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Thursday, July 10, 2014

Is Covestor Creating a New Fund Distribution Channel?

Reported by Tommy Fernandez

Yeah, they're a social media investing site. Yes, they are small, with only $38 million in AUM. Yes, they are still evolving their business model. Yet, burgeoning online investing site Covestor just might be forging a new distribution channel for fund firms -- and disrupt the supermarket platform wars.

The move in question involves the creation of what the company bills as the Covestor Core Portfolios, ETF portfolios which come in three flavors: growth, balanced and moderate.

These portfolios have a $10,000 minimum per portfolio for investors. Total trading commissions related to the portfolio are estimated at around $20 annually.

In a statement announcing the launch, Covestor CEO Asheesh Advani declared: “For less than the cost of one Starbucks grande latte a month, investors can now own diversified, buy-and-hold portfolios from Covestor.”

Growing Fund Sponsor Presence
Those are not the only portfolios on Covestor that feature ETFs. Others include the Island Light Capital Growth Portfolio, the Island Light Conservative Portfolio, the Island Light Capital Balanced Portfolio, the Island Light Aggressive Portfolio, the Island Light Income Portfolio, the Beckerman Institutional Asset Allocation portfolio, the 401 Advisor Seasonal ETF Growth, the Sizemore Capital Tactical ETF Portfolio, the Atlas Capital Broad ETF, the Diversified Target Yield Bond ETFs, the Harloff Capital Opportunistic EFT, the Mosaic Strategic Asset Allocation Portfolio Everyday Portfolio, the Strategic Growth Allocation Portfolio, the Stable Equity Portfolio.

All-in-all, these portfolios feature products from at least 13 fund sponsors, including: iShares, Vanguard, Pimco, StateStreet, PowerShares, WisdomTree, Guggenheim, Market Vectors, Cambria, DB, BlackRock, ProShares and EGShares.

How Covestor Works
Some of you may not have been formally introduced to Covestor Here's how it works. First, it's an RIA. Investors sign up for an account where they park their money with a custodian. They then peruse the platform to pick from over 100 Covestor "portfolio managers" who run a variety of different portfolio strategies.

This is where part of the fun comes in: these portfolio managers come from everywhere. Some are RIAs, but others include soldiers who have served in Afghanistan, doctors, physicists, what have you. Covestor is highly democratic in its aspirations.

Once a client selects a "model portfolio," Covestor's custodian then links the investor's account to the these strategies, automatically investing the money according to that portfolio's allocations. When the PM changes the portfolio's holdings, the custodian similarly changes the allocations in the investor's account.

Covestor generally charges clients from 0 to 200 bps for investing in these portfolios, which it then splits between itself and the operators of these model portfolios.

A Platform without Intermediaries?
Covestor is one of the platforms that is trying to forge a place for itself in the Wild West of online investing. (Direct investing is expected to account for 28% of retail sales by 2018, according to a recent report published by McKinsey & Co..) Admittedly, online investing is still in its early days, for example Covestor is just six years old, and a number of firms are still desperately trying to figure out how to handle this space. Whoever finds a business model that works (be it Pimco and Vanguard bolstering their online presences, robo-advising, and so on) will create a new fund distribution channel, one in which intermediaries have a smaller role in the whole investing process. Call it Direct-Plus if you'd like.

Covestor represents one such business model.

CEO Advani had this to say on the subject to MFWire:

We believe Covestor can impact financial advisors in two key ways.

First, we are already working with financial advisors with an investment management background to include them on our investing marketplace. Advisors want to be on our platform for several reasons. Covestor can help with distribution, visibility, content marketing and social media, for example.

Second, we are also starting to see that some advisors are incorporating strategies on the Covestor marketplace into their clients’ portfolios. So this is part of the trend of advisors “outsourcing” investment management so they can spend more time with clients on advice, relationships and education. 

It makes sense for advisors to use Covestor for this: Our marketplace offers access to actively-managed portfolios and alternative strategies that are less expensive than hedge funds with transparent holdings, verified track records, full liquidity, and low minimums.

At Covestor, we think online investment firms will “disrupt” the financial advisor business in many good ways.  Services like Covestor are leading the trend toward transparency, and also putting pressure on traditional advisors to justify their fees. These are all wins for investors.

Yet at the same time, we don’t think online advisory firms will replace traditional advisors. Some investors will always want a human element, and emotions play a big part in successful investing. Frankly, that’s never going to change no matter how advanced and sophisticated the technology becomes. 

The bottom line is we think there will be hybrid models that enable advisors to focus on planning and advice, while the online firms will focus on the rest.

Who Are Covestor's "Gatekeepers?"
The three Core Portfolios are the responsibility of Covestor’s Chief Investment Manager, Sanjoy Ghosh, and his team.

According to a company spokesperson, Ghosh joined Covestor from PanAgora Asset Management where he was director of investments. He led the firm’s new investment product portfolio development for PanAgora’s Active Global, U.S., Emerging Markets, Extended Alpha 130/30 and Long-Short Products.  Prior to Pan Agora, he worked at Putnam Investments.

Covestor’s investment director, Alex MacAndrew, a CFA who previously worked for Dimensional Fund Advisors and UBS, also plays a key role in the ETF portfolio construction, according to the company spokesperson.

Much More to Come
The Covestor spokesperson said that the company has "several more portfolios that invest in ETFs in the incubation stage, where we carefully monitor them before making them available to clients. Products in the pipeline include equity, fixed income and specialized portfolios."

Moreover, she said, "As an online marketplace, Covestor does the majority of its marketing online.  We are growing our database of subscribers by over 25% per quarter.  It is now comprised of subscribers to our Smarter Investing newsletter, our iGuides, and people signing up for trial accounts."

Advani said that "Mutual fund companies should not feel threatened by online advisory firms.  It will take several years for retail investors to migrate from funds to managed accounts."

However, he said, "passively managed portfolios have been increasingly commoditized and technology has lowered the cost of managing these portfolios.  For example, the cost of establishing and running a mutual fund is much higher than the incremental cost of adding a few more portfolios to the Covestor platform. "

  "Mutual fund firms should focus on delivering lower cost solutions to the advisor channel and directly to consumers," he said.

  Advani said that "Covestor is frequently approached by mutual fund companies interested in learning about online shopping for managers vs. funds. Online shoppers find it easy to select a person rather than a fund since it is a more common online behavior." 

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