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When investing meets technology

26 - 12 - 2016 | Khairani Afifi Noordin and Maxine Yong | The Edge Markets

Technology is changing the way we invest. The emergence of financial technology (fintech) platforms has provided investors with innovative ways to manage their wealth via mobile or web-based applications.

These platforms typically match investors with the providers of portfolio management services, trading strategies and new or existing asset classes. With avenues such as equity crowdfunding (ECF), peer-to-peer (P2P) financing, robo-advisories and quantitative trading platforms, Malaysians now have the opportunity to diversify their investments, minimise risk and increase portfolio returns both locally and abroad.

Here are some areas where fintech is already transforming the wealth management landscape.

Robo-advisers breaking new ground

Of the investment vehicles in the market today, robo-advisory platforms may be the most innovative option as they replace the need for human decision-making in wealth management and advisory services. By answering a few questions, consumers are able to receive automated financial advice on things such as asset allocation, portfolio management and periodic rebalancing - all at a fraction of the cost of engaging a financial adviser.

These platforms are set to grow exponentially in the near future. According to a recent report by IT consulting company Infosys, robo-advisory platforms are expected to reach US$2.2 trillion in assets under management (AUM) by 2020 - a significant jump from US$19 billion in 2014.

Hong Kong-based 8 Securities Ltd is one of the more prominent players in Asia. After establishing its pioneer robo-advisory service, 8 Now!, the online brokerage firm is planning to launch a robo-adviser app, Chloe, early next year.

Powered by artificial intelligence and machine-learning technology, Chloe is designed to effectively learn day by day as the system’s user base and database grows and match products to customers with different financial needs. For a minimum investment of HK$1,000, investors will be able to access a diversified portfolio that covers 28 countries, 34 industries and 1,637 stocks and bonds via exchange-traded funds (ETFs), says 8 Securities executive chairman Mathias Helleu.

“When it comes to savings, we all face the same issues, we all have financial goals to reach. We want to have access to a diversified portfolio with a reasonable fee, flexibility and simplified solutions - something that is not available today,” he points out.

“Therefore, we feel the need to introduce this service with a low entry point, under 1% annual fee and no other hidden fees. A service where you get the total flexibility of getting in and out of your portfolio at any time, any day, and at no cost. A service that has a user-friendly format on mobile. That is the kind of product we are trying to develop.”

Despite the large untapped market for robo-advisory services in Asia, Helleu says it remains a small segment at the moment. “We are seeing quite a big movement in the business-to-business (B2B) segment. But the business-to-consumer (B2C) segment is quite limited in Asia. Even in Japan, there is only a handful of companies offering robo-advisory services.”

“While this provides us with some advantages, there is a clear need to educate the public. Hopefully, some other players will join in as well to create an ecosystem in the market.”

Meanwhile, New York-based Wahed Invest is looking to change the investing landscape with the world’s first Islamic robo-advisory platform. Launched on Sept 26, the platform aims to optimise investors’ portfolios with shariah-compliant assets that offer the greatest returns for the minimum amount of risk.

CEO Junaid Wahedna says the platform scans securities on 24 stock exchanges, including global equities, emerging market equities, US equities, real estate investment trusts, commodities and fixed-income instruments. Although the platform is targeting the two billion Muslims around the world, Wahedna says it is open to anyone interested in ethical investing regardless of their faith.

The idea for the platform was conceived by Wahedna when he was working with an investment bank in the Big Apple. “A taxi driver from Bangladesh told me that he had more than US$50,000 to invest, but he only wanted to invest it in a halal way. Someone at his mosque had told him that Apple’s stock was shariah-compliant, so he told me that he wanted to put all of his savings into that one stock,” he says.

“I told him that it was a really bad idea and that he should diversify his investment. When I asked him why he did not go to an Islamic financial adviser, he told me there was no such service willing to cater to him unless he had over a million dollars.”

“He is right - even the wealth management divisions of Islamic banks need you to invest more than US$2 million. So, what can the rest of the Muslim population do? How can they invest their wealth?”

While there is an abundance of options in countries such as Saudi Arabia and Malaysia, they are not available in the rest of the world. Because of this, Wahedna came up with his concept and launched the platform in the US. He plans to launch globally early next year.

“We aim to provide the services that the elites receive to the man in the street. Our minimum investment is as low as US$7,500 - only a fraction of the usual US$500,000 minimum investment required by most conventional wealth management firms,” he says.

In addition, Wahed’s services are transparent and its investors’ portfolios are entirely liquid, making it a better option than the traditional deposit accounts offered by financial institutions. It takes pride in its strictly shariah-compliant investments and ensures that the firm and all the securities it trades in are monitored by its ethics review panel.

“If you go to a normal wealth manager, you give them your money and that’s it. You cannot monitor and track where it goes. Mutual funds do not disclose security on a daily basis. They only do so periodically. So, how do you assure yourself that your money is going to ethical investments? With Wahed, you know exactly where your money is, in what securities, at all times,” says Wahedna.

As the firm attempts to penetrate the global market, regulations will be its biggest challenge, especially since the platform may take away a huge chunk of local banks’ market share in those countries, he says.

“If we can achieve the level of efficiency that we are planning to reach, there will be absolutely no need for one to go through a wealth manager anymore. It will be cheaper, more accessible and more transparent. So, the banks’ wealth management division will not be relevant anymore.”

“This really takes away from a local economy because the money is leaving. Thus, regulators will not be happy and may restrict it. That is the biggest challenge we foresee.”

Malaysia is one of the biggest markets for Islamic robo-advisory services, says Wahedna. Plans to penetrate the local market are in the pipeline. And there are two ways for this to happen - either the firm will enter the market independently or it will do so via an institutional partnership, which will make the entry a lot easier.

“We are talking to a few institutional investors to collaborate with us, but it does make the timeline a lot longer than we would want,” he says.

Another challenge is offering the platform in the local currency, says Wahedna. ”In most parts of the world, securities are based in US dollars and people want to invest in US dollars. In Malaysia, however, the local economy is so advanced that people want to invest in the local currency. This means we have to build a separate system for Malaysia.

“Chances are, we will only have US dollar offerings worldwide before initiating localised offerings in local currencies. We foresee the launch of the US dollar one in the next two to three months. The localised alternative will only be available in the next six months.”

Letting the machine do the trading

Quantitative trading, which uses automated algorithmic strategies, was once the domain of fund managers or highly savvy investors. But in recent years, it has been adopted by more individual investors to enhance their returns, especially in this global environment where many strategies have not been as effective as they could be.

Professor Alex Frino, deputy vice-chancellor and professor of economics at the University of Wollongong in Australia, says quant trading has brought significant efficiencies to the global markets. One specific way it has done this is by lowering spreads - the gap between the sell and buy orders of a specific stock.

“Lower spreads mean that investing is cheaper for all participants, including retail investors, because they don’t have to ‘cross the spread’ to trade. My research over the years has looked at the impact of high-frequency trading (HFT) in particular in many of the world’s marketplaces. Without exception, we have found that HFT has a beneficial effect on overall market liquidity in equities and futures markets,” he says, adding that some people are quick to blame trading glitches on quant trading simply because they do not understand it.

Kris Longmore, an algorithmic trading and machine learning specialist, agrees that a quant model can be used to reduce the cost of buying and selling by optimising trade executions. Money saved on transaction costs is money in an investor’s pocket, he says.

Other benefits include automated and optimised risk management and the benefit of understanding a model’s prior performance through simulation on historical market data. However, Longmore warns that these can quickly turn into a disadvantage if used incorrectly. This is especially true for individual investors as quant trading requires a certain skillset that is typically quite multidisciplinary, covering mathematics, finance, econometrics and computer science.

How successful is quant trading in Asia? Frino says it varies tremendously as some Asian markets, such as Japan, are dominated by algorithmic traders, whereas other markets with less sophisticated infrastructure are more difficult to trade in this way.

“In our region, the markets most conducive to electronic trading, both in terms of infrastructure and regulations, are Japan, Australia and Singapore, with Hong Kong in the picture but hampered by the low speed of that market. There are a lot of opportunities to exploit inefficiencies, which is where algorithmic strategies really shine. So, there is fertile ground here for good quants to find success,” he says.

Jonathan Larkin, CIO of Quantopian, a crowdsourced quantitative investment firm, says many quant trading strategies rely on small but persistent information advantages. To see the real benefit of these trades, which have small expected profits per trade, investors often need to place many trades across a large number - think hundreds or even thousands - of trading instruments.

“For a typical retail investor with a limited amount of capital to trade, he may be limited by the cost of trading, by the ability to borrow and sell stocks short as a hedge or by the access to the data and trading platforms needed. These are actually areas where Quantopian has found a strong demand for access to open-source and low-cost data and tools for individuals to learn about and develop quant strategies,” he notes.

Larkin says quant trading strategies fail not because the investment rationale is flawed but rather the technical implementation is faulty. This is where platforms such as Quantopian shine as they take implementation and operational risk off the table.

“These risks include real-time market data handling, historical simulation, third-party data integration, symbology, matching production trading to simulation, performance attribution and reporting. These are many non-exciting but absolutely essential items to get right. Quantopian’s implementation here is battle-tested by thousands of users,” he says.

Longmore believes quant trading has its own regulatory implications. For example, the “black box” nature of some quant models and the resultant lack of transparency, data acquisition and privacy issues, and the reality that a degree of regulation is necessary. In an ideal world, regulatory bodies would provide a space for an objective debate about the issues and use to inform their regulatory practices.

Frino says his research has found that algorithmic trading is much less of a threat to markets than some naysayers would have investors believe. While sensible market regulation is very important, it is also important that regulators do not stifle markets by putting knee-jerk regulations in place to control something they do not really understand. There is room for regulators to have a lot more expertise in these matters so as to better manage this kind of trading in their markets.

Where is quant trading headed next? In the short term, the upgrades of less sophisticated Asian exchanges will allow for quant strategies to be deployed in new markets for the first time, says Frino. Over the long term, new technologies such as quantum computing will change the game again. And no one knows what that will look like.

Blockchain brings transparency, efficiency and healthy profits

Blockchain, the technology that underpins the world famous bitcoin, has garnered a lot of interest outside the cryptocurrency sector in recent years. As a distributive ledger, it would facilitate the operations of various sectors, especially banking institutions, to become more effective and efficient.

Last month, the Monetary Authority of Singapore announced that it was partnering R3 - a blockchain technology company - to conduct interbank payments using blockchain technology. The project, which involves eight banks, could possibly create a payment system for participants to transact in different global markets that are today limited by time zone differences and office hours.

What does this signal to investors? Ruben Tan, co-founder and chief technological officer at Neuroware, says the hype around blockchain is an investment opportunity for investors hungry for actual technological innovation. He thinks it resembles the rise of the internet and pre-dotcom era of the 1990s. Investors who missed that train can ride this new tech innovation boom.

“This year alone, we have seen more than 100 banks start blockchain projects and over US$1 billion in funding from venture capitalists entering the ecosystem globally. With Singapore leading the way in the development of blockchain, Malaysia has been hard at work behind the scenes,” says Mark Smalley, co-founder and CEO of Neuroware.

The company prides itself on having a team of technologists that helps organisations and individuals explore, adopt and implement blockchain technology. Based in Kuala Lumpur, it also develops tools, training programmes and protocols for businesses that want to benefit from the distributed ledger technology.

Smalley notes that most of the hard work of Malaysians put into developing blockchain has been going on behind closed doors with careful planning. In the past few years, Neuroware has been working with and educating institutions and regulatory bodies throughout the country on the technology.

“From an investment perspective, it is already making waves within the ECF space and is expected to massively impact the newly regulated P2P lending platforms. There are companies that focus on developing blockchain solutions. Some players are also experimenting with it as the foundation for new secondary markets here,” he says, adding that all these point to plentiful investment opportunities.

According to PwC’s latest report, Catching the Fintech Wave: A Survey on Fintech in Malaysia, the technology has immense potential and financial institutions cannot afford to continue to remain in the dark. Survey results show that 94% of fintech respondents were moderately to extremely familiar with blockchain while only 46% of financial institution respondents thought so.

“To put blockchain development into perspective, PwC’s Global Blockchain team has identified more than 700 companies entering this space and believes 150 of them are worthy of being tracked,” says the report.

What are the challenges for blockchain to take off in this country? A lack of education and a lot of misconceptions about blockchain and the “overly conservative” investment climate where investors are reluctant to invest in technology companies, says Tan.

“Currently, there are no standards committee or developer community overseeing and educating on blockchain development. I think what we need is not tighter regulations but more collaboration from the regulators,” he says, adding that as there is no way to regulate the HTTP protocol, there may be no recourse to regulate blockchain.

Smalley says the future of money is digital and Neuroware knows that with certainty. Many new commodity trading platforms are powered by blockchain. The multibillion-dollar question is: Who will be holding the ledger? He thinks Malaysians should find a way to hold it.

P2P financing altering investment landscape

P2P financing or lending is seen an alternative vehicle for investors looking for returns in the current high volatility, low interest rate environment, says Umar Munshi, CEO of the newly registered P2P platform operator Ethis Kapital Sdn Bhd. Besides being able to increase portfolio diversification and minimise risks, investors now have access to deals that were previously not made available to them.

“It is tough to find returns in today’s market where everything is volatile and it is difficult to predict returns. But with these new investment vehicles - P2P lending, for example - you can still look for growth areas and profitable deals. As P2P operators are a lot more nimble than big financial institutions, we are better at looking for those deals,” says Umar.

As the new vehicles have made investing a lot easier for individuals, there has been exponential growth participation among retail and sophisticated investors. This, he says, will eventually create a great impact on the traditional investing landscape.

“Over time, as more people get on board, the effects will be amplified and the platforms’ growth will snowball. The ease of user experience will attract more investors to come on board, and this will have a great impact on traditional investments because there will be a shift in the direction of the money,” says Umar.

“Meanwhile, for the younger generation of investors, these will be their first investing interactions. Since these technologies have eliminated the need for them to actually talk to investment bankers, manually fill in paper documents and all that, they will no longer be interested in exploring traditional approaches of investing. Think of it this way - now that there is Uber and Grab, would you spend half an hour by the roadside trying to flag a taxi?”

The new investment vehicles also allow for faster transactions, which is a significant value add in the investment process. “In some countries where the ecosystem of such investment vehicles are mature, instantaneous transactions are possible. Some leading P2P operators, for example, are able to give credit analysis and provide funding on the spot,” says Umar.

Although such speedy transactions may not be available in markets where investment vehicles such as P2P are still in their infancy, that may be possible in the long run, says Umar. “Here, we do not have sufficient data or a system to make such decisions through an algorithm or programme yet, so it will take some time. There are also regulatory treatments that we need to address.

“For example, at Ethis Kapital, the money will need to go through a trustee company before the deals are sealed. If this process is fully integrated, better speed can be achieved.”

Umar is no stranger to the P2P financing and crowdfunding industry as he is the founder of Singapore-based Ethis Ventures, which has a portfolio of four companies, including Islamic crowdfunding platform Ethis Crowd and Islamic P2P-crowdfunding hybrid platform Kapital Boost. Ethis Kapital is the only Islamic P2P platform operator registered with the Securities Commission Malaysia.

He says Ethis Ventures was established because there was a need for Islamic approaches in investment platforms such as P2P and ECF. He points out that there are many conflicting objectives at big commercial entities such as Islamic banks since there is a need for them to address shareholders’ interests and the bottom line, among others.

“Whereas for us, we do not have to address these factors. We only focus on funding fast growth, sustainable companies that are serving the community. What we have found over the years is that ECF and P2P projects actually move faster when there is a social angle because when people feel that they are supporting a cause, they will spread the word more,” says Umar.

Kapital Boost provides short-term financing alternatives to SMEs via a murabahah structure. They may also finance projects through a mudarabah structure, where the platform will raise funds to purchase physical assets for the companies’ operations.

“For example, you may have a work purchase order invoice and you need some cash to pay for this before you can start making your products. So, what we do is, we buy materials for you and sell them to you at a marked up price. Afterwards, you do your business, get paid and pay us back,” says Umar.

“For these types of financing, we go through core screening processes such as cash flow, commercial viability, business viability and industry analysis to assess their payment ability. We also apply alternative screening methods such as social media analysis and psychometric analysis if needed.”

The mudarabah structure has proven to be very effective as most of the successful campaigns on Kapital Boost is based on the structure. Some companies even went through several rounds of funding.

“For example, there is a batik producer that once received an order for 3,000 scarves. It issued the campaign on the platform and managed to raise the S$50,000 that it needed. The company was so happy with the outcome that it subsequently issued two more campaigns and both of them reached their intended goals,” says Umar.

Since its launch in July last year, Kapital Boost has raised more than S$1.2 million for 22 small and medium enterprise (SME) campaigns, with an annualised average return of 22%. As at Oct 27, 12 of the campaigns had paid off their funding.

Ethis Ventures has managed to get 50,000 registered investors from across the region, about 2,000 of whom are Malaysians. While most of the registered investors are between 30 and 40 years old, those above 40 contribute higher amounts of funding.

“This is why we need to do something to fully reach out to the older generation of investors who are less tech-savvy. From our surveys, we can see that they are actually very wary about the validity of these new investment vehicles. We need to make them understand that we are not a scam. We are actual credible investments. Of course, the risks associated with the investments are real too,” says Umar.

Education is a major challenge in this space, he adds. To push for faster growth, there need to be more interventions by the government, media, educational institutes and other stakeholders to provide sufficient information to the public on how the investment vehicles work.

“The retail crowd is very important. That is the uniqueness of these new vehicles, right - to let normal people invest? But we do realise that there are limitations, such as the need to look out for their interests and education needs. The man in the street may not be very savvy at investing. He may even put his life savings in there and lose it all, so we are considering how to manage these things,” says Umar.

He says there is a need to bring in bigger funds from institutions and the government to minimise the risks involved in P2P lending. Currently, several parties have expressed interest in partnering with the company, including those based in China and the Middle East.

“This is a key value preposition of a P2P platform - the fact that we can aggregate and bring in different types of funds from institutions, the government and individual investors to real-world projects. Each of these funds have different motives, objectives and focus. So, when you mix them together, they will be able to synergise well,” says Umar.

Regulating fintech

In response to the wave of digital investing options, some regulators have put in place frameworks to create a more robust, sustainable and credible industry for providers and investors. For example, Malaysia is the first in Asean to regulate peer-to-peer (P2P) financing when it announced six registered platforms on Nov 3. It is also the first in Asia-Pacific to legislate equity crowdfunding in June last year.

At the SCxSC Digital Finance Conference 2016 recently, Securities Commission Malaysia (SC) chairman Tan Sri Ranjit Ajit Singh said these moves were driven by several factors, such as strong demand for alternative financing from SMEs and new investment avenues for investors. Other factors included the widespread adoption of internet devices and social media, a change in demographics towards a more technology savvy and connected generation of consumers, and less burdensome legacy systems to allow the leapfrogging of technologies.

The SC will introduce the Digital Investment Services framework next year. This will allow approved licensees to offer automated discretionary portfolio management, which is a more cost-effective, accessible and convenient channel for investors to manage and grow their wealth.

“Thus far, the SC has received positive feedback from market participants and understand that there is strong interest to offer such services in the Malaysian capital markets once the framework is released,” says an SC spokesman in an email interview with Personal Wealth.

He adds that the SC is closely monitoring the emergence of the distributed ledger technology, which includes blockchain, and is evaluating its use in the capital market. Engagement with market participants on the implementation of the technology for specific use cases have already taken place and the process will continue next year.

The SC believes that facilitating growth and innovation and having a clear regulatory framework for market-based financing will provide certainty to issuers and investors. “In line with our regulatory mandate of protecting the interests of issuers and investors, the SC is cognisant of the risks that could emerge from these new market segments. Having the regulatory frameworks with the appropriate safeguard mechanisms will help protect issuers and investors,” says its spokesman.

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