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Social Media Investing: Changing Out of Pajamas

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If you think social media investing is about pajama-wearing day-trading amateurs, Covestor aims to prove you wrong.

The platform markets about 180 portfolios to retail investors. They are run by 135 managers, many of whom don't fit the traditional asset manager mold. There is Marine Corporal Ben Wong, a ground radio repairman who recently did a tour in Afghanistan. There is also a pilot, a homeopath, and one manager living in a boat off the Dominican Republic.

The public can view real-time performance data on all portfolios, which are called models. There are also blogs, articles and videos featuring the managers themselves as well as other Covestor experts.

To invest in a model, a customer becomes a member of Covestor, which then sets up an account that automatically mirrors the manager's trading. The instant a trade is made, similar trades ricochet all mirrored accounts. Annual fees range between 50 to 250 basis points on the amount invested in the model, which Covestor-a registered investment advisor- splits 50-50 with the managers.

"We now allow retail investors to have a user experience that feels a lot like the shopping experience they are used to for other types of goods and services they buy via the Internet," says chief executive Asheesh Advani.

Covestor, created in 2006, is an example of social media-driven investing, which includes such platforms as Marketocracy and Roboinvest. Covestor at first concentrated on proof of concept: that real-time transparency, easy retail access and egalitarian investment talent opportunities was feasible. Now, the firm is concentrating on developing a sustainable business model for itself and its investors.

So far, Covestor's total assets under management are tiny, last reported at $10.49 million as of November. Its executives say this is growing.

"We are professionalizing the team and many elements of the business process," says Advani. "We're repositioning this company to make it more of a marketplace than it has been in the past."

Advani is the prime mover behind Covestor's maturation, which includes bolstering of its media content, investor support and vetting of its managers. Hired in July, Advani was former global head of financial advisor products for Lipper, a subsidiary of Thomson Reuters that provides mutual and hedge fund data, analytical tools, and commentary. He soon brought in other industry veterans such as Tom Dorsky, Lipper's former global content chief, in March as chief operating officer.

Before, the site provided a lot of raw detail about the performance of its managers, but not a lot of ancillary content to aid investor shopping. The revamped website launched in January with new functionality like search filters to find models based on categories like asset class, cap bias, geography, and sector. It also expanded manager content output.

The site also revamped risk functionality. First, it launched scoring tools on factors like volatility, Sharpe and Sortino ratios, maximum draw-downs and value-at-risk. The site also calculates investor risk tolerance, from 1 to 5, to guide selections. For example, level 1 and 2 models cannot use leverage and inverse exchange-traded funds and can't have margin. Day trading is only for level 5. No accounts mirror options or futures. All managers must invest their own money to have "skin in the game."

Moreover, manager candidates need a year's history trading their models. If they aren't RIAs, they need to disclose personal trading accounts which the platform then monitors regularly with compliance software. Covestor watches candidates for three more months before displaying to assess risk, assign benchmarks and ensure rule adherence. Roughly 50 managers are on the waiting list.

In return, managers get a chance to strut their stuff, like Bob Gay, former director of quantitative research at Donaldson, Lufkin and Jenrette, who uses a corporate fundamental database he created extracting data from Securities and Exchange Commission filings (he's moving toward using data that comes tagged in the eXtensible Business Reporting Language used by the SEC).

Over the 365 day period ending May 8th, Gay's earnings surprise model earned 9%, while his high return model made 16.9%. His hedged portfolio netted 9.9%.

"I have a convenient, low-cost, and easily accessible way of displaying the value of my portfolios," he says. "When someone asks me how I'm doing, I just tell them 'Go look at Covestor.'"

Covestor's top five managers outperformed their benchmarks by 24% to 64% during the past year, according to Covestor. Others, of course, don't do well, but nothing is hidden- and that's the point, say managers.

Professional firms recognize the concept's potential. For example, Gay was hired in March to serve as director of research at Buford, Dickson, Harper and Sparrow, Inc. He says his Covestor performance was an important factor. James Hofmann, who formerly ran Covestor portfolios devoted to greater China and divided growth, is now an advisor at Morgan Stanley Smith Barney.

Covestor's model may also provide technical advantages over traditional firms, according to David Schehr, a research director on Gartner's banking and investment service advisory team. Covestor's mirror trading is instantaneous, he says. In the old model, there is a lag before traders can implement manager strategies.

"They have developed web technology that allows them to be faster and cheaper than the money managers," Schehr says. "From a technical process, the Covestor platform is likely to be as efficient, if not more efficient than that of money managers."

Will Covestor succeed? That may be the wrong question, sources say. Instead, executives should think on social media's long-term impact. Schehr notes another seemingly small development which later had huge consequences: the SEC's 1975 elimination of broker's fixed price commissions. Then, few people saw the significance of allowing brokers to negotiate commissions, but this led to the creation of the multi-billion dollar discount brokerage industry.

"Back then, people said 'Eh. It's nothing.' But look where we are now. Things that seem very small or minor at the time can have big ripples," he says.

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