I had a fascinating conversation a few weeks ago with an Israeli fintech entrepreneur who is trying to create a TripAdvisor equivalent for the world's mutual funds. In an era when the really big flows are going to passive managers such as Vanguard – whose fees are heading towards zero – and talk of consolidation among active houses is growing louder as pressure intensifies to cut theirs, here was someone who stood out simply by suggesting that active management might have a worthwhile future.
It's already clear that many investors are giving up trying to pick winning active funds on the basis of past performance because the results are so uneven and deciding to go passive instead, effectively swapping the possibility of beating the index, and paying the cost of trying, for the certainty of matching it at rock-bottom prices.
Oren Kaplan, the entrepreneur I spoke to, argues that the collected opinions of investment advisers and professional fund selectors provide an alternative means of choosing actively managed funds, in much the same way that TripAdvisor reviews bring the wisdom of crowds to bear on hotel and holiday accommodation.
Investment advisers rate funds through his service, SharingAlpha, on three broad criteria: investment team, strategy and fees. The site, which contains data on more than 100,000 funds tracked by Morningstar, then combines the advisers' individual ratings (which they can update) to produce an overall ranking for each mutual fund.
However, rather than simply publishing an average of all the scores given to a particular fund, the technology behind the site gives greater weight to rankings from more successful fund selectors – based on how well their previous ratings have turned out in practice. Fund selectors can opt to make their ratings public and therefore enable them to be compared with others, or to keep them private and use the service as a way to monitor their own success rate.
A service like this could allow anyone to see how the wider community of advisers and fund selectors rate a particular fund today) and how that rating is changing
It's an interesting idea. For a start, a service like this could ultimately allow anyone to see how the wider community of professional advisers and fund selectors rate a particular fund today, and how that rating is changing. Second, it will allow individual advisers to build up a record of picking funds (and fund portfolios) and to show how successful or otherwise they have been, relative to the rest of their profession. Therefore it's possible that advisers could find they have a way of showing how consistently they can add value through their fund recommendations compared with their competitors, while fund providers will be able to demonstrate how highly rated their products are by the advisory community.
Of course, it's still very early days – the service is only a few months old and will only become really useful when it has large numbers of users who have built up a record of selections over a reasonably long period. It's also possible that no very clear picture will emerge from all the adviser ratings.
Perhaps most advisers will turn out to have a fairly modest success rate, making any individual recommendation from them less valuable than users might hope, and the service more useful for picking funds based on collective wisdom than for demonstrating the superior success rate of any individual adviser. And maybe the act of making transparent the collective thoughts of a large number of fund selectors will start to erode the edge that the best of them currently enjoy, providing another example of the way that by observing something we may change the outcome. If money flows to funds because their ratings are rising, that may bring forward the point at which their performance starts to decline.
But these are questions for the long term, assuming SharingAlpha gains sufficient traction. The point at this stage, to my mind, is that although this venture may not have the right answers, it is asking a lot of the right questions. How do advisers make clear to clients and potential clients in a readily comparable way the value that they add?
How should individuals who want active management think about selecting funds if past performance is such a poor guide? And perhaps most important, how will rising generations of investors who have grown up with social media and are therefore inclined to trust reviews and opinions provided by others like them – rather than supposedly expert authorities – decide where to put their money?
This early attempt to bring the ethos of social media and the wisdom of (reasonably expert) crowds to bear on the conservative world of investment advice may be a great success or it may end up as a footnote. But I strongly suspect that this will not be the last service of this kind that we read about and that for the rising generation of investors, the habits formed through social media will influence every aspect of their lives, including their approach to investing.
This article was originally published in the September print edition of The Review. The print edition is available to all members who opt in to receive it, except student members. All eligible members who would like to receive future editions in the post should log in to MyCISI, click on My Account/Communications and set their preference to 'Yes'.