Upstart mutual fund challengers play matchmaker, connecting small investors with experts

Startups play matchmaker to challenge mutual funds

BOSTON — If you’re unhappy with your mutual fund, you can easily find another. After all, there are nearly 8,000 to choose from.

But is that thinking too narrow? That’s the case a couple startups are trying to make.

Companies like Covestor Investment Management and kaChing are betting they can tap into the disenchantment of a select group committed enough to do the investment homework most of us are unwilling to take on. Another requirement: Investors must be willing to try a radically different approach, one that’s too new to have much of a track record.

Pat Rosenheim took the leap after mutual funds in his Fidelity Investments 401 (k) lost nearly half their value.

This year’s rally gave the phone company technician enough breathing room to put another $30,000 into the stock market. But the 55-year-old Danvers, Mass. resident didn’t entrust it to fund managers, or put it into his brokerage accounts.

On Covestor’s Web site, Rosenheim spent months studying 20 professionals from outside the mutual fund world as well as amateur investors dubbed “model managers.” They’ve demonstrated strong performance and consistent strategies over the couple years Covestor has been tracking them, and agree to share information about their portfolios and credentials. Covestor screened the group from 20,000 users on its site.

From that 20, Rosenheim selected five whose approaches collectively seemed a good fit. When the model managers make trades in their own accounts, the same trades occur in Rosenheim’s Covestor account. It’s automatic, with Rosenheim’s trades following the model managers’ moves within seconds.

For the right to invest alongside the five, Rosenheim pays fees competitive with those of most actively managed mutual funds: around 1 to 1.5 percent annually of the amount invested, depending on the price model managers set for their services. Covestor splits fee money 50-50 with its model professional investors.

It’s too early for Rosenheim to fully endorse a product he only started using only a couple months ago. But he’s enticed by the new avenues open to investors thanks to the Internet and the social networking phenomenon it created.

“The rules are changing,” Rosenheim says.

For a price, you can swap portfolio and strategy information with almost anyone who’s willing, no matter where they are. And if parties agree to terms, you can almost instantly mirror someone else’s trades in your own portfolio. It can happen without the brokers and other middle men who can burden traditional fund investors with extra costs.

One of Covestor’s founders, Richard Tahta, was inspired by trading tips his cousin used to pass on to him — tips that he was usually too busy to act on before a stock had already shifted up or down.

Covestor, with operations in London and New York, and Palo Alto, Calif.-based kaChing have been around a couple years. They started as sites where investors could swap information, run ‘virtual portfolios’ that don’t involve real money, or follow portfolios of top managers. It’s only in the past couple months that the sites have enabled investors to automatically mirror experts’ trades via brokerage accounts.

The two appeal to slightly different crowds. Covestor requires at least $10,000 to set up an account, compared with $3,000 at kaChing. The latter company draws many clients from an association with the popular networking site Facebook, which lists 31,000 active kaChing users.

Investors can follow a wide range of managers ranked based on recent performance — the startups are too new to verify long-term records beyond a couple years. KaChing, for example, assigns “Investing IQ” numbers, with top performers listed as “Geniuses,” including a retired lawyer and a student.

Many of Covestor’s managers are pros overseeing separately managed accounts, an investment option tailored to wealthy individuals’ needs. Covestor enables those managers to bring in additional cash from followers on the site who don’t have enough money to get into a separately managed account.

“It’s an open platform where managers can compete,” Covestor CEO Perry Blacher says.

Covestor and kaChing aren’t for everyone. The tools offered to help find suitable managers can be challenging. For example, both point customers to complex metrics like Sharpe ratios to gauge how much risk to expect from an investment.

“If you’re not willing to research your mutual funds, and leave it to your broker, you don’t want to jump from that to this,” says David Schehr, who follows investment industry trends for research firm Gartner Inc.

And there’s no guarantee operational glitches won’t crop up. Because the ventures are so new, it probably makes sense to consider “dipping a toe in,” rather than investing a big piece of an individual portfolio, Schehr says.

There are protections — Covestor and kaChing are Securities and Exchange Commission-registered investment advisers, agreeing to play by regulators’ investor-protection rules. And they have safeguards, including processes to ensure managers that investors follow actually are making trades using the assets they oversee — meaning they share their followers’ pain from bad moves.

The startups also face a tough job winning over an investment advice industry loyal to mutual funds. After all, funds hold nearly $11 trillion, compared with the two startups that still count their total assets in the millions.

“Is it going to be a major factor in the next five years or so? Probably not,” Schehr says. “But there is an evolution in how people are managing their money. If it’s not these two, there will be other niches like this that will form and challenge the traditional mutual fund.”

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Questions? E-mail investorinsight(at)ap.org.