Over the last several years, robo-advisors and other fintech companies claiming to “disrupt” the financial industry have made enormous inroads into attracting investors and growing assets under management. The benefits espoused have primarily focused on:
- Reduction of fees normally associated with non-traded offerings, such as non-traded REITs and private funds.
- Ease of use to invest for unsophisticated investors. This includes fancy apps.
- Open to the largest pool of investors possible, such as non-accredited investors, foreign investors.
- For the case of robo-advisors, enforcing behavioral limitations to prevent investors from exercising their human emotion in an actively managed portfolio.
And this good! The problem is that they are also startup companies with VC funding, with large cash burn rates, big valuations and a need to big or go bust. Which means that while their mission is important, revenue generation is existential.
VC Money Covers Shortfalls in the Business Model
Fintech companies with VC money may make decisions that are not in the best interest of their customers in order to generate a profit and stay afloat. Which means that sometimes the mission takes a backseat, naturally, at the expense of its users.
When a fintech startup goes public, for example, the early investors and employees may not see the same level of success. This is because a public company is beholden to its shareholders and must generate a profit in order to continue to exist.
In 2018, the Wealthfront Risk Parity fund, internally built, imploded versus other risk parity funds created by professional quantitative investors. Wealthfront had the option of using third party risk parity funds, but the fees they could generate by attempting to create their own in-house fund that matched the performance of third-party funds was incredibly alluring. But that’s not their core competency, they’re technologists, not quantitative investors!
Of course anybody can hire top engineers and call themselves proficient. But that’s not how it works. Investing is hard, and for the best investors it takes years and years of experience and internalization. Real estate investors have years of experience and knowledge in the industry, which fintech platforms may not have. This experience and knowledge can help you maximize your returns and minimize your risk. If anybody could just hire investing talent, everyone would do it.
Backtest vs in sample risk parity performance comparison… Wealthfront vs AQR pic.twitter.com/NQ7LLxkUGH
— Jake (@EconomPic) October 10, 2018
And the result was a disaster. The S&P dropped over 3% on a single day, treasury yields increased, and the Wealthfront Risk Parity fund dramatically under-performed similar funds. The worst part is that they didn’t have their investor base opt-in. Rather, for many investors, they had to opt-out. But the whole point is that it’s a “robo-advisor”.
You’re signing up for Wealthfront because you don’t want to actively manage your portfolio. As a result, a large pool of investors took it in the teeth because a technology company, trying to find creative ways to generate revenue, strayed way outside their lane and crashed into a tree.
My pet thesis is this Risk Parity Fund came about BECAUSE their business model is terrible: Raise oodles of VC money for a low fee commoditized product with no exit strategy or even produce high yield income from the business. Uh Oh, better get creative . . .
— Barry Ritholtz (@ritholtz) October 10, 2018
Real Estate Investors First, Technology Second
Why, is this relevant to Streitwise? Because we see the same thing happening in the commercial real estate crowdfunding sector. Do you know, have you researched, have you questioned the incentives and the alignments of the actual people making decisions as to which properties become available on the crowdfunding platforms or the investment decisions made through other Reg A+ (or similar) REITs?
These are technology companies primarily, with a secondary goal of hiring real estate professionals. Streitwise is a real estate company first, using technology to make the investment process cheaper and process, second.
The Streitwise REIT, sponsored by an independent real estate investment company (Tryperion Holdings) with a history dating back to 2013, exists and will exist whether or not the move to online real estate investing becomes an entrenched trend. We have our money it, our family’s money in it.
For us, it’s about finding quality, long term investments, determined by a team that has decades of commercial real estate investment experience.
We want the entire sector to succeed, but many deals get capitalized because of shiny “projected returns” and the informational asymmetry of raising money online. We see properties acquired because money is available and the fees to the sponsor leaves little skin in the game, not because a particular opportunity has a good risk adjusted return profile. And when the Wealthfront phenomenon hits real estate crowdfunding, it won’t be pretty either.
Doing your homework on any investment is not “active management”, it’s essential to compounding returns over a long time horizon. Startup fintech mission statements make for great marketing collateral, don’t let it result in collateral damage to your portfolio.
Mr. Karsh is CEO and Co-Founder of Streitwise and Tryperion Holdings.
Prior to forming Streitwise, Mr. Karsh was an Acquisitions Analyst for Canyon Capital Realty Advisors and the Canyon-Johnson Urban Funds, where he was responsible for underwriting, structuring and executing value-add and opportunistic transactions. He holds a Bachelor of Arts degree in Political Science from the University of Pennsylvania. Mr. Karsh is a member of ULI and is also a Real Estate & Construction member of the Jewish Federation of Greater Los Angeles.