Month: October 2018

Index funds are the most highly traded equity investment vehicles, with some funds like ones created by Vanguard Group cumulatively being valued at over $4 Trillion USD. Index funds have democratized investing by allowing access to passive investments for millions of people. But what are they?

An index fund is a market-capitalization weighted basket of securities. Index funds allow retail investors to invest in a portfolio made up of companies representative of the entire market without having to create that portfolio themselves. Compared to actively managed funds like mutual funds and hedge funds, index funds tend to have much lower fees because the only balancing that happens occurs based on an algorithm to keep the securities in the fund proportional to their market cap (market capitalization, or market cap, is the number of shares that a company has on the market multiplied by the share price).

Starting in the 1970s, the first ‘index funds’ were created by companies that tried to create equally weighted portfolios of stocks. This early form of the index fund was abandoned after a few months. It quickly became apparent that it would be an operational nightmare to be constantly rebalancing these portfolios to keep them equally weighted. Soon companies settled on the market capitalization weighting because a portfolio weighted by market cap will remain that way without constant rebalancing.

With the incredible advancement of AI and extraordinarily powerful computers, shouldn’t it be possible to create new types of ‘passively managed’ funds that rely on an algorithm to trade? What that could mean is that index funds might not have to be market cap weighted any longer. This push is actually happening right now and the first non-market cap weighted index funds to appear in over 40 years could be available to retail investors soon.

But this means that we need to redefine the index fund. The new definition has three criteria that must be met for a fund to meet:

1. It must be transparent – Anyone should be able to know exactly how it is constructed and be able to replicate it themselves by buying on the open market.
2. It must be investable – If you put a certain amount of money in the fund, you will get EXACTLY the return that the investment shows in the newspapers (or more likely your iPhone’s Stocks app).
3. It must be systematic – The vehicle must be entirely algorithmic, meaning it doesn’t require any human intervention to rebalance or create.

So, what can we do with this new type of index fund?

We can think of investing like a spectrum, with actively managed funds like hedge funds on one side and passively managed index funds on the other and all the different parameters like alpha, risk control and liquidity as sliders on a ‘mixing board’ like the one in the image above. Currently, if we wanted to control this board, we would have to invest in expensive actively managed funds and we wouldn’t be able to get much granular control over each factor. With an AI-powered index fund, the possibilities of how the board could be arranged are endless. Retail investors could engage in all sorts of investment opportunities in the middle, instead of being forced into one category or another.

The implications of a full-spectrum investment fund are incredible. Personalized medicine is a concept that is taking the industry by surprise and could change the way that doctors interact with patients. Companies like Apple are taking advantage of this trend by incorporating new medical devices into consumer products, like with the EKG embedded into the new Apple Watch Series 4.

Personalized investing could be just as powerful. Automated portfolios could take into account factors like age, income level, expenses, and even lifestyle to create a portfolio that is specifically tailored to the individual investor’s circumstances.

So why can’t you go out and purchase one of these new AI managed, customizable index funds?

Well, unfortunately, the algorithms do not exist, yet. The hardware and software exists today to do this but we’re still missing the ability to accurately model actual human behaviour. Economists still rely on some pretty terrible assumptions about people that they then use to build the foundations of entire economic theories. One of these weak assumptions is that humans act rationally. Now, there is a lot of evidence to suggest that many people act in the way that we are programmed to by evolution. The problem is, a lot of what allowed us to evolve over the last 4 billion years of life on earth, is pretty useless for success in 2018-era financial planning and investment.

All hope is not lost, however. New research into the concept of bounded rationality, the idea that rational decision making is limited by the extent of human knowledge and capabilities, could help move this idea forward. One of the founding fathers of artificial intelligence, Herbert Simon,  postulated that AI could be used to help us understand human cognition and better predict the kinds of human behaviours that helped keep us alive 8,000 years ago, but are detrimental for wealth accumulation today. 

By creating heuristic algorithms that can capture these behaviours and learning from big data to understand what actions are occurring, we may soon be able to create software that is able to accentuate the best human behaviours and help us deal with the worst ones. Perhaps the algorithm that describes humanity has already been discovered.

Nothing.

Zero, nada, zilch, bupkiss. That’s how much your idea is worth.

But…but, my idea is brilliant! It will change the world! My new plan for how to solve snow-covered streets is worth billions!

Really? Who is willing to pay you a billion dollars for your idea? Anyone?…Anyone? Bueller?

I’m sorry to burst your bubble, but the likelihood is that any idea that you’ve had, someone smarter than you has already had. Your idea is worthless. So what? It doesn’t matter that it’s not worth anything now. What matters is what you do with your idea.

Take your idea for a product or service, and sell it to someone. See if there are people willing to put down actual money for what you’ve thought of. And don’t be afraid to tell people what your idea is. If it’s so easy to replicate that just by telling someone, they could take it and turn it into a business, then your idea wasn’t really worth anything, to begin with. How do you sell your idea? Take it to market! Start by defining the problem that you’re trying to solve. Research the hell out of it, what the pain points are that your idea addresses, who has those pain points, and how you can reach those customers. See if you can interview people with the pain. Ask them to tell you a story about the pain and see if it really bothers them enough to change what they’re already doing. This type of research costs nothing but your time and will provide valuable insight into the minds of your target audience.

Steve Blank, the entrepreneur responsible for customer development methodology says The Lean Startup is dead. What does that mean? Basically, there’s so much money available through angels and VCs that a young company’s success depends almost exclusively on their ability to raise huge sums of money and not on their ability to bootstrap a startup.

I am not confident that Steve is correct, especially if you live outside of the Silicon Valley bubble, or are creating a startup that doesn’t immediately scream ‘FUND ME’ to Angels and VCs. It’s still possible to build a company without raising a hundred million dollars, it’s just difficult. I’ve been building my company, InOrbis Intercity for over three and a half years now. It started off as a worthless idea, just like yours. But it has grown to be more than that. We’ve just had our first profitable quarter, and we’re still only in Alberta. The vision I have for the company is beyond large. It will be a billion dollar company. But it takes time for great things to happen.

In order to change the way that people travel, we have to reinvent the model of a transportation company. We can’t rely on what companies like Uber did for intra-city ridesharing, and we definitely can’t copy what the airline and bus industries have done (RIP Greyhound). Our vision involves fleets of autonomous vehicles bringing business travellers, vacationers and more between the hundreds of cities that are within a few hundred kilometres of each other. So far, we have connected 6 cities with a combined population of nearly 3 million people. If we provide to access 100 times that number in 5 years, then we’ll be well on our way.

If you have an idea, and you want to talk to someone who also had one, and has tried to turn their idea into a reality, I am always open. Send me a message, I’ll happily sit down with you for a coffee to tell you my story and ask you about yours. I want you to succeed just as much as I want to succeed.

Think your idea is worth it? Let’s make it happen.