Strateer Blog

It still surprises me. Most online broker accounts are inactive and nobody is doing anything about it. Even though most of these accounts have a balance and/or open positions. In fact online broker generate 90% of their transaction revenues with just 10% of their accounts.

It seems like the business model of online broker firms has been so far: drive an aggressive marketing campaign to bring in bodies and then hope that some of them are active investors. Those people that turn out to be active investors get a lot of additional services and tools (most of these too complicated for me) to make them stay as long as possible and to not make them move to the competition. So everybody is fighting for this 10% of active accounts. Nobody cares about the other 90%.

I am one of those 90%. I am too busy to follow my portfolio each day, but I know what I should do: limit my losses, manage my risk, lock in my profits, sell my loosing investments (my wrong ideas) and try develop as long as possible my winning investments (sometimes I am right). This has nothing to do with market timing. This is intelligent buy-and-hold.

It would be easy to get me to trade: My online broker firm should monitor my position for me. I do not want a tool that I have to use/understand. I want my broker to just monitor my positions for me. Automatically.

So when I lost a certain amount, I get an email giving me an update on my position, telling me what the situation of that stock is right now and providing me a link to trade. Or when I made a  nice profit that is at risk of being lost, I get an email telling me that now could be a good time to lock-in those profits - nobody went broke from doing that yet.

Turns out that online broker firms do not follow what their customers are doing. They do not upsell. They ignore the inactive accounts, even when it would be so easy to create a set of default alerts for each position one of their customers enters (hey, I can always opt-out of these alerts).

But I think this is changing. The margin/balance business of online broker firms is dead. Options volume (very profitable) is declining and everybody is bracing for a reduction in trade activity. Now it is the time to think about way to generate incremental revenue. I think we can help with Alerts4All.

When I mention Strateer to people I meet, I often get a surprised look. Starting a company that provides a better way to invest into the stock market seems to be completely insane to people given the current state of the financial markets. People behave as by the end of year there will be nobody left that owns stock. So let’s close the stock market - the last one please switch off the light.

I have a contrarian point of view: There will be still a stock market next year, and as well the year after that. And there will be investors buying and selling stock. There will be even individual investors. And they will have the same problems that they have now: They want to improve their performance and they are still too busy to follow the markets constantly. Furthermore they are non-systematic, emotional and in general should not invest. But they do, some to well and many more could do well.

I would conclude that therefore there will be retail brokerage firms in the years to come that service these people. And these firms will have the same problem they have today: 90% of their revenue is generated by 10% of their accounts - because all the other account holders are too busy to log into their account every day/week.

If we had a company with a high burn rate, I would be concerned. But given our size and stage the timing is all right (okay, I could do with a little bit less negativity around me). We will need 24 months to launch and establish our service. By then people will realize that the stock market is still open and alive.

There are many reasons why New York should be the center of the universe (it has been to me since I moved here in 2002) but in terms of tech startups, New York seems to struggle compared to the usual suspects on the West Coast or even Boston.

One reason that is always thrown into the discussion amongst NY based startups is the tech brain drain by Wall Street. For many engineers the job security and lofty salaries paid by banks and hedge funds made joining a startup seem a dumb idea. Furthermore the lock-in effect of end-of-year bonuses created a timing-problem. When looking for that great engineering candidate, a startup does not have 6 months time to wait.

This problem might have gone away – at least for some time.

Risk of joining a startup
Amidst the financial meltdown we now see major Wall Street firms cut headcount in IT. In earlier downturns we saw headcounts in administration and on trading floors shrink but IT always seemed to be excluded. Not this time. I have friends at Merrill Lynch that got all projects stopped right now and that have been told to wait for the announcements what will happen after the merger with Bank of America. Whose platform will the bank consolidate on (I heard Merrill’s might make the race)? What about the teams that work on the discontinued platforms?

Janco Associates, a management consulting firm, earlier this fall declared that the financial firms’ woes will glut the IT job market. According to them and based on interviews with sources within Lehman Brothers and Merrill Lynch it has been confirmed that a large number of IT professionals in both organizations will lose their jobs by the end of the year. More than 230 IT professionals at Lehman Brothers who make $250,000 or more a year will be out of a job by year-end. At Merrill Lynch, more than 180 IT professionals making more than $250,000 a year will be without work as well. And let’s not forget all those hedge funds that will blow up over the next couple of months. A friend of mine just left his position as Head of Software Development at a midsized Quant Hedge Fund ($400M in assets) to start his own tech startup. According to him, most funds below $1B in managed assets will not survive the next 6 months.

So the relative risk of joining a startup, right now, has been reduced significantly.

Salary
For those engineers that do not loose their jobs as part of the downsizing, there is still the salary aspect. It is true that most startups probably will not be able to match the salary levels enjoyed on Wall Street. But next years bonuses are quite uncertain right now. This removes already one lock-in reason to join a startup right now.

But there is another reason that might make the salary question become less important. In the last weeks I spoke to quite some engineers from investment banks and hedge funds - we are hiring financial service engineers right now. None of them liked their job in financial services too much from a technology perspective. Some guys from Lehman Brothers were fed up having a very narrow scope in terms of technologies and relevance of their projects. The  same I heard at Merrill Lynch. They are looking for the satisfying experience of being part of designing and implementing and application end-to-end across all layers. Something a tech startup  is all about.

Eventually great engineers want to use interesting technologies to solve challenging problems. Wall Street’s huge IT departments with headcounts of a couple of thousands in each major firm did not do a good job to provide an environment that is interesting to work in. In the end great things are achieved by a small team of great engineers. As an example a major investment bank used to have a problem with their equities execution platform, which had become a piecework of many different platforms acquired over the years. When it came to build a new global equities execution platform they set up a team of only 10 engineers to build it. That leaves many engineers with boring maintenance and life support for legacy systems.

The financial crisis removes a major obstacle for the development of the NY tech startup scene. Engineers from Wall Street are joining startups – Josh Koppelman created a website for them (www.leavewallstreetjoinastartup.com) - or founding their own startups. Strateer is one of them, somebody else is working on build a discount consumer platform to trade government bonds and another company was founded to compete with rating agencies for better credit ratings, using mathematical models and natural language processing. There are many more.

Unfortunately though, this is only one (positive) effect of the financial crisis for NY tech startups. At the same time when hiring tech talent becomes easier, it be comes extremely challenging to raise money. VCs, in anticipation of a nuclear winter, are keeping much more cash in their funds (I heard a number of 40%) to help provide liquidity to their existing investments during the next year if needed, and Angels are preserving cash for what ever comes next year. But that topic has been covered already extensively during the last weeks.

Today the stock picking site Kaching announced that they have become an SEC registered investment adviser. I believe other stock picking sites like CoVeststor have done or will do the same. Becoming a registered investment adviser points into the direction social investment communities are heading: Taking on the Mutual Fund industry. We will provide as well alternatives to the Mutual Fund industry who is bloated, too expensive and performs mostly worse than the market does. However I do not believe stock picking is the right way to do that. I repost a comment to stock picking I left on Techcrunch:

“‘Of the 350,000 portfolios on kaChing, 1,500 have actually generated positive returns…’ The problem with ranking is, that it does not contain positive information value. When you rank, you always get winners - question is whether this is luck or skill. Not the performance but the risk adjusted performance of a portfolio is relevant. All these ‘winner portfolios’ have huge Beta’s. Another problem with ranking fantasy portfolios: What if a user generates two portfolios, one bullish another bearish. One of the strategies will win but this does not mean that the owner of the portfolio is a good stock picker. Having said that, I believe social investments and taking on Mutual Funds is very interesting. But there are problems attached on how to identify long term winning strategies.”

I believe following arbitrary stock picks is not providing real value to individual investors. It the strategy, the systematic investment that creates long term winning investors. That is what we are focusing on with Strateer.

Roger Ehrenberg wrote a great post about ’short-termism’ (see here).

Similar to the ‘weight-loss’ self help books that Roger refers to, there is no easy and fast way to get rich by investing in the stock market. All books, all newsletter or websites that suggest they have the right method to get rich fast exploit an inherent impatience and greed that is probably the biggest factor for investment failure for individual  investors. It is striking, that today the launch of triple-leverage ETFs has been announced. Apparently current volatility is not enough. Given that the double-leveraged ETFs are more popular than their non-leveraged cousins I am sure there will be plenty of demand for the new ‘Basement Bomb-Building Kits‘.

Instead of chasing the dream of getting rich fast and getting ripped of in the processes of trying, investors will have to learn to be realistic.

Individual investors need a good system (Diversification, Risk Management, Profit taking), the right investment horizon and discipline to follow it through. Unfortunately as most individual investors are busy, they do not have the time to follow such a system manually. So they ‘outsource’ this job to mutual funds or index certificates. Unfortunately those strategies have not served the individual investor well in the last couple of years.

The vision of Strateer is to empower the individual investor with better, easy-to-use institution grade tools. This will help the individual investor to become a better investor and generate better returns.

However, in a recent discussion the question was raised, whether the individual investor should invest in individual stocks at all. The best strategy for an individual investor is supposedly a well diversified portfolio with a long term investment horizon and with few trades. But that is not what individual investors do. Recent economic literature actually identified that contrary to the normative prescriptions retail investors hold concentrated portfolios with only a handful of stocks and they trade actively those stocks.

So why do individual investors buy individual stocks (there are 34M retail brokerage accounts in the US)? Are individual investors stupid? Why do individual investors deviate from what standard portfolio theory prescribes?

First of all it is important to us that individual investors trade individual stocks. However we believe that you can only build a long term business on  providing value to your customer and not by benefiting from the fact that there are stupid people in this world.  Therefore, given that we agree that the standard portfolio theory has merit, it is important that those investors who do invest in individual stocks are not stupid.

Some famous professional investors state that the individual investor can be successful in the market: Peter Lynch said “The amateur investor has numerous build-in advantages that if exploited should lead to a better performance than the markets.” Warren Buffet said “The average investor with only average intelligence can consistently outperform the market”. Hopefully these two gentlemen did not say that to sell more of their books.

An interesting article by Korniotis/Kumar analyzes the cognitive abilities of individual investors that invest in individual stock. Economic literature so far indicated that investors do not build a diversified portfolio either because of informational advantages or due to psychological biases (familiarity of the stock suggesting information advantage, over-confidence, wrong risk assessment).  In other words, they either know something or they are victim to misjudgments. In their article the authors group the investors by cognitive abilities and show that the group that is smarter is consistently outperforming the other group. This is quite intuitive: There are smart investors and dumb investors. The first group is able to generate market or above market returns, the other group consistently under performs.

The important take away for us is: Not every investor that buys individual stocks is stupid (intuitive, no?). In fact there are smart investors, that know how they should invest (broad portfolio allocation, value investing, long-term systematic). The only problem is, that they have no way to implement what they know they should do. They cannot manually analyze a broad portfolio because they do not have the time, mutual funds are not the solution (expensive and under performing the markets on average) and index certificates are no sure thing in side way moving markets (which we believe is what we will see over the next decade).

This is where Strateer offers help: We will provide the tools that allow investors to build the right system for them. Such systems might be broadly diversified or just based on a hand full of stocks. The system might be value orientated, momentum orientated or a combination of both. The system might have a short term horizon and trade actively or it might just trade a couple of times a year. But they will be a better alternative to manual and time consuming excel spread sheets, expensive and underperforming mutual funds and buy-and-hold index certificate investments.

People keep telling us, that hedge funds are very secretive and would never let anybody come close to their strategies.

Interestingly I heard the same before a couple of years ago when it came to CRM data. Back then the question was, would companies trust a hosted solution (e.g. Salesforce.com) with their most private and business critical sales and business development information. Turns out, that as soon as somebodye provides an easy and reliable solution to a pressing problem (I have experienced myself the pain of operating and customizing a CRM solution  and spending north of $500,000 on it) all other issues become secondary.

We believe the same applies to hedge funds when it comes to operating their technology. So while we are at it to provide a hosted hedge fund solution we will even take it one step further and make it that easy to use, that you don’t even need to be a hedge fund anymore - every investor is a potential customer to us. Howard Lindzon wrote a related post regarding Transparency and Reputation.

Today small businesses have access to hosted enterprise level CRM tools . Soon small investors will have access to hosted institution grade hedge fund tools. But providing tools is only the first step for us. Connecting investors and allowing them to collaborate and benefit from the crowd’s wisdom are the benefits that a hosted solution can offer.

The NYSE released its newest set of statistics on program trading. This summer a quarter of all trades on the NYSE will be executed through Program Trading. That means the the buy/sell orders are initiated automatically by a computer program. Interestingly 100% of these trades are executed by institutional investors. The individual investor is left out here.

Many of these trading programs are dedicated to exploit price arbitrage opportunities and only work if they are highly leveraged. These programs lead to hundreds of trades every minute - sometimes even more. With prices from retail brokers between $4.99 and $9.99 per trade these arbitrage strategies are not feasible for individual investors.

However, the ability to automatically analyze market data and trade accordingly seems to be valuable to individual investors as many of these are struggling with a lack of time to follow the markets. Additionally, many individual investors tend to have no system on when to buy and - more important - when to sell. The interesting question for us is therefore: How can we leverage institution grade technologies to provide better tools that are optimized to the individual investor.

In the coming posts we will dig deeper into this question and show some approaches that we have come with.

Howard Lindzon posted on his blog about the trouble most individual investors have selling stock. He has repeatedly talked about the need to have an Exit Strategy when entering a position.

We at Strateer could not agree more. In fact that is one of the problems we want to solve for private investors. Many people buy stocks upon impulse without knowing when to sell them (either taking profits or cutting losses). In addition to that, they don’t have the time to constantly watch their positions - most people have a life.

Our first product that is scheduled to launch shortly will address this issue with an easy to use, straight forward tool. More to follow soon …

This week we are finalizing our market data providers for our Alpha launch next month. After talking to 6 different vendors I am truly amazed on the complexity that has been added to a seemingly simple problem: Getting market price data streamed from one service provider (that collects the data from the different exchanges) to our our data server.

Connectivity
Different ways to connect for every service provider. While this was not totally unexpected, I would have hoped that some vendors had integrated some standard market data formats, for example FIX. This would have allowed us to use some open source libraries for connection handling and data parsing. We are looking for an Internet connection - dedicated line is not an option as we are planning on running our whole infrastructure on Amazon’s Webservices (AWS). The variety that we get offered, from local API (one vendor only offered a Windows DLL) to open socket to VPN tunnel is quite amazing. Unfortunately this increases the changing cost and makes it difficult / expensive to evaluate multiple vendors at the same time.

Data
The market data is collected from different exchanges and sometimes not even directly from an exchange but from another third party that aggregates data. Therefore each vendors structures and normalizes the data differently. Some for example always send consolidated volume with each price tick, others send sometimes incremental volume (that means we have to add it ourselves) and sometimes updated aggregated volume. So we have to be careful to look at the data structure in detail.

Pricing (or what is it with delayed vs. non-delayed data?)
That is the most confusing part of this. First we have to pay our data providers a fee to get their data pipe connected to us. Most of them have a flat monthly fee for this, some try to participate on our monthly user fees. So far so good.

But then we have to register directly with each exchange (we will start with NYSE, NASDAQ and AMEX) to be licensed to show market data to our customers (and even report personal data to the exchanges). While we do not have to pay a fee if we show/use delayed data, we have to pay a per-user fee for each customer that we provide with real-time data. You would think that in a competitive environment, prices would tend toward marginal cost of provisioning the service. Here the exchanges have $0 marginal cost for each additional user we sign up. The data is there anyway and it is already broadcasted to the data providers. So why can the exchanges still impose a tax on their real-time data (while they give it away for free if it is 15 min delayed)?

It looks like competition will finally get to this: Since Monday BATS Trading, an ECN, provides its real-time data to Yahoo! Finance (Press Release). They probably don’t do it for free, but they do it for a fixed fee that is not user based. That is a start. A little bit later that day, NASDAQ announced that they would provide a way to allow free access to its real time data as well. Google Finance for example uses this service. I heard that they charge a flat fee of $100,000 per month. Not really interesting for a startup, but again a start in the right direction.

I predict that in 2 years, real-time market data will be free of any license fees to the exchanges - of course data providers will (and should) charge for their service to collect, normalize and deliver market data. Hopefully they will standardize their interfaces a little bit.