By J.B. Beckett1
1Author and Founder, New Fund Order
Asset management, as it exists today within the new Western capitalist model, has a very real problem with any notions of social investing, equality or fair distribution of wealth. Indeed the model’s foundations are built on the notion of “equality of opportunity” and “inequality of outcome”. The American dream. Much of the profits from that model have gravitated to those who provide rather than those who receive. Those who control rather than those who work. How might artificial intelligence change this?
How? The way social networks have changed society cannot be understated and likewise the role social networks could play for asset management. The key is one of engagement, individual control yet without losing the benefits of pooling investors, by creating social investment structures: mega-blocks. We have seen early signs such as “direct-index” exchange-traded funds (ETFs) but we can go much further.
Why? Recall that Karl Marx’s Das Kapital asserts that workers become disenfranchised in the capital model by capital owners and machines. How true that feels today where the paranoia of “artificial intelligence threatening jobs” pervades all media. The symptoms of that low engagement are a low savings ratio globally, wage disinflation and a lack of alignment (needs matching) between investors and asset managers. Workers typically don’t engage with their long-term savings plans until they retire, and too much control remains in the hands of employers, advisers and asset managers. It is why robo advisory is proving so difficult. Asset managers have never been more remote from the workers they are supposed to serve.
Perhaps perversely, that same technology could empower and re-engage workers back into asset management. It could remove the countless intermediaries that suck out the value of asset management. Yet instead, capital flows are being herded into a small number of indices, held in exchange-traded funds (ETFs), controlled by a small number of index providers and supersized asset managers. These ETFs neither accurately match the needs of the investor nor efficiently allocate capital back to corporations. It is groupthink on a multi-trillion scale. It, too, is symptomatic of the problem noted above but is not the solution.
A “New Fund Order” will herald change for the asset industry; Moore’s Law is unwavering in this respect. Indeed AI evolution is faster than linear, as Moore suggests. The industry has been in a stupor of old business models, commission, star manager culture, asset concentration, marketing, high costs, low transparency, lavish hospitality and poor fund selection. Asset management is beginning to detox from those heady party days. The party is over but for now the masses remain sedated on the methadone of vast market cap-weighted ETFs.
The reality is that ETFs also face issues. Capable of so much more than how they are being used today, they have been held back by a simple presumption that pooled investing is about cramming masses into a single model, yet somehow each trying to derive their own utility from it. Clearly it hasn’t worked, trust in asset management and active managers has never been lower, herding patterns are accelerating, as are the daily trading volumes of index products. The optical value of ETF has become a blunt question of only cost. A huge mistake, but one being driven by the index manufacturers and misplaced academics and pundits. Perhaps in their minds they chose the lesser evil. What started as disrupter is now supposed deliverer.
Meanwhile, concern turns to the asset concentration building among ETFs, as a result of using outdated index construction. In simple terms, the pooling of vast uncontrolled open-ended structures, funnelled into controlled closed-ended securities, is a recipe for Minsky-like commodity bubbles. Earnings, then, do not drive price, the order book does, the equilibrium between buyers and sellers. That may sound fair but as the order book is controlled by brokers motivated by profiteering, not workers, then it falls short. Instead, what we have is a growing index anomaly and a missed opportunity for ETF. I am now even more convinced that we are only at the beginning of ETF evolution. Fully dematerialized fund structures are the future, all others will become obsolete. It is no coincidence that active asset managers are rapidly buying ETF businesses, the potential for active intellectual property through ETFs is huge. This might be summarized as the move to “smarter beta” or codified alpha.
However, I believe ETFs will go even further in the future. I have already begun to structure and codify what “ETF 2.0” might look like. A complete rethink of how ETFs operate, in 2.0 investors will have individual pathways, cross-matching assets for expected return, risk, time horizon and maturity, investors trade through blockchain within the ETF, with fully dematerialized, frictionless trading between investors. The key aspect here is the simultaneous checking of the asset pathway, individual pathway and block pathway – I call this your Asimov test. ETF 2.0 will allow:
“Tech” is full of jargon but safe to say that “blockchain” provides us the necessary infrastructure and AI the ability to manage the block once created. The ETF becomes the centralized clearing agent for all of its investors and trades within the ETF, allowing instantaneous transparent straight-through processing (STP) and DvP, investors still benefiting from novation, fully dematerialized fungible assets and economies of scale (as with current ETFs), but now investor trades are matched inside the ETF, not simply pooled and traded outside on the market. It would make the investors within an ETF a complex adaptive community, trading as a block with other blocks and the rest of the market. Meanwhile ETF 2.0 would communicate continuously with other ETFs, exchanges and trading platforms to ensure correct real-time pricing.
Everyone shares the success of the ETF, assets and returns, weighted to their individual pathway and maturity. Workers become their own capital owners built on the principles of mutuality. The ETF provider deducts one disclosed cost to administer the algorithm, the trades and investors. While this may feel quasi-ponzi to some, this is no fugazi. The quandary left behind by Bernie Madoff (other than his conceit, deceit and fraudulent behaviour) was that the biggest failing of any ponzi is the incorrect estimation of cash flow and matching of assets over time. Eventually they run out of cash. The concept of cash-matching individual investors is itself well supported by liability-driven investing. The technology to match thousands of individuals has been beyond us, until now.
A rapid reduction in friction? Once an ETF is repurposed for individual pathways, rather than aggregated pooled outcomes, then assets are coded for cost, time and risk-matched to investors who need them. ETF 2.0 can trade internally, frictionless through blockchain technology, within the ETF and then only traded externally with the market when in net surplus of cash or assets. In effect we can create mega-blocks of investors, providing efficiencies in turnover costs and accurate investor-matched, risk-targeted allocations. This redesign of mutual investing would require a complete rethink in how asset management is structured today, including advisers, fund managers, fund investors, custodians, exchanges and clearing houses.
Suddenly, passive becomes social, benchmarks become meaningless, replaced by block economies. Each worker can view their own pathway to maturity in augmented reality from the comfort of their own home or on the move. Effectively, we would create a different pooled model and we haven’t even begun to think about quantum computing and isotopic algorithms and a hundred other cool bits of jargon that few of us properly comprehend. Science fiction is rapidly becoming a near-term indication of science fact; the lines are blurring.
To some “ETF 2.0” may sound like the onset of techno-Marxism on asset management; for others it is salvation. I explore the concept in detail in my FINTECH Circle Institute lecture and invite ETF innovators and coders to come together to create ETF 2.0 mega-blocks.