Court is about to deal with the issue of mutual fund fees head-on.

In this case, the potential to save on costs is there, but thus far the fees we've seen on the site are at or slightly above what we've come to expect with mutual funds. We are told by kaChing that in some cases the fees will come down to as low as 0.25%.

What this open an systematic approach can do is create a nice hybrid between actively managing your money and ignoring your investements at your own peril. Mutual funds were supposed to do this for us and, for decades, were the sole solution for most indivudal investors; and we just put up with the fleecing on the costs. It really wasn't until the launch of Exchange-Traded Funds that individual investors had better choices at significantly lower costs.

To be clear, the idea of auto-executing trades is not new, but most attempts to tackle the effort came from the broker side, rather than the product side. OptionsXpress (OXPS) rolled out Xecute several years ago to allow users to auto-trade the recommendations made in an investing newsletter. Folio Investing introduced the concept of basket trading to individual investors and has since created over 300 ready-to-go folios  that automatically trade based on certain characteristics you choose, and Financial Engines created a black-box, push-button advisory service designed to operate in the confines of a retirement account. Options broker thinkorswim, now part of TD Ameritrade (AMTD), offers auto-execution service as part of its Red Option newsletter advisory service.

But the kaChing approach is different. While they are registered with the SEC as an investment advisor, they are not a broker and they are not (necessarily) trying to drive trading activity. They are genuinely interested in the qualities that make a successful investor and an effort to replicate and disseminate those qualities. The execution, which is in this case handled by Interactive Brokers (IBKR), gets nary a mention in the offering because what's really important is who you choose to follow and why.

In the case of kaChing they've determined that an investor's ability's are measured in three distinct categories over a minimum one-year time-frame, which they call the Investor IQ. They are:

1. Risk Adjusted Return (using an Information Ratio, rather than a Sharpe Ratio);
2. The extent to which an investors sticks to his or her strategy; and,
3. The quality of the investment rationale, which is based on a behavioral algorithm that gauges user reaction to research posts.

"Geniuses" are those investors able to amass an Investing IQ of 140 or above. The ability to auto-execute a manager's trades is limited to these geniuses and there are currently ten geniuses available on the site. We suspect this is an effort to control kaChing's own risk and probability for success, and it is a smart move. We also suspect that the number will only increase and we will enjoy watching the effort grow.

Investors face the same issues they do elsewhere, like maintaining a diversified portfolio, understanding what you own and learning how to choose a manager. But any disruptive event in the finance space, we think, deserves closer inspection.