Courtesy of Financial Technologies via Flickr

Courtesy of Financial Technologies via Flickr

Bill Marcus speaks with Michael Kitces about financial services that are primed for disruption. Technology is starting to permeate into the financial services space and make us recognize that there’s so much that we used to do manually.


BILL MARCUS: This is part of the Think Further series, presented by Alger. I’m Bill Marcus. The world of algorithms and nodes have midwifed yet another invention- a line of businesses called “financial technology.” Software driven financial technologies like crowd sourcing and bit-coin, intending to disrupt financial systems and institutions with code that anybody anywhere can write. It’s an industry Accenture says will octuple in value in the decade that began in 2008, so that it will be worth 8 billion dollars 3 years from now. As Pinnacle’s research director Michael Kitces is well known to accounts, attorneys, and financial planners. Always interesting, always thought provoking, occasionally challenging. Michael Kitces publishes an e-news letter, aptly named the Kitces report. He pangs to the Nerd’s Eye View, a financial planning blog that can be found at his website Michael Kitces’s Columbia, Maryland wealth management firm Pinnacle Advisory Group oversees nearly a billion and a half in client’s assets. Michael, good day.

Michael Kitces: Good day, good to be here.

BM: Michael, let’s get started by defining our terms. Which one of these are to impact the economy the most in the future? Crowd funding, peer to peer lending, algorithmic asset management, thematic investing, payments, data collection, credit scoring, education lending, digital currencies, exchanges, cyber security, and quantum computing- yeah, I’ve thrown a lot at you.

Michael: Oh yeah, that’s a long list.

BM: Pick any one you like.

Michael: Well, because I come at this from the financial advisor standpoint, first and foremost because it’s the industry I live in- I think algorithmic investing is an interesting angle we see right now. You see the rise of the so called robo-advisors out there right now that I think are quite frankly, more hype than substance when you look at the actual assets they’ve been gathering over the past 5 years. As asset managers, their cumulative assets are about 0.01% market share, which is not exactly what we call disruption, right? You got to one ten thousandths market share in five years. But, I think they are kind of a sign of the broad trend out there which is just technology is starting to permeate into the financial services space and make us recognize that there’s so much that we used to do remarkably manually that just doesn’t need to be manual anymore. And to me, the parallel is to look back 30-40 years ago. Loook what happened after Mayday in 1975 when we deregulated fixed trading commissions and allowed, what basically were technology saavy firms to come in and broker stocks in a new way. The end result of that was 20 years later you saw a 95% plus decline in the cost to transact a stock trade, and the rise of massive platforms like Schwab, E-trade, and the like. And so, I think we’re witnessing that kind of transition go through now with not necessarily the robo-advisor trend as a subset, but the idea with just using computers to execute algorithmic investment strategies which I think expands MUCH wider than even just doing asset allocation. It’s what we actually see a lot of quantitative hedge funds do now, like program giant spread sheets and algorhythms in order to execute trading strategies. And as robo advisor platforms become broader, I think that’s basically what you’re going to see for any investor. So I’ll be able to log into any website and say, hey, I heard that value tilts are great. So I click a button and my portfolio has a value tilt. And I say, I heard profitability was good too, so I’m going to tilt profitability. And I’ll say, I’d like to amp up the dividends a little bit so I click another button and I get another filter or screen that just pushes towards higher dividends stocks. And those ways to slice and dice portfolios using computers in a world right now where we have to find investment managers to do that for us; I think a layer of that is going to come out. And what I think we’ll see in the long run is that investment managers that really have a genuine, unique, analytical value and capability will continue to do fine in that future environment. But a big group out there that’s basically hugging a bench mark or replicating a strategy that a computer can really do on an automated basis are going to be in a lot of trouble. And that’s a multi-trillion dollar investment market.


BM: To substantiate or to underscore what you’re saying, this past February Heather Cox, a digital marketing officer told her audience at IBM Interconnect 2015: “People need banking, but they don’t necessarily need banks.”

Michael: Right, and that’s part of the broad dynamic- that, why do I go to the bank when I can frankly do it with my smartphone, tablet, computer, or camera, so we can see everything like Mobile check deposits and Mobile banking and transfers. And that doesn’t necessarily mean the relevance of a branch or human-to-human is completely gone, but it starts to really change the nature of what you actually need to do in a branch vs. not; what you can do from a computer, smartphone or mobile device. And I think that’s really the fundamental challenge that companies are going through and frankly the opportunity for the upstarts are coming in is: very few new players are coming and saying they’ll come in and take over the entire segment of the entire channel, where a lot of the upstarts are coming in and saying otherwise- Here’s one part of the process that just has been historically terrible. We’re make this better, and we’ll shine a bright light on how bad this has been for the traditional financial services industry, and ultimately I suspect what will happen for a lot of these companies, is their technology will either getting mimicked by the incumbents, or for the early players probably bought out by the incumbents. But that ultimately is what drives the technology progress for it. We saw the same thing in the late 90’s; relatively few of those companies persisted and disrupted established players. But a lot of them got bought by established players and it did ultimately move the technology progress forward.

BM: I hear the use of adjectives to describe bankers as “complacent”, even “frightened”, to give an answer as to whether or not they want to authorize a loan. Peer to peer lending speeds that process up, and so a small or medium sized enterprise is disgusted with how they need to deal with banks. And so, they’ll want to move towards peer to peer. Is that something you’re hearing?

Michael: I continue to hear and see. I think it’s funneling from both directions right now. On one hand, you have borrowers who are interested in borrowing and have a need to borrow and are tired of the process of being underwritten for a loan by a bank, which feels completely inhuman. Well, ironically completely inhuman because you can’t get another human being to understand your circumstances. And it just feels like arbitrary decision. I suppose then it’s with some irony that they’ve decided the better solution will be to move to a fully digital environment where they won’t see another human being anyways (laughs), and get their loan that way but get it in peer to peer context where they can explain their story and have a wider range of people consider their story and circumstances to see whether or not they want to loan money. I think part of the peer to peer network frankly also is driven by the opposite side, which is the desire to lend; the desire to get yield as a lender that ironically the banks seem to struggle to figure out right now; how to lend money and earn profits from lending, they seem more interested to do it in other ways. While in today’s ultra-low interest rate environment, there are plenty of end level consumers that are tired of getting 0.1 out of their money market and 1.1 out of a long term CD. And they say, wait, I can get HOW much yield off of peer to peer lending even after doing what seemed to be relatively high quality loans across that I can diversify reasonably well because the technology lets me do it? Okay, then why am I giving money to a bank when I can go somewhere else and get a much better yield? So I think the matchmaking of the two; the frustration of consumers trying to borrow from banks and the frustration of consumer investors tired of depositing their money into banks that don’t give them a yield because the bank isn’t doing anything useful with the money either. That’s kind of leading to this scenario where both the people with the money and those who need the money are collectively disintermediating the banks and get the business done together directly. Of course, the internet and the technology are simply becoming the enabler or facilitator of that transaction.

BM: In a 2014 report, Accenture says New York’s financial technology sector has grown at twice the rate of Silicon Valleys in the past 5 years. Are there any cities in the developing world that show promise?

Michael: Frankly, the Fintech innovation seem to be happening where the financial services firms are in the first place. You see rise of the so-called Silicon Alley in NYC, the counterpart of Silicon Valley in California. You see the rise of Fintech in Sydney, Australia. I was actually there at one of the Fintech incubators just a couple of weeks ago, seeing what’s going on there. The Fintech space there is hot, it’s exciting, and people there are excited to be in innovative financial services in Australia. We hear about a lot FinTech start ups coming out of Singapore as well, again, kind of a concentrated base of wealth and assets, and it’s the first place a lot of financial services spots are built from and based in. Those seem to be becoming the hubs around which the innovation is occurring.

BM: Bitcoin. Has a very bad rep because it’s used to criminal enterprises, drug trafficking, terrorism. There’s no central authority needed for access or verification. Can we rule out banks after using digital currency?

Michael: There are a few things to me that are interesting about BitCoin. The first is at a high level, I certainly don’t rule out the idea of banks using digital currency. If we’re just talking about moving from the physical medium of cash to a more digitally based world of transaction, frankly we’re moving there already. Credit Cards, Debit Cards, and we’re now seeing all the different payment systems and connecting to smart phones. Granted, they still go back to our “original based currency” (the good ol’ US dollar), but the idea of digitally facilitated payments and transactions that don’t occur with hard dollar cash is, I think, a trend that is already underway and will only continue as we go into this increasingly digital world. I think the real breakthrough on the adoption of digital payment mechanisms is the rise of smart phones. So I think the classic challenge of really switching to a digital payment system in general was that you always needed to have a digital thing with you that you always had to carry around, until the last few years where the smart phones became the medium that facilitates it.

The more interesting thing to me about BitCoin and the Block chain more generally is the potential it has to circumvent the traditional payments system. I think that’s the true, either call it disruptive threat or disruptive potential of the BitCoin and the Block chain, isn’t if we’re going to have alternative currency. But, when you look at it and say- well what would if it look like of a business came in and said they wanted to facilitate all their transactions through Bitcoin because by doing that, they can make prices cheaper by avoiding paying traditional credit card processors 2.9%. That’s a really big deal. It’s a disruption of the traditional payment system around credit cards; an alternative where the block chain allows it to operate outside of the original payment system at a lower cost. It doesn’t necessarily mean you’ll live in the Bitcoin world, it means what if we end up in a world where Bitcoin is the payment medium, and all any other business vendor does is handle business transactions with customers with Bitcoin. And at the end of the day at the close of business, they convert their outstanding balance of Bitcoin into cash at the close of every day. That, to me is the opportunity. Not necessarily that Bitcoin becomes the new currency, but that the Bitcoin payment system becomes a different payment system so that we’re not locked into the traditional credit card processing ACH systems and the potential for Bitcoin to do that at a lower cost. That to me is the real disruptive potential in the whole Bitcoin block chain space.


BM: Have you heard about this one, in Honduras where they’re going use block chain to figure out their land use?

Michael: I remember seeing something about this- it’s part of how their handling land registry? Because their problem is they’re using block chain for land records so they can get away from the corruption challengers that they have. There’s kind of a problem when land registry is controlled by a corrupt government that doesn’t always honor the registries. I heard they were trying to move their entire registry process to a Block chain so that it could be a third party neutral system and not succumb to the dangers of government corruption.

BM: This raises another question of how Fintech is going to be applied in developing countries as opposed to the developed world.

Michael: I think that dynamic is one of the big differences that you’ll likely see going forward. At the most basic level, Block chain is sort of an independent framework we can use to save problems. Developed nations, I think the problem they’re trying to solve, is how can they take away market share from a developed player by using block chain in a manner that facilitates something lower cost and appealing for consumers. Or how they can use Block chain to disrupt small business’s payment systems by pulling away from traditional credit card systems or ACH. Where as in developing nations, that’s not their biggest problem. Their biggest problem is validity of records in the first place; the security of financial accounts, the security of land records and other key documents. And so the adoption of block chain there seems to be less of how can we disrupt incumbent payment processors, and more about how can we disrupt incumbent corruption of a government or financial system and move to a third party alternative that can be more secure because it’s not based off the government or financial system.

BM: So financial technology is transformative, and it’s going to change the way businesses are done everywhere.

Michael: Absolutely. I think that’s been the ongoing march of technology, and it’s always been an interesting dynamic. I’ll apologize to whoever said it first, but there’s a saying out there: “We tend to overestimate change in the short term, but grossly underestimate it in the long run.” I think we underestimate the ways it will sort of change in direction and how it will evolve, and so I look back 15 years ago with the rise of our last tech bubble. It was 1999 and we were saying within 3 years there will be no more supermarkets and all bricks and mortar stores will be gone. And that didn’t happen, and there’s still a whole lot of brick and mortar stores gone. But, we look back and we see- wow, yeah, Amazon basically did disrupt every major book seller out there. It took them 10 years, not 3 years, but most of the brick and mortar book stores really are gone now. We looked at these kind of rising phones which were just flip phones at the time, but just the idea of- oh, how does communication change when your phone is with you all the time and not just at your home or office? It began to revolutionalize how we communicate, and the ultimate outcome was the phones were so good we put computers in them. And now with phones with computers in them are so good, now we’re using them for payment processing in a manner I don’t think anybody was envisioning 15+ years ago.

So, I tend to look at most technology as being more evolutionary than revolutionary. But, it’s really fascinating how much evolution compounds over time and how far you can get in 10-15 years from where you were in square one. Certainly, we saw that when we went from the mid 80’s to the late 90’s with the tech boom that happened then, and I think you see it now from the tech bubble of the late 90’s vs. what we’ve actually gotten. Where a lot of the predictions didn’t come true, but we still have dramatically changed our world because of technology including that in the financial services space And when I project that forward another 15 years, certainly I see those same kinds of changes continuing to unfold. We don’t often use the technology quite the way we’d expected, but there are certainly dramatic outcomes when you get 15 years out and look back.

BM: I see a confluence of millennial ideology with finance. That’s the ideology of those folks in their 20’s and 30’s. Dogecoin started as a joke by a programmer in Portland, Oregon. That was less than 2 years ago, came from nothing and is now worth 12.5 million US dollars. It’s been used to fund the digging of a well in Kenya, a competitive driver, and helped to get Jamaica’s bobsled team to the Sochi Olympics, and has even been in the subject of a hacking attempt. The hacker getting millions, but the community of Dogecoin all came together and made the holder 21 million Dogecoins, worth approximate $12,000. You’ve heard about this, right?

Michael: (laughs) Yeah, and from the flip side it’s always funny to see where this comes from and where they get going. You know, all of the controversy a year or two ago with the fallout from another Bitcoin platform- Mt. Cox was based off of a collectible card game, in which the name originated from. It’s kind of fascinating how memes turn into certain companies or companies that turn into disruption, and I’m going to bet it wasn’t actually the Dogecoin that really drove the outcome per se. But, what happens when you get something that’s new and innovative and creative that people can band together and use. Although, at the same time I have to admit, I feel like sometimes we overrate how much financial technology disruption in general is a millennial driven outcome. As though baby boomers aren’t using Skype or tablets or smartphones- frankly, I think we make the scope of technology and its potential too small when we just dub it a millennial phenomenon. Sometimes, we don’t recognize the potential of technology and what it can do. FinTech really spans a much wider range. Like, anybody can benefit from technology that makes their lives useful and easier. And frankly, to me some of the most interesting intersections in the Fintech space come for solutions that can get adopted by folks a little further up the age spectrum. Simply, because if you look at the distribution of income and wealth, that’s where the income and wealth is. If you come up with the next greatest thing in Fintech and its only relevant for 20 year olds and not 55 year olds, you’re going to have to wait a long time until the 20 year olds really have the money to drive very much through your system. There’s a lot more potential if you could go where the money is, and so my only other takeaway on the Fintech space is: don’t do it the disservice of seeing it as a millennial only phenomenon. This is a multi-generational opportunity for anyone who wants technology to make their lives easier, and frankly some of the best opportunities is where the money is. The money is still largely with the boomers, and solutions that are relevant for them probably have the most uptake potential in the immediate term.

BM: Michael, thank you so very much for taking the time to speak with me today.

Michael: My pleasure, absolutely. You take care, guys.

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