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Covestor Disrupts Wealth Management with New Multi-Managed Account

Retail investors replicate different models inside an MMA, with transparent access to their account.

Tired of underperforming mutual funds and high management fees? Today, Covestor Investment Management launched an online investment site that allows retail investors to trade alongside other individual or professional managers by replicating the trades of model managers.

The concept builds upon Covestor.com, an online social networking/portfolio-sharing site launched by the company's founders in 2007, where tens of thousands of investors are sharing their trading activity with other participants. (See "New Online Investing Site Poses A Threat to Fund Managers"). They can view their verified performance metrics and receive email notifications of their top stocks, for instance.

Now the founders of Covestor have formed CVIM, a registered investment advisor (RIA) with the SEC. With a minimum of $10,000, investors can subscribe to different strategies of individuals or professional managers whose strategies they follow on the site.

"We always had the idea of de-institutionalizing investment management, says Perry Blacher, CEO of Covestor Investment Management in an exclusive interview with Wall Street & Technology. Combining the tools of social networking with the transparency of online brokerage, Blacher and his team have created an open platform.

"You get the active management of say a hedge fund or mutual fund, but you get the transparency and safety of an end account in that you still own the end securities," explained Blacher, who previously ran business development for Microsoft MSN's Internet properties in Europe and worked as a consultant with McKinsey and worked at Chase Capital Partners in private equity.

In fact, sometimes the expert is an individual with a proven track record investing their own money and not a professional. "Lots of people take recommendations from friends, yet there's no mechanism to invest with friends, and you have to be there when he (or she) has an idea," said Blacher.

To ensure safety and make sure that investors can see that the trades took place in their accounts, they open up an online brokerage account with either TD Ameritrade or Interactive Brokers. "You can see that you own the securities, and what you own," said Blacher.

To verify that their trades are real, the model managers are trading in a new account. "We capture the information from their trades in real-time. We screen it for suitability and then send it to your managed account for reconciliation," explained Blancher. When the manager executes a trade, it takes on average about two minutes (including the suitability checks) for the entire replication process to be in the investor's managed account.

"It's a bit like an open-source hedge-fund. Anyone can come in and compete and offer their services. Unlike the expensive UMAs, there aren't a lot of middlemen taking charges here. It's a straight management fee," said Blacher.

Investors pay a fixed management fee that varies by strategy, which is typically between 0.50 percent and 1.5 percent. CVIM rewards the managers who are RIAs from this money. "We only charge you on the actual subscription that you make," said Blancher, noting that investors are not charged a fee on the money sitting in cash. "It's really about being a sort of fair honest, open accountable way of doing investment management," said Blacher.

If the managers are individuals, then CVIM pays the $120 a year per subscriber that follows their model. "If they are regulated we share the fees," he explained.

Blacher compares CVIM to the mutual fund supermarkets that many online brokers such as Schwab and Fidelity have created. "Covestor is a similar mechanism to offer the investor this wide range of portfolios to invest in. It's also a distribution mechanism that never existed before for the portfolio manager, he said. Just as the mutual fund supermarket platform helped the portfolio managers build a following, through this platform professional managers and individuals can attract subscribers. The difference is that with a mutual fund, investors cannot see what the portfolio manager is doing everyday and mutual funds charge higher fees and are expensive to set up, he said.

In contrast to hedge funds and mutual funds where the manager's decisions are kept secret until they report them quarterly, semi-annually or if they report them at all, here there is complete transparency into the managers' holdings and returns.

"We provide all information for the clients to make the decisions on which portfolios they want to follow," said Blacher. "You can see the transactions, and are able to view the models available for subscription," said Blacher. Investors can view the model manager's holdings and performance. "It's all validated because we're capturing the information and calculating the performance metrics," emphasized Blacher.

The individuals or professionals sharing their strategies with CVIM have been building a track record for the last two-to-three years. "We're tracking these models, giving you information on the person's background, instruments they're interested in and their strategy," noted Blacher.

Part of the philosophy of CVIM is that the model manager — who is either an individual or a professional RIA — has skin in the game. "You're in it together, they've got their own money at stake," so they have a vested interest in this too.

Ten models are currently available for subscription, two of which are professional investment advisers and eight are individuals. One such adviser is Sean Hannon, an RIA with Epic Advisors, LLC in New Jersey, who has an annualized return of 83.46 percent and 1,167 followers on the site. He has a fundamental long/short style and tracks about 150 stocks. "He's a classic value investor who used to work at Morgan Stanley and Goldman Sachs," noted Blacher. You can click on "followers" and see which members are tracking Sean and then click on Epicadv to see which members Hannon is tracking. "The people are absolutely tremendous, they have incredibly compelling strategies," said Blacher. They represent diverse strategies with some trading one-to-five times a month and up to 50, 60 or even 80 times a month.

CVIM utilizes Covestor.com as a breeding ground for model managers it can recruit. CVIM is adding five-or-10 models a month and is gaining interest from hedge fund managers who don't have a retail channel, according to Blacher. One individual model manager is dubbed retire48 who trades his own I.R.A. account in e-Mini futures. Another is , who trades his entire retirement account through CVIM. His return since inception (June of 2007) is 29.74 percent.

Investors can pick a manager's models and automatically replicate the strategies in a single account, which at this point, are limited to U.S. stocks and exchange traded funds (ETFs) and ADRs. The investor's cash is auto-traded to replicate the different strategies of the model managers they select.

However, there are restrictions on investors imposed by CVIM. As an investment advisor, CVIM has a suitability requirement, so clients are required to fill out a questionnaire about their appetite for risk before they invest. This generates a risk score, which determines which models are available to them. They can update their risk score, at anytime using the CV.IM console. Investors can also set certain restrictions on securities that need to be excluded. For instance, if a model holds Google stock and the investor works for Google, they can restrict trading in Google shares.

Although $10,000 is the minimum to participate, each strategy requires at least $5,000 to invest to ensure that the cash available to replicate the strategy. "You want to investor to have a reasonable match in proportion to the model's holdings. You don't want him sitting in cash," said Blacher. According to the firm's materials, the CVIM replication engine calculates the proportions in which a model should be followed, screening for trading restrictions and client exclusions and generates a series of orders. These orders are sent using an institutional order management system from Advent, to the investor's management account in near real time (between zero and three minutes).

Behind the scenes there's a lot of technology to provide transparency to investors on how the subscriptions are going, both what the investor owns and how much the investor made or lost. At the end of each day, CVIM confirms its trading records using the client's custodian records from their individual brokerage account at TD Ameritrade or IB. They can also view positions, transactions and receive monthly performance reports on the CV.IM console. "In the institutional world, there been a big cry for greater transparency and liquidity. Madoff could never have happened under this sort of model," says Blacher.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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