a16z Podcast - a16z Podcast: How Technology Is Changing Investing

Episode Date: February 17, 2018

As people begin to gain access to information that was previously left to only trained specialists, a new set of asset classes are being created -- and they are changing the way we think about everything from banking to customizing portfolios and more. But if investing (and most decision making, in fact) is about navigating uncertainty, what can new tools and models do -- and not do -- for investors both big and small? Recorded at a16z's Summit event in November 2017, John Fawcett, CEO of Quantopian and Joshua Levin, co-founder and chief strategy officer of OpenInvest discuss, in conversation with a16z's Angela Strange, new models of investing for both retail and institutional investors... thanks to new technologies. The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments and certain publicly traded cryptocurrencies/ digital assets for which the issuer has not provided permission for a16z to disclose publicly) is available at https://a16z.com/investments/. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see https://a16z.com/disclosures for additional important information.

The content here is for informational purposes only, should not be taken as legal business tax or investment advice or be used to evaluate any investment or security and is not directed at any investors or potential investors in any A16Z fund. For more details, please see A16Z.com slash disclosures. Hi, and welcome to the A16Z podcast. As the average consumer gets access to more and more information that used to be reserved for trained specialists, we're starting to see new asset classes form that are changing the way that we think about banking and investing. In this episode, chief strategy officer and co-founder of Open Invest, Josh Levin, CEO of Quantopian, John Fawcett,

and A16Z's Angela Strange, talk about interesting new models for both retail and institutional investors and what impact they might have. This conversation was recorded at our summit event in November 2017. Josh, a lot of your team comes from Bridgewater, which is now one of the better known hedge funds, especially after Ray's, Ray Delio's book has come out. Why would someone come to open invest for a trading strategy that doesn't exist somewhere else? Sure. So I spent the last decade in the impact investing and sustainable finance space dealing with a lot of the world's largest institutions, banks, and investors. And I was constantly getting pummeled by individuals and small and mid-sized institutions asking how to do this stuff. How can we get involved? How can we

do values-based investing, and there's basically no solution for them. I think the three big mega-trends in wealth management you should know about is a move towards passive investing, a move towards interest in socially conscious investing, and then just better digital tools, awesome digital interface. And we realize that we could take their skill set and point it towards, instead of beating the market, point it towards passive investing, towards buying and holding the market, but actually point the customization towards people's values. I come on to your site, and I say, I want to invest in, or I don't want to invest in weapons companies. How does that work?

You'd start with an index with tons of different stocks. You start with an index. You start with the universe. And we don't just pull out the four weapons companies that would be in the index. That would be stock picking. That would be active management. Our system will instantly break apart the entire portfolio and tweak the other holdings that are correlated with those four weapons companies on all the important vectors to match

the characteristics of the index. So that the client is restored to a beta of one. or to broadly tracking that index, but they no longer hold weapons companies. And so this has allowed it to become much more cost-efficient and much more customized for clients of all sizes to implement their values in their portfolios. So you guys support eight causes now? Oh, I think we have about a dozen. And working with institutions, we obviously do a lot more customization around their concerns.

How do you see that expanding? Like how many causes do you think you could or would want to support? what's the new process for adding more causes onto the platform? I mean, there's no limit there for us. We're moving into a world, obviously, with greater and greater transparency, more and more data. The key is to curate and have amazing design so that you can put the decisions of people's fingertips that they really want at the moments that they want it. That's how we can empower the actual end owners of capital to have more of transparency

and more say in what's happening with their money, and that's our goal. Foss, I love your tagline, which is leveling the playing field on Wall Street. What do you mean by that? There's just a huge imbalance between the amount of data that could be used in investing and just the number of people that are trained and equipped with the right tools to do it. We have a platform that we give away for free, sort of the opposite of every other quant hedge fund in the world. And that's a magnet for talent. So we attract people from all over the world who want to learn about the field

and try their hand at creating strategies that produce superior returns. How do you find these quants? Where do they live? The saying around Quintopian is, you know, you get what you ask for with the internet. About half of our new traffic land on discussions about things like Markov chain models or common filters in trading or different research topics that people are trying out or papers they're trying to reproduce on the platform. And so the content in the community and just the continuing discussion and frankly, it's an incredible, incredible challenge to try to produce a good strategy.

That's the magnet that draws people in. As the basis of all marketplaces, if you think of something like Airbnb, what does their platform actually do? It not only matches people with rooms with people who want to rent, but there's also our ratings components, scheduling components. What are some of the things on your platform that quants really need? There's a couple of things you just absolutely have to have if you're going to be doing quantitative investing. The first is you need market data. So you need the basics of the data ecosystem. You need corporate fundamentals in order to build up a universe.

and then you need data from which you can draw a signal. So we have a platform that has a consolidated data plan. Quantitative investing, you're running a lot of historical simulations. When you run the simulation, you want to have as-traded data on the simulation day. So that's key. And then there's a workflow. And one of the things that we get to do that's really fun is we can observe the behavior of the quants that are on the platform, and then we get to see how their stuff performs out of sample.

We've noticed that the people who have good outcomes out of sample when we're testing after they've created an algo spent about 100 times the amount of time on the research step. Then we have a second piece, which is actually about making the algo that's going to do the trading. And so some people will spend all their time in the algo editing and tweaking it and back testing over and over again. And kind of intuitively, they end up with something that's very overfit. Whereas the people that spend all their time in research, they come up with a bunch of ideas that they eliminate for different reasons in the research step, and they do far less, relatively speaking, back testing,

and they tend to have greatest success. So I find it somewhat reassuring because that is the creativity step, right? That's the step that really is still very, very dependent on human creativity. And that's the thing that ultimately prevails. How do you judge if these quants are any good, right? I imagine there's a wide spectrum of people

that come on from beginners. There is. Yep, there's everything. One key thing, you know, I mentioned to overfills. that is a huge trap. There's a lot of statistical traps for these types of strategies. So, you know, first step is to try to eliminate that as much as possible. So when someone comes to Quantopian,

they actually are creating their strategy in the browser, you know, on our system. And so we're building this big database of strategies. So it's in a database, and it's marked with the date. And that one piece of information is incredibly important because it makes a bright line between the data that's in sample that the author could have known about when they were working, and then everything that happened afterwards. And so then you can do comparisons statistically

between the out-of-sample and the in-sample, and you can eliminate many overfit strategies. So that's key to the evaluation. And then downstream from that, there's like 50 features now from each strategy and starting to do tests on the predictive efficacy of each of those features and building up our own sort of meta-algo for the evaluation.

We can run from the database of algos all the way through to, here's a recommended portfolio. And we can run a historical simulation of that portfolio of algorithms. And that's really important because we can pick up the entire investment process and apply the same rigor where we can do in and out of sample testing on our process. And that's really key for making investment into a software business where we're doing incremental improvements on this piece of software that is our investment process. You're also tracking the behavioral data of where clients spend their time.

Yeah. So let's jump into shareholder. activism, which you often think of, you know, the large investors acquiring 10% of a company and hosting management. But I think what we mean in this concept is just, are people voting on the votes that the day I would have a chance to? So I think 90% of the stats just came at, 90% of institutional investors are very involved in proxy votes, whereas the number for retail is something very low. So what do you hope is the engagement that comes out of retail? So I don't know if you own individual shares and companies, but if you do, you get this giant paper packet in the mail.

And nobody reads, I mean, you need like a law degree in a free weekend. And actually, disrupting that paper packet was one of the initial conversations that led to this whole company. It's a nightmare on the back end. But we just released the ability for clients to vote in shareholder resolutions with a swipe on their smartphone, like Tinder. And part of its curation. So you just see the votes you'd care about. Oh, Procter & Gamble is having a vote on LGBT rights in the workplace. which just happened.

You get the two cents summary, a link to learn more, swipe your vote, share with others, move on to the next vote. Even just taking the individual shareholders directly and indirectly owned nearly 80% of U.S. equities markets. We have collective control of a lot of these companies, and no one's using their legal rights because it's been obfuscated, but we've been cutting through all of that as part of this broader mission to create a toolkit that shifts some of the power from this massive chain of intermediaries in the value chain, more towards the

and owners of capital, which is individuals, families, and institutions. And so what's an example of a very important vote that came up recently? They're happening all the time. Because you could make the argument like, ah, who really cares? Like, it's a diffuse number of individuals. It's not going to have, like, a really significant impact. The spring is the big season. And there was actually a seminal vote last spring with Exxon on climate change,

where 63% of the votes were in favor of Exxon reporting on the risk of their business. from a regulated two-degree world, which was a big deal. We just had a vote on Oracle and whether they should report on the gender pay gap in their company and what they're going to do about it. These things are going on all the time, and people know these brand names and they care about the issues. It's just that no one's given them the ability. One of the big debates going on in the investing world right now is the whole trend from

active to passive. Lots of numbers around there, but I guess about a decade ago, there were a fifth of assets under management, which were passive. now it's up to a third. Is this a good thing for investors? You see this continuing? I see it from two angles. One angle is actually,

indexing is great when the markets are all going up. So then if we have like a 25% correction, what are all these index holders going to do? And so I think that's a real and important risk. And just in sort of my gut, like everyone doing the same thing, when has that ever been a good outcome for markets? So I think it's legitimate to have some

concerns. There's a lot of talk about like the change of the market structure and what will happen if everyone's indexing at the same time. The other angle that I take on it is this is automation. You know, this is applying data and software to building, you know, portfolios at a mass scale for both retail and institutional investors. It's lowering costs. I mean, it's it's really, really incredible how low the cost is to be exposed to, to indices, these instruments. So, you know, I think there is just inherent good from lowering the cost, particularly for retail investors. And so I think that there's an equilibrium somewhere that we have to reach where it's probably higher than it has been historically, but it's not 100%. And I think

for institutional investors, there's a real need for actively managed portfolios because they have different needs, right? So they're not just trying to appreciate their assets. They have to be defensively posture. They have to be prepared for their obligations. year to year. And so there's always going to be a need for active management. It's interesting to see where we're going to settle out in terms of the mix. I think there's a trend, especially among the millennials, but even broader, just being more globally conscious, more cause-oriented. Like, how do you see open invest progressing? Like, do you foresee, like, more and more investors are going to care about what they're really investing in? And that's going to be,

like, a big attraction away from passive investing, because you're sort of this mix between you're active because you really care about the causes, but it's passive because it somewhat creates a new index. So if we have a paradigm of mutual funds, then the next revolution was ETFs and index investing. And then there's a third paradigm coming, which is there's a post fund future coming, right? Why are we all in these cookie cutter vehicles? Why is the banking system built on slogging them? Because you're pooling against certain costs, namely transaction costs. What happens as transaction costs go to almost zero? Well, instead of buying a fund, you're just going to be renting a strategy from the cloud,

which will be buying and selling securities and optimizing for your goals, financial values and otherwise. This is coming, and we're at the forefront of it, and our belief is that the banks are not going to lead it. And if you talk to strategy groups at the banks, they know it, they see it. But half their staff is based on slogging funds and maintaining that entire ecosystem. and you have a population that doesn't have the financial literacy that necessarily demand it, even though there's advantages. So I think what's going to drive uptake towards the third paradigm is the values-based conversation.

85% of millennials, one investing company is aligned with their values, right? It's not going away. And when you really open that Pandora's box with your stakeholders or with your family, everyone has different values. Then next week, you watch a documentary on private prisons. You don't want that. It's changing all the time. So you need an entirely new type of infrastructure to actually accommodate this.

That's what we're driving forward. So in your user base, is there a big distribution in terms of the values, or people like kind of tightly clustered around similar values? Like, everybody in the platform doesn't like gun companies or, you know, what's the distribution look like? So with retail investors, there's a lot of clustering around climate change. It's not more an issue. It's not just millennials, by the way.

Our second biggest segment is 55 to 65-year-olds. And they're more focused on military and tobacco and younger people have different issues. So, for example, we're currently onboarding entire pension fund. And the pensioners themselves are going to be voting in real time on environmental and social, political issues on their smartphones. And we'll just be managing and rebalancing the entire fund and netting off the trades. And it's passive for everyone. But this is the type of power you start to be able to put the fingertips of actual asset owners. when you have this hybrid model

where you can have active management with a passive holding. Let the software abstract away the financial complexity. These guys, they don't know about finances. Most people shouldn't be stock picking. Your guys should, but most people don't. Let the software abstract that away,

but let people weigh in on the things they know and that they care about. And then you're also just going to strengthen your client relationship. Foss, I want to end on a similar type question for you and you touched on this a little bit if you're going to do funds across different asset classes. But fast forward, 10 years,

what does Quantopian look like? like in terms of scale of quants, just paint the future vision of this. Well, I think if we manage our business properly and we diversify these funds, there's an incredible number of people around the world who are being trained in different analytical and model building fields that just aren't getting into the market.

Which is creating jobs in finance, contrary to a lot of the headways. Yeah, it's just a different kind of job, right? It's a much more, in my opinion, like creative job. and the thing that we want to accomplish over the next 10 years is if you think about the explosion and data from the real economy, we want to have total coverage. We want every single data set that exists to have, you know, several humans look at it, try to extract signal from it, try to drive meaning from it, and then apply that into many, many different investment vehicles. There's just an enormous arbitrage free for the taking and it really has to do with coordinating enough

people to do the creative work. And I think the machine can really, really add at the beginning and the end of the process. So cleaning the day, tagging the data, getting it to our community to do the creative part of turning it into signals and then taking those signals and combining them. Those are the right jobs for full automation. And hopefully, you know, I have a massive amount of assets to deploy into these vehicles. I think this is just a start of new models that we're going to start to see in the space. So I'd like to, if everyone can join me in thanking, King Foss and Josh. Thank you.