Index Funds: Good for Corporate Governance & Good for Crypto

On March 8th, Dick Weil, co-CEO of London-based Janus Henderson Investors,wrote an op-ed in the Wall Street Journal arguing that the SEC should prevent index-funds from voting on shareholder proxies. In it, he argues that index funds “have no interest in the performance of particular companies” and that index funds “lack a strong incentive to cast informed votes.”

Unfortunately, Mr. Weil misses some of the most important incentives that drive long-term equity holders, including index funds. In fact, index funds are likely to be superior to active funds for effecting good long-term corporate governance.

Index Funds Are Long-Term Owners

In October 2017, Jack Bogle gave an interview with Morningstar that addressed this exact issue. His argument, as usual, was clear and compelling:

Benz: How about on the governance front. I know you and I have talked about this over the years, about whether passive products are more limited than active managers from the standpoint of influencing corporate governance of the companies they own. What do you say to that assertion that passive products because they can’t walk away from some of these companies altogether don’t have that ultimate weapon that active managers do have?

Bogle: I’d say traditional index funds are the last, best hope for corporate governance.

Benz: And why is that?

Bogle: That’s because they’re the only true, long-term investors. Corporate governance should be based on long-term factors affecting the corporation, not a bunch of traders who want you to report higher earnings, gonna try and get on your board for a minute, and in a moment … I don’t know how they’re this smart to do it, but realign the entire company and then all will be well. It just doesn’t happen. In fact, the reverse is more likely to happen.

So, I don’t see … The old Wall Street rule was if you don’t like the management, sell the stock. The new index fund rule is if you don’t like the management, fix the management because you can’t sell the stock.

The critique of index funds and corporate governance comes from the mistaken idea that it is only by buying and/or selling a security that you can influence management and the allocation of capital. While there is no doubt that individual actions in the secondary market affect the price of a security, and the price of a security can affect capital allocation decisions, it is a relatively indirect link. Activist shareholders typically use these actions, but as a means to more direct control, either influence or direct membership on the board of directors.

Unfortunately, because discretionary investors have the power to walk away and sell a security, there is a weakness in their commitment to fixing a company. While some of the best activist private equity funds might spend years working to improve the returns of a company, most active investors show no such patience.

Index funds effectively operate as permanent owners of the business, so their incentive is to work to improve the performance of each and every company in proportion to their market capitalization.

Patient Capital Has Value

Perhaps one of the most compelling aspects of index funds as investors is their reliability as a patient source of capital. There is no doubt that the short-term focus of current capital markets is a problem for public companies looking to optimize their performance for the long term. Very often, significant changes in corporate strategy take years to implement, and can often result in negative short-term performance in exchange for the potential for significant long-term upside. Unfortunately, if most investors hold securities for short periods of time, management can be pushed for making decisions that are optimized for long-term value creation.

In fact, this problem is the focus of Eric Ries’ new startup, the Long-Term Stock Exchange.

For example, as of 2013, the average active mutual fund had a turnover of over 85% (according to Morningstar). This means their average holding period for a stock was barely over one year! They are not long-term investors, and their financial interest is incredibly biased towards short-term performance. They are not going to support any solution to a corporate problem that might hurt short-term performance.

This is not just a problem for active mutual funds. Private equity buyout funds, based on their structure, predominantly look for returns often within a relatively short number of years. Because they often use debt to leverage their buying power and maximize return on capital, their playbook also includes damaging short-term actions like the payoff of significant one-time dividends that can starve a business of long-term capital.

Index funds provide long-term, patient capital that is well aligned with the desire to see companies optimize their corporate governance for maximum shareholder value. The time frames of active investors are just too short to align with management changes and strategic choices that may not pay off for years, if not decades.

This Applies to Crypto, Too

One of the most exciting developments in cryptocurrencies has been credible initiatives around index investing. Bitwise Investments (currently available) and Coinbase (available soon) have both announced crypto index products and platforms. (disclosure: I am a private investor in both.)

Over the past few years, more and more investors are convinced there is an incredible opportunity for blockchain-based products and platforms. Though cryptocurrencies have the same liquidity as public companies, they are based on far younger organizations and will take time to develop. Index funds can act as a stabilizing force amidst the volatility, especially if index funds see continued net-positive inflows like their brethren in equity and debt assets.

Amidst all of the volatility, index funds will likely also have a role to play as aggregators of long-term holders of cryptocurrency. Index funds, given their incredibly long time implicit frames, are aligned to advocate for governance and development that will maximize the long-term value of the ecosystem.

Index funds may not control the marginal price of these assets, but they can provide a structure for a large pool of investors to have a long-term influence on the direction of these platforms. Whether the future belongs to proof-of-work systems, proof-of-stake, or other alternatives, my guess is that we’ll find that, over time, that access to long-term, patient capital is a huge benefit to products and platforms in crypto.

Long-Term Ownership Will Improve Governance

While there is no question that active investors can have a positive impact on the governance of corporations, it would be foolish not to see the additional advantages that index funds bring to the financial ecosystem.

Index funds may actually be the missing form of long-term, patient capital that we’ve needed in corporate governance to better align companies with the creation of long-term value for all of their stakeholders.

Stanford CS 007: Personal Finance for Engineers (Kickoff)

Update: For those looking for full course material, I’m posting it on a parallel site:
http://cs007.blog

Yesterday, I had the great pleasure of officially kicking off a new course at Stanford University, “Personal Finance for Engineers“.  The course is offered through the Computer Science department (CS 007), but is open to undergraduate & graduate students of any major.

Personal Finance for Engineers

 

It was a packed room, and I was delighted. In fact, I was delighted for three reasons.

First, I love teaching. In an unexpected coincidence, the room my course was assigned, 200-034, is the same room that I taught CS 198 for the CS 106 Section Leaders over 20 years ago as a graduate student. It was the home of CS 198 for many years. To see it filled with students again was wonderful.

Second, the level of student engagement has been outstanding. Originally set for a maximum of 50 students, I expanded the enrollment to 75, and with waitlist interest the total number of students easily went over 100. For a new course without a track record on campus, I was delighted to see so many students interested in the topic.

Third, the topic is incredibly important to me.  Those of you who have been following my efforts around personal finance education know that I care deeply about the topic. Over the past 7 years, I’ve given talks at dozens of companies like Facebook, LinkedIn, Twitter & Dropbox, hoping to better educate and inspire employees to learn more about personal finance and make better financial decisions.

I’m hoping this class can amplify those efforts even further.

Making Personal Finance Education Open

I feel grateful to Stanford University and the Computer Science Department for supporting this effort, and I hope that by making the material public, we can help get higher quality education about personal finance to as many students as possible.

My hope is that by circulating this material, more people will engage to give feedback on the content, make suggestions for improvement and continue to improve the material and the class.

After every class, I’ll be posting the slides for the session up on Slideshare. The materials from the first class, “Introduction,” are now available.

As the introductory session, I focused the seminar on three topics:

  1. Why the topic of Personal Finance is worth studying?
  2. Real data from a survey of students enrolled in the class.
  3. Full syllabus for the topics that will be covered during the course.

Student Survey Data

The second topic is based on 10 questions I asked every student in the class to complete before the start of the first session. It is hardly a scientifically representative student survey, but I wanted to ground some of the initial discussion of financial topics with data about their own experiences & expectations.

73 students completed the survey. It’s worth sharing the results of the 10 questions here:

A few data points worth sharing:

Question 1: A little over 50% of the class are either graduating seniors or graduate students. Only 14% are freshman or sophomores.

Question 2: Approximately 3/4 of the class (76%) had a “magic number” in mind when asked about how much wealth would define success for them. While the most common answer fell between $10M-$100M, the range spread from $20,000 to $15B. It was truly a blank field in the survey, so students typed in whatever number came to mind, and it started the process of open & honest discussion on why students picked the number they did.

Question 3: 92% of the students reported that they had either “some” or “quite a bit” of knowledge about the finances of their parents or guardians. Given the selection bias inherent in who signed up for this course (or even what type of students end up at Stanford), it’s hard to assign deep meaning to this result, but this was a class of students who clearly had received some meaningful exposure to financial decisions at home.

Question 6: 92% of students in the class do not expect to be responsible for any student loans after graduation. This was the most surprising result to me, based on both overall market data and my own personal experience .

I have two possible hypotheses to explain the result of Question 6. (1) The selection bias for enrollment in the class might explain part of the result. It is possible that the type of students who are most willing to sign up for a class on personal finance are not burdened by student loans.  (2) It is possible that the financial aid policies of the premier schools, like Stanford, have been highly effective in lowering the number of students requiring loans dramatically. For families with household income below $125,000, tuition is waived, and 71% of families with up to $245,000 receive scholarship assistance. (In fact, 34% of families making over $245,000 also get scholarship assistance.)

Since the syllabus was not shared in advance, Question 10 gave me a clear read of the expectations and hopes students had coming into the class. Not surprisingly, the students were, for the most part, very pragmatic. They are looking for information about compensation & job offers, the stock market, real estate and how to maximize their earning power during their careers.

Feedback

Throughout the next few months, I’ll be posting the course material in the hopes of receiving both corrections and ideas for improvement. If there are topics or material out there worth formalizing into the curriculum, I want to know about them.

Best way to reach me about the course will be through twitter @adamnash

Thank you in advance for your help.

 

Helping People Save is a Job Worth Doing

“Every day stuff happens to us. Jobs arise in our lives that we need to get done. Some are little jobs, some are big ones. Some jobs surface unpredictably. Other times we know they’re coming. When we realize we have a job to do, we reach out and pull something into our lives to get the job done.” — Clay Christensen

In the summer of 1993, after declaring computer science as my major, I got my first high paying software development internship. Over that summer Hewlett-Packard paid me over $5,000, which seemed like an unbelievable amount at the time.

Unfortunately, like a lot of people, I was so excited by receiving this windfall that I promptly spent it. By Thanksgiving, I was shocked to find that my bank account was nearly empty. All that money, gone. It literally sickened me.

That was the moment when I decided to learn as much as I could about personal finance and I got religious about saving.

The Theory of Jobs to Be Done

For a lot of people, there is a moment they can recall when they consciously decided that they wanted to start saving.

When I attended Harvard Business School at the end of the dot-com era, I was incredibly fortunate to spend time with Clay Christensen, who at the time had just recently published the now famous book, The Innovator’s Dilemma. In his class, we studied his new theory of disruption, and how industrial giants filled with smart people would make seemingly smart decisions that would lead to their downfall.

One aspect of his theory, which later went into his book, Competing Against Luck, is the Theory of Jobs to Be Done. Quite simply, Clay believes that companies can go astray by focusing too much on the data about their customers and the features of their product. Instead, he argues they should focus on the end-to-end experience of the job that their product is being hired to do.

In the past few years, I’ve come to believe that saving is a job that a huge number of people want a product to help them do and help them do it well.

Saving Itself is a Goal

Our lives are filled with a large number of small financial decisions and problems, but there are only a few very large financial moments that warrant the creation of an entire companies to support. Spending, borrowing, investing and financial advice all certainly fit that description. I believe that saving belongs on that list as well.

Americans are in a terrible state when it comes to saving. 6 in 10 Americans don’t have $500 in savings. An estimated 66% of households have zero dollars saved. If you are cynical about small, one-off surveys, The Federal Reserve itself estimated in 2015 that 47% of households didn’t have the means to cover a $400 emergency expense.

Saving is a huge problem, so it isn’t really surprising that tens of millions of Americans seem to be looking for something to help them save. Enter Acorns.

Hiring Acorns

Over the past two years, it has been astounding to watch Acorns grow. An elegantly simple product, designed from the ground up for a mobile generation, Acorns has grown to over 2 million accounts in less than three years. In the first half of 2017 alone, Acorns added over 600,000 new customers. Their overall mission is to look after the financial best interest of the up-and-coming, something I personally care deeply about.

It isn’t really surprising to see why so many Americans have decided to use Acorns to help them save. 75% of Americans have a household income under $100K. Acorns simple features like Round Ups automate the process of making sure that as you spend, you save. Acorns has now performed over 637 million round-up transactions for their customers – each one an action designed to help people save more. I believe that on any given day, thousands of people decide to hire a product to help them save, and increasingly they are hiring Acorns.

When I met the founders of Acorns two years ago, we immediately connected over the common ground between their culture and Wealthfront’s (the company I was running at the time.) They are very different services, focused on different problems and audiences, but with a shared belief in the power of automation. This is a company worth supporting, and I feel fortunate to serve on their Board of Directors.

At a time when people continue to grow more and more frustrated with the solutions offered by incumbent banks and brokerages, I continue to be excited about the opportunities for new products that are built around automation and world-class software design.  As an industry, we can and should radically improve the financial solutions that are available to everyone. Acorns is proving that saving is a job worth doing.

Silicon Valley Home Prices, Stock Prices & Bitcoin

I’m writing this post with a bit of trepidation, because talking about Silicon Valley home prices these days is a bit dicey. The surge of the last five years has been shocking, and almost no one I know feels good about how difficult it is for people to buy a new home in Silicon Valley in 2017. Some houses are pretty bad but others arae actually at a reasonable price, because they come with furniture and some even come with shutters from plantation shutters installation Sydney. They are actually really good quality.

So if you need a trigger warning, this is it. Stop reading now.

The truth is, as shocking as the rise in Silicon Valley home prices has been, there has also been an asset boom in other dimensions as well. Total compensation for engineers is up considerably and stock prices at the big tech companies continue to rise.

To visualize this, I thought I’d put together a few charts based on real market data. As a proxy for Silicon Valley, I pulled the last 5 years of home prices from Zillow, and monthly stock price data from Yahoo.

Palo Alto Home Prices

Two days ago, the Mercury News reported that a home in Palo Alto sold for $30 million.  A quick check on Zillow seems to confirm this.

I chose Palo Alto as a proxy for Silicon Valley home prices because it is historically “ground zero” for Silicon Valley tech companies, and it has relatively close proximity to all of the massive tech giants (Apple, Google, Facebook).

I picked June 2012 – June 2017, not only because it is roughly five years, but also it also happens to mirror the time that Facebook has spent as a public company. For many in the local real estate market or online sites as SafeguardProperty.com, correctly or incorrectly, the Facebook IPO still looms as a transformational event.

As you can see, in June 2012 the average Palo Alto home cost $1.38 million. Five years later, the estimate for June 2017 is up 84.6% to $2.55 million.

Apple (AAPL)

Apple is the most valuable company in the world, as measured either by market capitalization ($810B as of 6/7/2017) or by profitability ($45.7B in 2016).  Thanks in part to this exception financial performance, Apple stock (AAPL) has risen 84.5% in the last five years, from $83.43 per share to $153.93 per share.

84.5%? Where have I heard that number before?

That’s right, the increase in Apple stock over the last five years is almost exactly the same increase as the average home price in Palo Alto over the same time period.

In June 2012, it took 16,555 shares of Apple stock to purchase the average Palo Alto home. In June 2017, it took 16,566 shares. (Of course, with dividends, you’re actually doing a little better if you are a shareholder.)

If you look at the chart, the pink line shows clearly the large rise in price for the average Palo Alto home. The blue line is the number of AAPL shares it would take to by the average Palo Alto home in that month. As you can see, AAPL stock is volatile, but five years later, that ratio has ended up in almost the exact same place.

Alphabet / Google (GOOG)

Alphabet, the company formerly known as Google, may not be as large as Apple in market capitalization ($686B), but it has seen far more share appreciation in the past five years. Since June 2012, Alphabet has seen its stock price rise 240.4%, from $288.95 in June 2012 to $983.66 per share.

What does this mean? Well, it means that if you have been fortunate enough to hold Google equity, the rise in Palo Alto home prices doesn’t look as ominous. It took 4,780 shares of Google to purchase the average Palo Alto home in June 2012, but it only took 2,592 to purchase the average Palo Alto home in June 2017.

Facebook (FB)

Facebook, the youngest of the massive tech giants, already has one of the largest market capitalizations in the world. As of today, Facebook is valued at $443B. Facebook stock has risen 394% in the past five years, from $31.10 in June 2012 to $153.63 in June 2017.

To state the obvious, it has been a good five years for owners of Facebook stock. Not many assets could make owning Palo Alto real estate look slow, but 394% growth in five years is unbelievable. In June 2012, you would have needed 44,412 shares to buy the average Palo Alto home. In June 2017, that number had dropped significantly to just 16,598 shares.

Bitcoin (BTC)

While I realize that Bitcoin is not a stock, the original idea for this post came from a joke I made on Twitter recently given all of the buzz about Bitcoin, Ethereum and ICOs over the past few weeks.

I couldn’t resist running the numbers.

For the small number of readers of this blog that haven’t been following the price of Bitcoin, the increase in value over the past five years has been unbelievable.The total value of all Bitcoin outstanding is currently about $44.5B. Since June 2012, Bitcoin has risen approximately 4,257%, from $6.70 per Bitcoin to a current value of $2,858.90.

You can see why there has been so much buzz.

In June of 2012, it would have taken 260,149 Bitcoin to buy the average home in Palo Alto. In June of 2017, that number is now down to 892.

Needless to say, anyone who sold Bitcoin to buy a house in 2012 is likely not loving these numbers. But to people who have held Bitcoin for the past five years, Palo Alto is looking cheaper by the day.

Silicon Valley Is Seeing Significant Asset Inflation

To be clear, I’m not attempting to attribute causality to these charts. I believe the real driver of home prices in Silicon Valley is the lack of sufficient building of new supply at pace with the economy, combined with a significant increase in compensation for technology employees and historically low interest rates.

But the fact is, if you are fortunate enough to have equity in one of the tech giants (or in Bitcoin), houses might actually be looking cheaper now relatively than they did five years ago.

I always find it enlightening to look at real data and compare it to intuition. Hope you find this data and these charts as interesting as I did.

Not Everyone Has a Grandma Flora

4 Generations: My Grandmother, My Mother, My Wife, My Daughter

Four Generations: My Mother, My Wife, My Daughter, My Grandmother

My grandmother, Flora, might be the reason I ended up the CEO of Wealthfront. When I was a teenager and first became interested in investing, she walked me through everything. CDs, Mutual Funds, Stocks, Bonds. She not only explained the basics to me, but walked me through the details of how to research different mutual funds, find their expense ratios, and ask the right questions about their performance. I opened my very first mutual fund account with her help.

You see, my grandmother, a retired schoolteacher, does this tirelessly for a lot of people. If a family member has questions about their finances and investments, she is always happy to make time to sit down, review their accounts, and help them figure out where they are paying too much in fees and whether they are diversified properly. At one point or another, she has probably sat down with at least a dozen different family members and friends, with carefully organized manila folders filled with statements, and helped explain the problems with their accounts.  Her dedication to financial education is probably one of the sources of my passion for the topic.

Unfortunately, not everyone has a Grandma Flora. But thanks to the hard work of the Wealthfront team, I am proud to announce that, as of today, the Wealthfront Portfolio Review is now available.

WPR

I’m proud of the Wealthfront team for this launch, but I’m hoping my Grandma is too.

Did You Like Being an Executive in Residence (EIR)

This is the fifth and final post of a multi-part series on being an Executive in Residence (EIR). The initial post outlining the full series can be found here. The previous post was “Challenges of Being an Executive-in-Residence (EIR)

As I’m writing this post, I’m feeling a bit sheepish as I promised the to finish this series last year. I was reminded last weekend that people are finding significant value in the series, largely because so few people actually write about being an EIR. In my previous four posts, I stayed objective and incorporate lessons from other EIRs that I’ve had the opportunity to both know and work with.

Despite the series, I still receive questions about my time as an EIR, and the most common question I still get is:

Did I like being an Executive in Residence?

For those who want the short answer, it’sYes, I did.

For the complete picture though, I’ll try to put into my own words why I liked the experience of being an Executive-In-Residence at Greylock Partners, and why I’m grateful for the opportunity.

My Three Top Reasons for being an EIR:

1. The Typical Benefits

As I wrote in my earlier post, “Should I be an Executive-In-Residence (EIR)?“, there are a number of benefits to being an EIR, and my case was no different.

The position gave me the opportunity to create, build and grow relationships.  While I was heads down at LinkedIn, it was often hard to do this well outside the company.  My time as an EIR definitely helped me go into my next role better reconnected into my professional (and personal) networks.

My time as an EIR also allowed me to both broaden & deepen knowledge about multiple markets. I had both the time and the connections to explore a wide variety of product categories and sub-sectors, and more importantly, learn more deeply about what strategies and tactics were finding success.

One of the most obvious benefits of being within a firm like Greylock Partners was the incredible visibility into the startup community. There are so many incredibly talented entrepreneurs and executives building new businesses, and being an EIR provides not only exposure to them, but the opportunity for deep & frank discussion & debate.

Lastly, at a venture capital firm you quickly discover what are the unique knowledge sets where others in the startup community find value.  At Greylock, I had the time and focus to both clarify both my thinking and content around product leadership and growth, two topics that continue to be in high demand.  The investment in thought leadership, that I was able to make during my EIR role has continued to pay dividends well beyond the relatively short time I spent in the role.

2. A Time for Self Discovery & Clarity

About six months into the role, I had the good fortune to experience one of those rare life events that gives you both the time and the catalyst to think deeply. In May 2012, my wife & I welcomed our daughter into the world, and I took a month off to both manage the chaos that comes with a new addition, and reflect a bit on next steps.  (For fans of my blog, this is when I wrote my piece on the Combinatorics of Family Chaos).

During that time, I came to a new level of clarity about what I was looking for:

  • Product. As someone passionate about product & design, it had to be a consumer product & service that I was passionate about.
  • Stage. I’ve had the good fortune to work for both startups and large companies at almost all stages.  That being said, there’s no question that I deeply enjoy the technology, product & strategy issues that come with hypergrowth.
  • Role. After a range of technology & leadership roles, I realized that I wanted the opportunity to help build and lead a company. I wanted to be the CEO.

Finding a company that fit the above felt a little bit like finding a needle in a haystack, but fortunately Silicon Valley turns out to be one of the better haystacks in the world, and the EIR role gave me time to find my needle.

3. Finding My Needle

In the summer of 2012 I met Andy Rachleff for the first time, through an introduction by Jeff Markowitz at Greylock. While I knew of Andy by reputation, we had never had the chance to meet in person. Wealthfront was not a Greylock investment at that time. I told Andy that I loved what Wealthfront was doing, and that I had opened an account almost immediately after it launched in December 2011. That being said, I told him that the only way to make Wealthfront succeed would be to find the right talent and the right growth strategy.

Over a few months we met and debated different ways to attract the right talent to Wealthfront and find a growth strategy that would succeed. One day, as I was discussing the company with my wife, Carolyn, she provided me with exactly the final clarity I needed.  She said, “It seems like you really like Wealthfront and want it to succeed.”

It was true. I not only liked the idea of Wealthfront, but I also liked the idea of a world where Wealthfront was successful. I signed on before Thanksgiving (Wealthfront had about $79M under management at that time), and formally joined after the new year. Andy wrote his own version of his decision to bring me on as CEO on the Wealthfront blog, but I credit the EIR role with the time, the relationships, the clarity and the opportunity to find my dream job.

Right product. Right team. Right role. Right time.

 

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.