I’ve been mulling over the issue of describing risk in expert investment communities. Part of the value proposition of the community concept is the clearinghouse-like pairing of “advisor” to “advisee”. Users looking to tap expert advice in these expert networks need to be able to size up a potential advisor/guru on a variety of fronts for these communities to best work. While there will always be fast money chasing the hot hands, longer terms investors do require a better fit when looking for an asset manage.
So, here are the 3 ways that expert communities can address risks for their community members:
- performance/suitability: while pure performance is actually an easy-ish thing to do, the hard part of measuring portfolios is the qualitative side of performance in terms of describing risk. Here, metrics like Beta and Sharpe Ratio help to benchmark portfolios to a given standard measurement but the
questions remains how to match up a given portfolio to a user’s own profile. If I see that a top performing expert has a Sharpe Ratio of x, a Beta of Y, what does that mean for me? Is it a match? Or are we emphasizing different things? While some communities have created basic tools for measuring risk, others have employed heavy-hitting academics in this field to best quantify/qualify risk. It will be interesting to see how differing descriptions of performance and suitability contribute to the success of these communities. - explanatory style: Here, sometimes the process is more important than the outcome. I assume some users (myself included) are turning to tap the expertise in an expert network by following the investment process of the gurus. They want to read their insights, understand better how and why an advisor decided to make a particular trade. Although it may not be high-brow to admit this but for a lot of investors, the explanatory style of the person they choose to follow and what MarketGuru’s CEO calls “follower care” (the work an advisor puts in to continually guide his followers through the process) may be actually more important than investment returns (at least in the short term).
- lifestyle match: Barry Ritholtz addressed this in a piece he wrote for TheStreet.com 3 years ago but I think it’s good to rehash. As he puts it, “…some investors undertake a trading regimen that requires far more time than they have available. “ Clearly here, it’s important that users/followers in communities like Vestopia or Covestor recognize the time requirements implicit in following different experts. Some gurus are more buy-and-hold oriented while others are actually trading a lot. One style is not necessarily better or worse — it’s just important that the style matches your own. As these communities roll out portfolio management tools that allow a user to automatically conduct trading based on their guru’s movements, this issue becomes mitigated. Nevertheless, this is an important issue for participants. From the other perspective, it’s also important as advisor/gurus market themselves accurately to help ensure a good match between styles — for best “follower care”.
We are still very early in the evolution of expert investing communities. While firms like Marketocracy have been doing their thing for years, the recent startup environment and investments made in this space have contributed to a flurry of activity and with some extremely smart and enterprising founders addressing this space, I expect to see sea-change type activity in how investors invest over the next few years. Exciting stuff.
