ETFs as an Open Platform

This post originally appeared on the Wealthfront Blog on March 20, 2014, under the title “Wealthfront Named ETF Strategist of the Year.” This post summarizes the content of the speech I gave at the ETF.com event in New York when accepting the award.


T
oday I am proud to announce that Wealthfront has been named the “ETF Strategist of the Year” by ETF.com (formerly IndexUniverse), the world’s leading authority on exchange-traded funds. We are especially gratified to be chosen for this award from among all investment management firms that use ETFs, not just new entrants.

At Wealthfront, we strive to build a world-class investment service and we’re proud to have assembled an unparalleled investment team led by Burton Malkiel. Over the past year, we added asset classes, released an improved and more diversified investment mix, delivered different asset allocations for taxable vs. retirement accounts to improve after tax returns, and launched the Wealthfront 500. In short, we aim to relentlessly improve our service to help our clients reach their financial goals. It’s gratifying to receive public recognition for our efforts.

Our success thus far has been predicated on a lot of hard work and a fundamentally different approach to building an investment management service. While we are different, our service owes its existence to the profound innovation generated by a relatively new financial product: The ETF.

Why ETFs?

Academic research has consistently proven that index funds offer superior returns, net of fees, over the long term vs. actively managed mutual funds. Despite this irrefutable evidence, index funds have grown their market share relatively slowly over the almost 40 years since Vanguard launched the first one in 1975. It wasn’t until State Street launched the first ETF, the Standard & Poor’s Depositary Receipts (Ticker: SPY), in January 1993 that passive investing had the proper vehicle to enable explosive growth. In just the past 10 years, ETFs have attracted almost $1.5 trillion, which now equals the amount of money attracted by index funds over the past 40 years. We believe the ETF’s success is primarily attributable to its role as an open platform.

The Power of Open Platforms

“We are especially gratified to be chosen for this award from among all investment management firms that use ETFs, not just new entrants.”

Open platforms have had an enormous impact on the technology landscape in recent decades. They enable a much wider variety of market participants, business models, features and services than closed platforms. By simplifying, standardizing & commoditizing the way applications & services interact, open platforms tend to provide far greater opportunities for diversity, innovation and lower costs.

ETFs As an Open Platform

John Bogle was extremely public about his distaste for ETFs when they first launched. By virtue of their ability to trade like equities, ETFs made it much easier to trade index funds. Active trading is the source of much of the under-performance individual investors experience in the markets — it raises transaction costs, tax-related costs, and possibly worst of all, results in market-timing errors. Passive investing was created in large part to minimize these issues.

Ironically, the primary danger of ETFs is also their most valuable strength. By providing a fund format that can be freely traded by any broker-dealer, index funds are not only released from the constraint of pricing and trading once a day, they can also be accessed by any client, from any brokerage firm. This has freed index fund issuers from the previous limitations of one-off distribution agreements with individual brokerage firms, and the associated myriad fees and subsidies. Not only can clients of any brokerage firm trade ETFs, but ETFs also offer significant improvements in transparency and facilitate much lower trading commissions.

As a result, innovative financial services can now be implemented over the custodian of choice, freeing up a new level of innovation that was extremely difficult before.

No single firm controls the creation of ETFs. No single firm controls the trading of ETFs. No single firm controls access to the ETFs that have been created. Fees have been simplified & standardized. ETFs for large common asset classes have become commoditized. Thanks to this environment we now have access to a broad, open platform of high quality, inexpensive financial products, with a far more competitive market of custodian platforms and pricing models on which to innovate. The emergence of brokerage application programming interfaces now make it possible for software experts to automate the use of ETFs in ways never before imagined.

The Future of Investing

Over the next decade, we will see increasing value created for both investors and market participants around automated investment services. With trading costs approaching zero, new strategies not only become possible, but practical.

Wealthfront is an obvious product of the ETF revolution. Despite launching just over two years ago in December 2011, Wealthfront now manages over $750 million in client assets. (In fact, Wealthfront added more than $100 million in client assets in February alone.)

Coming from the world of software, the benefits of open platforms seems obvious to us. As long as ETFs remain a relatively open platform for innovation, we’ll continue to see a broad range of new solutions for investors in the years ahead.

Google vs. The Teamsters

Yesterday, Google launched Chromecast, a streaming solution for integrating mobile devices with TV, part of another salvo against Apple.  Google vs. Apple has been the hot story now in Silicon Valley for a couple of years.  Before that, Google vs. Facebook.  Before that, Google vs. Microsoft.  Technology loves narrative, and setting up a battle of titans always gets the crowd worked up.

Lately, I’ve been thinking about the next fight Google might be inadvertently setting up, and wondering whether they are ready for it.

350px-Optimusg1

Self-Driving Cars or Self-Driving Trucks

It turns out I’m not the only one who noticed that Google’s incredible push for self-driving cars actually has more likely applications around trucking.  Yesterday, the Wall Street Journal wrote an excellent piece about Catepillar’s experiments using self-driving mining trucks in remote areas of Australia.  It had the provocative headline:

Daddy, What Was a Truck Driver?

This is the first piece in the mainstream media that I’ve seen connecting the dots from self-driving cars to trucking, even with a lightweight reference to the Teamsters at the end.

Ubiquitous, autonomous trucks are “close to inevitable,” says Ted Scott, director of engineering and safety policy for the American Trucking Associations. “We are going to have a driverless truck because there will be money in it,” adds James Barrett, president of 105-rig Road Scholar Transport Inc. in Scranton, Pa.

The International Brotherhood of Teamsters haven’t noticed yet, or at least, all searches I performed on their site for keywords like “self driving”, “computer driving”, “automated driving”, or even just “Google” revealed nothing relevant about the topic.  But they will.

Massive Economic Value

The statistics are astonishing.  A few key insights:

  • Approximately 5.7 million Americans are licensed as professional drivers, driving everything from delivery vans to tractor-trailers.
  • Roughly speaking, a full-time driver with benefits will cost $65,000 to $100,000 or more a year.
  •  In 2011, the U.S. trucking industry hauled 67 percent of the total volume of freight transported in the United States. More than 26 million trucks of all classes, including 2.4 million typical Class 8 trucks operated by more than 1.2 million interstate motor carriers. (via American Trucking Association)
  • Currently, there is a shortage of qualified drivers. Estimated at 20,000+ now, growing to over 100,000 in the next few years. (via American Trucking Association)

Let’s see.  We have a staffing problem around an already fairly expensive role that is the backbone of a majority of freight transport in the United States.  That’s just about all the right ingredients for experimentation, development and eventual mass deployment of self-driving trucks.

Rise of the Machines

In 2011, Andy McAfee & Erik Brynjolfsson published the book “Race Against the Machine“, where they describe both the evidence and projection of how computers & artificial intelligence will rapidly displace roles and work previously assumed to be best done by humans.  (Andy’s excellent TED 2013 talk is now online.)

The fact is, self-driving long haul trucking addresses a lot of the issues with using human drivers.  Computers don’t need to sleep.  That alone might double their productivity.  They can remotely be audited and controlled in emergency situations.  They are predictable, and can execute high efficiency coordination (like road trains).  They will no doubt be more fuel efficient, and will likely end up having better safety records than human drivers.

Please don’t get me wrong – I am positive there will be a large number of situations where human drivers will be advantageous.  But it will certainly no longer be 100%, and the situations where self-driving trucks make sense will only expand with time.

Google & Unions

Google has made self-driving cars one of the hallmarks of their new brand, thinking about long term problems and futuristic technology.  This, unfortunately, is one of the risks that goes with brand association around a technology that may be massively disruptive both socially & politically.

Like most technology companies in Silicon Valley, Google is not a union shop.  It has advocated in the past on issues like education reform.  It wouldn’t be hard, politically, to paint Google as either ambivalent or even hostile to organized labor.

Challenges of the Next Decade

The next ten years are likely to look very different for technology than the past ten.  We’re going to start to see large number of jobs previously thought to be safe from computerization be displaced.  It’s at best naive to think that these developments won’t end up politically charged.

Large companies, in particular, are vulnerable to political action, as they are large targets.  Amazon actually may have been the first consumer tech company to stumble onto this issue, with the outcry around the loss of the independent bookstore.  (Interesting, Netflix did not invoke the same reaction to the loss of the video rental store.)  Google, however, has touched an issue that affects millions of jobs, and one that historically has been aggressively organized both socially & politically.  The Teamsters alone have 1.3 million members (as of 2011).

Silicon Valley was late to lobbying and political influence, but this goes beyond influence.  We’re now getting to a level of social impact where companies need to proactively envision and advocate for the future that they are creating.  Google may think they are safe by focusing on the most unlikely first implementation of their vision (self-driving cars), but it is very likely they’ll be associated with the concept of self-driving vehicles.

I’m a huge fan of Google, so maybe I’m just worried we may see a future of news broadcasts with people taking bats to self-driving cars in the Google parking lot.  And I don’t think anyone is ready for that.

Trend Micro Keynote: Innovation & Inspiration

I had the opportunity yesterday to kick off the 2011 Trend Micro Engineering Summit with a keynote on Innovation & Inspiration.  It’s a topic I’m passionate about, and I appreciated the chance to put some key learnings together and present them to a great technology team.

The talk is broken into three sections:

  • Lessons from Distributed Computing about how to think about Distributed Organizations
  • Three types of Risk
  • Hackdays and Cultures of Innovation

I would definitely consider the slides “draft” quality, but worth sharing nonetheless.

Those of you who attended by “Ten Things I Learned About Product at LinkedIn” talk will recognize the Optimus Prime quotes.  What can I say?  I’m a sucker for the Transformers. (I will get those slides posted up here soon.)

Enjoy.