| 16 March 2010

“In the future,” said Andy Rachleff, co-founder of kaChing, “we expect the vast majority of our new Geniuses to be outstanding Registered Investment Advisors (RIAs) whose verified track records we import.”

“More than 40 RIAs approached us,” he said, “since the launch of our service in late October to join our platform.”
Simon Veingard, Co-Founder of Covestor, told us early on, “an asset management business [focused on individuals] is inherently un-scalable” individual managers can only manage so many stocks, so they tend to build a team around them to help multiply the efforts. Therefore Covestor is, “not just smart individuals but also investment managers looking for distribution.”

Providing a platform for RIAs is not only not new, it’s big business. In fact, Charles Schwab (SCHW), Fidelity and TD Ameritrade (AMTD) bank huge portions of their revenue and (increasingly) their profit on attracting RIAs and their assets.

Editor's Note: This is the last of a six-part series. To see part one, go here.

Several weeks ago Charles Schwab (SCHW) announced that it has helped more than 500 advisor teams “convert to independence” since the company began focusing on the RIA segment in 2005. These teams, according to Schwab, brought over $45.5 billion in new assets that are now in custody at Schwab.

This is a far cry from the $6.6mm in assets gathered thus far by kaChing, but is a clear indication of the market potential, showing why kaChing is so interested in the RIA market in the first place. Companies like Schwab, however, are not slowing down their efforts.  In 2009, 172 new advisor teams moved to Schwab, a whopping 40 percent increase from 2008.

There are big differences between the two approaches. And this is where we start to see some possible game-changers. Schwab and TD Ameritrade provide a lot of marketing, back-end and even customer support, but ultimately it is up to the RIAs to manage their campaigns, deal with customers, apply for registration with the SEC and more.

If you’re an RIA with kaChing or Covestor, however, there’s really only one thing you need to know: how to pick stocks; or rather, how to manage a portfolio. “Stock picking and portfolio management are completely different,” kaChing’s co-founder Dan Carroll explained to us. “Many guys who may be good at stock picking are not good portfolio managers. They don't know when to buy more, average in, sell, short more... this is the hardest part.”

We interviewed Jeff Borack, a kaChing genius and one of the 0.001% of “amateurs” able to rack up genius status on kaChing. We wanted to know what it was that he hoped to accomplish with kaChing – in other words, was this a full time career for him? Was he doing it to promote other efforts?

“The best possible outcome is that kaChing becomes popular and I'm able to legitimately consider this as a long-term career alternative,” he told us. Mr. Borack charges a 3% management fee, of which 0.75% is retained by kaChing. If he’s able to amass $3 million in assets he would be making $67,500 per year gross.

After roughly nine months in the hunt, Mr. Borack has just over $238,000 in kaChing customer assets mirroring his trades.

But at least his expectations are set appropriately. “The question of how big I think I can get is a function of time,” he told us. “If I maintain good performance and I do this for 10 years, I have no doubt that I'll attract sufficient assets to live comfortably.”

Mr. Borack could be an RIA and he could set up shop and work with the team at Schwab, but he genuinely likes the kaChing approach, especially because they manage a lot of the client relationship. “My relationship with my followers is exactly what I want it to be. KaChing is fully responsible for managing the client relationship, and I'm free to respond to questions on my wall, generally regarding companies I've researched and investment rationale.”

A practicing RIA may shudder at the thought. Most RIAs are very protective of their clients. In Mr. Borack’s case, however, not only does he not own the client relationship, he doesn’t even know who his clients are. “When someone asks me a question on kaChing,” he told us, “I'm not aware of whether or not they're mirroring my portfolio. I might be responding to followers, brokerage account clients, or just random people interested in what I'm doing. The relationship is indirect, and sometimes unilaterally anonymous.” Just the way he likes it.

But this raises an interesting question. If they’re not his clients, and it is up to kaChing to determine whether or not he qualifies as a “genius,” then isn’t he at risk of losing everything with one bad stock pick?  “If my long-term performance is good, I have no doubt that I'll be able to weather a storm,” he said.  “Even if my future doesn't involve kaChing, good long-term performance and investment rationale will always attract assets.” True, and we suppose the opposite is true as well.
RIAs, for that matter, can’t keep clients if they don’t perform, regardless how tightly they manage their client relationships.  

“My only job is to generate the best returns I can,” he told us. “I would imagine that working with Schwab or Fidelity would transfer RIA responsibilities to me that I'm not equipped to handle, the most important of which is finding clients to start my practice.”

Mr. Borack actually did fall below genius status at one point last year. KaChing geniuses have 60 days to recover before losing their accounts. (He recovered.)

Interestingly, he returned a stellar 70% during the period that he lost his genius status. So we pressed him on the idea that kaChing alone decides on the criteria for his status. “I sincerely hope that kaChing will continue to innovate, and the investor IQ score is the obvious place to start,” he said. “What's great about real IQ scores is that you can be tested when you're 10, 20, 30, 40, or 50 years old, and your score really shouldn't deviate much. The fact that kaChing's investor IQ scores are non-stationary indicates to me that the formula might not be quite right yet.”

“That being said,” he continued, “I would have no idea how to score a diverse group of investors using an automated or quantitative process. The challenge is daunting.” Indeed.

So perhaps this is where this new breed of “social” financial services innovators can offer something unique. KaChing and Covestor handle all customer service. They register with the SEC. They are responsible for the fiduciary requirements and vetting trades to make sure they’re appropriate for each client. They handle the transitions with the executing brokers. They handle all the marketing and client and asset acquisition.

All in all, we think Mr. Rachleff may be on to something with his shift in strategy. It’s possible that this approach will serve to open up a new marketplace of talent – and along with it a new way of marketing to individuals looking for better returns. The managers are free to focus on what they do best: research stocks and manage portfolios. This works for guys like Jeff Borack. It’s unclear whether it will work for established RIAs – a target specifically identified by kaChing’s Andy Rachleff.

What kaChing and Covestor can provide to RIAs is a way to generate leads. By the way, this is not new and is the very foundation of the investment newsletter business. Let’s take Jim Collins, for example. He publishes OTC Insight. Like most prominent and established authors he has a good performance, good communication, transparency and a clear investment rationale; ideals kaChing and Covestor would appreciate.  

Mr. Collins’ newsletter has been ranked in the top 5 of all newsletters tracked by Mark Hulbert* over the last 10 and 15 years consistently. While his newsletter business is decent, the letter serves primarily to feed new accounts into his asset management business, Insight Capital Management. With some help from the leads generated from his publishing efforts, Mr. Collins has quietly racked up $641 million in assets under management.

The similarities do not end there. Thinkorswim and optionsXpress (OXPS) caught on to this idea early and currently allow you to mirror the trades made by many investment newsletters. (But be forewarned! We should also mention that, like actively managed mutual funds, most investment newsletters do not outperform market indexes.)

Have kaChing and Covestor improved on the process and techniques created by the investment newsletter business? Absolutely. But whether they’re able to create a marketplace as sizeable (either in terms of publishing or driving leads to asset management) remains to be seen.

In Conclusion

All in all we think companies like kaChing and Covestor are fighting the good fight. Their efforts to offer alternatives to existing services and to challenge assumptions should not go unnoticed. We suspect they will come under the typical strains one would expect from young, venture-backed organizations. Owners eager for results will tip the balance toward tried and true methods of gathering assets – as has already occurred in the case of kaChing with the shift toward supporting RIAs.

We only hope they hold out long enough to actually force change on the industry. It’s an industry that really needs it.

Whether it’s Financial Engines, Cake and Marketocracy or kaChing and Covestor – they all want to change the way things are done in the world of financial services. But most, if not all, fall victim to the gravitational suck of two simple things: assets and sales.

There are already concerns that kaChing may have just converted itself into just another asset shop. At least some of kaChing’s former participants seem to agree. To wit: Here’s a quote from “James” on the kaChing blog: “Like I said before, you’re just another investment firm now! Anyone with a brain will take their money to a big firm. You’ve lost your niche! If that’s what you wanted congrats. However, I feel disappointed, because you almost had me fooled into thinking you actually cared about something ‘new.’”

Technically, the jury is still out on the new guys, and they are still early in the race. (“We are clearly in the early adopter phase,” says Mr. Carroll.) There are a lot of places to innovate in the finance space. But building an alternative to the actively managed mutual fund requires more than just smack talk. And actually, good alternatives already do exist in the form of indexed ETFs, for example, or even some of the new actively managed ETFs created by firms like IndexIQ.

If those alternatives aren’t enough then what we’d really like to see is a complete rethinking of the way mutual funds are created, managed and sold. We only wish someone would work on slaying those dragons. That’s a fight we could get behind.

Editor's Note: This is the last of a six-part series on the topic. To see the first article, go here.




* Mr. Hulbert has a team that tracks the trade recommendations made by each newsletter author. He writes commentary about their performance for The New York Times, CBS MarketWatch and Barron’s. In a sense he’s created the “genius” criteria for investment newsletters.