SIP015: Bernard George and Patrick Aber on Reinventing the Online Broker - Sure Dividend Sure Dividend

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SIP015: Bernard George and Patrick Aber on Reinventing the Online Broker

Today’s conversation is with Bernard George and Patrick Aber, the co-founders of NVSTR. NVSTR is an online broker that provides institutional-level investment tools for use by individual investors.

Bernard and Patrick met at Harvard and have worked at some of Wall Street’s most sophisticated financial institutions. Our conversation covers their history prior to NVSTR, the platform’s current capabilities, and how investors can best use it for their own investment success.

Please enjoy this conversation with Bernard and Patrick of NVSTR.

Full Transcript Below

Nick: so I find in conversations like this it’s often interesting and insightful to hear a bit about the background of the people who are doing the work.

So I thought an interesting place for us to start would just be to get a bit of a career roadmap for each of you. I guess starting at college and then sharing a bit about the places you stopped along the way before co-founding NVSTR.

Bernard: yeah no that sounds great. So here’s how Patrick and my story starts back in 1998 when he met our freshman year at Harvard back then we had a lot of interests in the quantitative space math and science not necessarily investing at that point.

But we did both worked on different startups in college did  software development type internships that kind of thing. But when we graduated we ended up both coming to New York and working on Wall Street.

The interesting tie-in there I think from my perspective is that we found Wall Street to be a really interested application of math, so similar to physics which I studied in college.

There’s lots of interesting ways to mental models for explaining how things work I’m getting it sort of a deeper understanding.

So my first job on Wall Street was at JPMorgan at first I was in an exotic interest rate derivative structuring group. So what we would do is structure these very complex derivatives to solve very difficult problems that corporations had.

An example was pension funds in the early 2000s we’re facing a big asset liability mismatch, so was right after the dot-com stocks had gone down a lot at the same time interest rates were really low.

That meant the value of their liabilities was inflated but the value of the assets that they were finding those liabilities with was also taking a hit.

We structured some really interesting high rate interest rate equity options that helped those corporations. Now after that role they moved on to the proprietary trading desk at JP Morgan so essentially what that is an internal hedge fund that managed the firm’s own capital.

And I was responsible for corporate credit derivatives and capital structure arbitrage strategies there. So basically what that means is investing in companies but looking at all the different instruments that trade in the cross the capital structure to find the best way of expressing fundamental view that we have.

And very often since each company has corporate bonds options credit derivatives equities all these different instruments that trade. if you have a very detailed fundamental view you can often structure positions that express that view in a much better risk reward way than stay just going out and buying the stock or just buy the most liquid bond.

That’s a strategy I think which is really influenced the way I think about investing through the rest of my career and actually has had the big influence on NVSTR too because I think the key to that strategy is the intersection of both fundamental and quantitative ways of thinking about investing and I think that’s a really interesting area of opportunity.

Because you not only need to understand what’s going on with companies what are the risks what are the upsides like how to analyze the forward-looking nature of every single company which is  fundamentally a qualitative thing but also understand the quantitative nature of it. Because a lot of those qualitative aspects can be quantified either through historical data or through generally just quantifying the pale profile of each instrument in all these fundamental scenarios that can play out.

After JP Morgan we’re going to went on to trade debt strategy and a couple of other bank prop desks including Credit Swiss and also most recently at a hedge fund called C12 Capital. There in addition to trading corporate credit and capital structure arbitrage strategies I worked on cross asset relative value strategies.

And a big part of that was portfolio construction so thinking about big portfolios with lots of different asset classes and in though how do you put them together in a way that maximizes the potential returns subject to a number of different risk constraints.

So that’s my background in a nutshell.

Patrick: yeah and yes I was Bernie said we met in college we both came to Wall Street right after school. I worked as an a fundamental equity investing fund for about a year right out of school and then a quantitative based hedge fund called Tower Research Capital working on a few different quantitatively driven strategies there in in equities and mutual funds.

And I was there for about four years and then I switched over actually to the commodity side so it worked was the second higher on a quantitative desk at a commodities fund this was sort of the late 2000s when commodity investing was really gaining popularity and a lot of institutional investors wanted exposure to this asset class.

There had been an influential paper saying that it’s possible to get equity like returns from commodity investing which are much uncorrelated to other types of assets.

So there was kind of this big boom in commodity investing at that time so that was an exciting time to be in that space and that fund was bought by Carlyle the private equity firm so I I worked at Carlyle for a couple years after that acquisition. And that bring me up to NVSTR.

Nick: are there any formative experiences or particular insights the either of you gained during the first half of your career that you would say we’re particularly influential in your decision to start NVSTR.

Bernard: definitely so actually I think although the path to becoming sort of tech entrepreneurs is very windy for us I don’t think it would be possible for us to create NVSTR without the experience we had in the first half of our careers.

And I think the idea for NVSTR really came out of our collective realization that there’s just a massive divided between the tools and the technology and the investment processes that sophisticated institutions have versus what’s available to your regular retail investors individual investors.

And we experienced that frustration firsthand we’re at work we felt super well informed it was relatively easy to make intelligent decisions just given the tools on the processes that you have. But if you come home when you’re sitting in front of a regular to account whether it’s you Etrade Fidelity or you name it essentially you’re sitting you’re using an abacus I mean it’s a perfectly good for executing the trades.

But for investing executing the trade is such a small fraction of  having a successful portfolio and it doesn’t really help you with much before that.

So we found it NVSTR to really truly attack that problem head-on found that a lot of the existing brokerages were catering to this sort of active trader set and a lot of the kind of innovation that’s happened in the space in the last few years has been in that use case I’ve heard sort of day traders people who look at in technical charts and graphs and things like that.

And I think for and from the brokerage in existing brokerages perspective you can understand why that’s the case because they tend to make a lot of money off those customers.

It turns out that those customers are seeing less than 20% of the investing public so the rest of the rest of the people out there kind of not really well served with these products.

So with NVSTR we wanted to create a product which was solely focused on helping people invest better and the way its taken shape is it’s essentially a next-generation online brokerage with the community of intelligent investors. And the goal is to make smarter investing easy through technology and collaboration.

A big piece of that which we both had a lot of experience with in our prior lives is portfolio construction. We estimate that across the US individual investors are leaving roughly sixty billion dollars a year on the table just by virtue of the fact that they may not be allocating their portfolios as well as they could.

So that the way you get to that is there’s roughly three trillion of brokerage assets out there and the difference between their studies out there from the respected journal in the respected journal the portfolio management. That suggests that by optimizing your portfolio intelligently and essentially creating the sort of minimum variance allocation continually you can get 2% of alpha.

And while 2% of alpha might not sound like a lot compounded over say a 20-plus year investment horizon it can amount to hundreds of percent of cumulative returns.

So that’s just one example for portfolio construction there’s so many other areas where the investment process that an individual investor sitting in front of their brokerage account can be improved.

Smart investing essentially boils out boils down to two things one is security selection and two is portfolio construction so how you put those securities together into an into a portfolio and I think there’s a lot of really low-hanging fruit on both of those fronts.

Nick: so I thought it would be interesting to take this conversation and basically split it into like a 25/75 split where we spend the first quarter talking about you two as individuals and entrepreneurs in the last three quarters talking about the investor platform and how it differs from the traditional brokerage platform.

One of the things that really stands out to me is this emphasis on a community of investors and on social investing and on the I guess network effect benefits that you’re trying to create through NVSTR.

So I was wondering if you could touch a bit on that and explain what the benefits are for users of the NVSTR platform?

Bernard: yeah definitely so that this ultimately is inspired by our professional investing careers as well because professional investors have networks they’re always bouncing ideas off of people whether they’re sell side analysts whether they’re colleagues at other firm whether they’re investment community committees within their own firm.

So this concept of having a healthy discussion where a variety of viewpoints come together and insight is sort of distilled out is critical and constantly being challenged constantly hearing things that you may not have otherwise thought of. And we definitely found that aspect was missing from the individual investor use case.

And we think about all say 40 million plus  individual self-directed investors who are who are out there there’s a lot of collective experience there’s a lot of collective intelligence and we wanted to construct a platform that could help unlock that.

Patrick: and that’s something that’s really missing from accounts that are offered today if you have any Etrade account as an example and I have an Etrade account we don’t even know that there’s you put all this work into selecting companies that you’re interested in you have a thesis you’ve constructed your portfolio in some way and all that kind of hard work and knowledge is just going straight down a black hole the way the way the products are set up now.

So our goal is to bring that information back share it share it intelligently with people that and people that you care about and with the ultimate goal of helping everyone to invest better as a result.

Bernard: yeah and there’s a there’s definitely a lot of sort of information theory and some empirical studies around the topic there’s one with when paper which was published in science which we have linked to on our blog which studies how collective decision-making can often be more optimal than individuals making decisions on their own.

And there’s often a there’s also a sort of a more basic enormous first principles information theory type argument which is that when you create a composite of a lot of different views the error on the composite view is a is lower. And I think there’s other arenas where that concept has gotten a lot of attention.

One at one for example is in polling Nate Silver who a lot of  sort of popular statistics has a lot of it was obtained a big following as a sort of popular statistics guy and he’s applied his um that concept with great success to polling I think it’s all about sort of creating a system where you have a lot of different inputs a lot of different sources of information and create and combine them in a way where they’re unbiased and the result is much more accurate than any individual input to that system.

Nick: this whole concept of the wisdom of crowds is very interesting and powerful, and I’m curious with all the conversation that you see in the media right now surrounding privacy and those sorts of concerns.

Do you find it difficult to balance the sharing of knowledge versus the requirements of user privacy on a platform like a brokerage?

Bernard: yeah it’s a great point I think the key is to customize but to maybe be fully transparent about what shared and when and to only use that information in a way that helps users.

So for us the default privacy setting is sort of similar to like LinkedIn so you connect to somebody and only then can you see their ideas. And then information that we aggregate across the whole platform for this sort of platform wide collective wisdom is completely anonymized.

So there’s sort of no harm to the individual and we can take great care to protect individual’s privacy.

Nick: so from an aggregate point of view what I’m visualizing in my head is that an investor who has an NVSTR account can go in and check and see what the body of investors on the platform, how their weightings differ from indices and whether they’re overweight or underweight certain securities is that the case?

Bernard: it’s similar to that so there’s sort of two levels of collective intelligence that that are aggregated. one is among your own circle of friends you can sort of talk stocks with trusted friends like you would in in real life or on any other platform it’s just sort of a great way of aggregating all of that and keeping it all in one place and making sure that your friends are updated as your thinking involves without you having to go in and sync up another account with your brokerage and just making sure that you that it’s easy to keep people up-to-date.

The other the other sort of context where this collective intelligence really benefits people is the platform wide aggregation and that is very much along the lines of what you alluded to so you can you can look at our community ideas page and basically see what are the top stocks that people are thinking about.

By what percent of the user base is long what percent is short compare and contrast that to your own portfolio to your friends portfolios and we also have a layer of machine learning that sits on top of all of this.

So what’s really exciting about this is the view the benefit of applying techniques that have provided so much value another venue so you think about like Netflix or Amazon or Yelp or all of these other platforms that we’re all used to using we’re collective intelligence is distilled and you get actionable insight without having to dig through the raw data yourself and it’s very customized and tailored the way you think.

We have a lot of that technology and the platform as well where you can look at what we call a collective intelligence screen and that basically puts stocks in front of you which are similar to the stocks that you might already have or the stocks or sort of interesting to you based on the types of types of stocks that you have shown an interest in.

So if you say a div a new investor and created a portfolio dividend stocks you’ve been engaging on the social side on a lot of stocks that are like that we’re able to leverage all the work that everybody else on the platform has done who thinks similar to you and sort of expose ideas to you which are on the horizon of your thinking.

You can kind of think of it as like you can spend ten more hours like googling stuff and researching these things but why not just benefit from all the work that so many other people who think similar to you have done before you and just get those  get those ideas instantly.

Nick: that is very interesting and a truly unique way to source new investment ideas I haven’t heard of anything like that.

How do you guys think about portfolio construction asset allocation and I guess portfolio rebalancing and management over time?

Patrick: yes and this is another I think big differentiating point for an investor in a traditional brokerage account you really get nothing along these lines as long as you have the cash balance or the margin access margin to do a trade you’re able to do it and that’s pretty much it.

But based on our decade-plus each on Wall Street investing professionally we realize that there is certainly a better way to build a portfolio it’s not just one trade at a time it’s not just kind of a round number like 100 shares or a thousand shares there there’s a there’s a purposeful intelligent way to build a portfolio.

And the way we bring that to users on NVSTR is through a very seamless easy-to-use investment process that does some very sophisticated calculations behind the scene. But what you see in the user interface is I think actually easier to use than a traditional brokerage.

You have once you’ve done sort of you your research and connected with friends and interacted with the collective intelligence all that you’ve got let’s say ten stocks that you that you’re interested in having in your portfolio. The optimal portfolio is probably not going to be just 10% of each stock.

Stocks have different risks they have different correlations to each other they also might meet your needs and investment requirements in different ways so if you have a 5% dividend stock versus 0% dividend stock and you have you have a target of let’s say 3% a year.  That another kind of point to optimize around that you can’t you can’t really do in your head.

Basically finding a portfolio that meets kind of your goals and is within your risk limits is what our optimizer are can help you with. And so that takes some very well-established well understood financial Theory that’s used extensively on Wall Street. Modern portfolio theory and applies it to individual investing in a very sort of easy-to-use way.

So based on your views on your stocks your risk constraints and any other goals that you have like a dividend requirement it will calculate the portfolio for you that has the optimal that has the highest return that would within your constraints. And then from there it’s basically like a shopping cart interface to get to actually trade into that.

So it’s rather than having to go type in each ticker and then type in  buy a hundred of these sell 50 of those you see it as this very familiar shopping cart interface and then it’s really just one click to trade  from the portfolio that you have into your optimized portfolio.

Bernard: yeah I think part of what makes that so powerful is that it’s not only a more sophisticated way invest of investing and allocating your portfolio a smarter way but it’s actually easier.

You don’t have to take your list of 10 or 20 or 30 stocks and think oh I should have X amount in this X amount of that what should I do here it’s just one click you sort of set your objectives so I want to make sure that my portfolio has no more than X amount of risk or has produces this amount of dividend income.

Set those objectives identify those objectives set them up front and then let the computer do with the computer too as well analyze the virtually infinite range of possible allocations that you could have and select the one that’s best.

And interestingly that optimal allocation will change over time as market prices move  you maybe you have a value investment with the price target is that investment as that price goes up and approaches your price target it may make sense to reallocate that capital to somewhere else in your portfolio.

So all of this done is all this is being done continually behind the scenes and when it makes sense to reallocate. the pros and cons of that are presented in a very clear way so if you rebalance you can increase your expected returns by X amount you can if you do that your risk increased or decreased by this amount and you can compare basically your current portfolio to this hypothetical optimal portfolio and when it’s compelling enough just click a button and rebalance into that into that new one.

And should your circumstances change so the other could be you could imagine two investors one in his early 20s one maybe in his 60s maybe they have the same set of stocks and ETFs but how they should put them together is very different given their  they’re given the risk tolerance.

So you’re able to specify some of those higher-level attributes that you want to get out of your portfolio and not have to worry about Oh am I meeting those investment objectives. but just have the system sort of take care of that and let you focus on and just on the security selection part of it.

Nick: this portfolio management tool is truly fascinating to me because you don’t have to be a public equity investor for long to realize that security selection is only about half the battle and then deciding what weights to assign to each security can be another challenge in itself.

So my next question is how much flexibility do users of NVSTR have to generalize the portfolio management tool outside of the public equity markets and apply it to ETFs or other investment vehicles?

Patrick: yeah ETFs are offered on the platform it works exactly the same way as with stocks and I think that’s actually a very powerful aspect for people who do want to express views through ETFs rather than strictly a portfolio of individual names. and this I think is something that’s lacking from the robo-advisor type of product and this is this is feedback that we’ve gotten from a lot of users as well is  you have your well balanced portfolio of ETFs but then often you want to express a view in an individual stock as well.

Because you like their product you like their management or they have and that’s a strategy that you want to pursue so that really works seamlessly on NVSTR so you can have an allocation to SPY an allocation to a bond fund and also an allocation to let’s say five dividend stocks and the optimization will work across all of those instruments seamlessly.

That’s really important because for example if you if you want to take a large position in a stock that’s heavily weighted in SPY index which that’s people have fund with your own the intelligent way to optimize that is to sort of take account of the fact that you will you already have some exposure to this in your other instrument  that you own.

And that’s not something that’s offered anywhere else as far as I know so yeah it’s completely seamless to make sure your ETFs and your stocks and optimized across all of this together.

Nick: one of the questions that is going to be on most listeners mind as they learn about this new brokerage platform is fees and I you can see on your website that you guys you guys show a very nice fecund of investor versus the other major brokers and your fees are very low.

So I’m curious just if you guys could explain how you think about fees and where you see broker fees trending towards in the future?

Bernard: yeah so fees I mean I think we obviously wanted a price things super competitively fees are our clear way of getting an advantage when it comes to investment performance.

But I think what a lot of investors quickly realize is that once you have a portfolio of a certain size or as you sort of grow up in investing. It’s um it’s less about sort of saving maybe five dollars here and there it’s more about having a truly intelligent investment process and if you can  you can get an extra one five plus percent of investment performance then that can very quickly outweigh some of the transaction fees.

And I think there are obviously platforms out there with lower fees the vast majority of users are on platforms with higher fees. but we think that our  our value proposition for users is really when it comes down to the investment process and in helping people get more get more on that side.

And we think if you compare this to some other financial product like say financial advisor one of the things that our user base has been very excited about is that it’s super tramp the fee structure is super transparent compared to what you what you might pay at a financial advisor.

So if you have a financial advisor you might be paying say 1% of your assets every single year but the value that you get is so hard to quantify and certainly impossible to quantify upfront when you’re before you make that decision to pay it.

For on our platform one of the exciting things is that you can see the value up front before you place trade so if you if you use in the portfolio optimizer you can see the very concrete metrics in terms of how it can improve the projected performance of your portfolio the risk how it can help meet your financial goals in a better way and just oppose those amounts with the amounts that you might pay in commissions and in in many cases there’s in ten hundred X plus difference there.

So I think our goal is to be super transparent and let let users make those decisions.

Nick: NVSTR offers margin is a margin accounts from what I’ve seen on website and given the sophistication of your portfolio optimizer tool. What kind of risk controls do you allow investors to use with respect to margin accounts and margin calls?

Bernard: yeah so margin is as a two-edged sword like you don’t want to you can use it to make more money but it does involve additional risks so you want to be very careful about how do you use it one of the great things about our platform is that the portfolio optimization framework on the risk management framework makes it very it makes it much safer to use leverage if you choose to.

And there are some cases where if you’re say hedging a portfolio where leverage is in most cases a risk reducing trade but it might increase leverage. So we think armed with this risk grant management framework it becomes it becomes more of another arrow in your quiver I guess to improve that potentially improve the quality of your portfolio or build your portfolio to meet your objectives better.

One of the things that we found really scary before building NVSTR is the use of margin accounts and a traditional brokerage where it’s so easy to do something super dangerous. I mean you can go levered long super concentrated and super risky stocks and there’s just no guidance that that’s not a great  for most people that’s not a great thing to do.

And there’s no sort of connection between it’s very hard to make that connection between your personal objectives and what you want to get out of your portfolio and the trades are actually placing.

Nick: another form of levers that people often use is options trading does the NVSTR platform allow for buying and selling options?

Patrick: we don’t offer that today is something that we’re set up to add pretty easily in the future. I think within this optimization framework it’s actually a really great a really great sort of setup to use options in an intelligent way.

As reducing your downside risk and sort of intelligently changing around your risk profile.

I think in general option options trading it’s a complex its very complex and potentially confusing area especially for individual investors. But I think within the context of our optimization software it we should be able to help people use this tool in an intelligent way in a way that actually potentially even reduce risks. So that that’s something that we do look to add down the road.

Bernard: yeah we also have noticed a lot of broker just pushing the options product and I think there’s we think about like the spectrum of like what additional changes you can make to your investment strategy to improve the risk reward or to improve the effectiveness options is way at the far end of the spectrum.

There’s so much more low-hanging fruit in terms of portfolio construction asset allocation security selection and I think if you jump to that deep end too quickly for a  for a lot of users that may not necessarily be the best thing. Because it is one of the areas of the market where there are a lot of sharp shooters out there you’re jumping in the deep end and you want to make sure what you’re doing and you have the right tools to analyze the risks and make sure that they that they fit in with your portfolio and your investment objectives.

They and I think another reason why a lot of record is I’ve pushed that product is they are it is a super profitable asset class for brokerages just because it involves so many transactions which may not necessarily always be in the best interest of the end investor.

Nick: yeah that’s a great point I mean you read all these studies from major brokerages where the best performing investors often trade the least. Or sometimes the best investors have forgotten they haven’t or what-have-you so those studies are amusing illustrations at that point.

We’ve talked a lot about the different features that NVSTR offers I’m curious whether you guys have any opinion on what the most valuable component of the platform is?

Patrick: I think it’s really the combination of finding giving you all these tools to find great ideas and synthesizing those ideas into a portfolio customized for you all in one place.

There are plenty of places to trade stocks already and there are places to discuss stocks, but I think what’s missing is the connection.

If you read on a discussion board or something online about people discussing a stock you don’t know you probably don’t know those people you have no way to find out who they are you don’t know whether they actually hold that stock or whether they work for a company that invests in that stock or even they work for that company themselves that that context is really missing.

And again going back to our backgrounds that’s something that as a professional investor you always have whether it’s you’re reading a research report from a bank or you’re listening to a conference call from the company management or you’re just getting together with your co-workers to discuss an investment idea it’s never this kind of anonymous like fire hose of information that you often see it on the Internet.

I think kind of having a one-stop shop for investment information from trusted sources and a place to build a portfolio around those ideas all in one place that’s I think that’s the key to it for me.

Bernard: yeah and I think building on Patrick’s point I think one of the really exciting things about the platform is that it’s this very rare combination of both easier to use and more sophisticated. There’s been this sort of fallacy in the industry for years where complexity and confusion has been conflated with sophistication and substance.

But this sort of takes the complete opposite direction where on the surface it’s much easier to use than a regular brokerage account great for first-time investors. But under the hood what’s going on is super sophisticated and you’re so sophisticated that you may never outgrow it as an investor.

And I think I think that sort of elegance packaging something that’s really good for people and in something in a package that’s very easy to use and usable and that people actually enjoy interacting with I think is uh is huge.

Nick: I thought we could close up by talking a bit about your journey as entrepreneurs and all the work that you guys have put into building NVSTR to where is that today.

What would you say has been the most fulfilling part of the work you guys have done so far?

Bernard: for me I think it’s sort of being able to pivot a lot of this expertise that we’ve built in our professional investing experience to help a lot more people. I think in our old rules if we’re if I’m investing off JP Morgan’s balance sheet I mean it doesn’t it’s hard to feel  connected to the people who do making money for.

Here I think it’s really fulfilling to think that we can package a lot of those concepts in a way that can help a lot of people out. and it’s also been really fulfilling to see to be able to try to bridge some of the gaps that we that we perceived where there’s a lot of the level of sophistication in terms of how people think in the forefront of investing is kind of disconnected from the popular discourse on the Internet. And I think to be able to bridge that gap I feel I feel pretty excited about.

Patrick: yeah it’s for me is this is the first time really in my professional career that I’m working on something that friends can use my family can use.

So it’s institutional investing is a very important part of the economy and like university endowments and large pension plans and investors like that certainly need smart managers to make good decisions with their money.

Definitely no knock on that industry but for me personally it’s great to be able to interact with my dad on the platform and talk about talk about his ideas and share thoughts on recent news about a company and same with friends and former co-workers just building something that can actually help people who are important to me in my life it is it’s been awesome that’s the most rewarding things for me.

Nick: that’s awesome to hear. Now the last thing I’ll ask is if people want to learn more about the NVSTR platform or the work that you guys are doing where can they learn more about you?

Patrick: yeah so they can visit nvstr.com at nvstr.com we also have a blog where we share a lot of these type of thoughts it’s just blog.nvstr.com that’s the best place to get started.

Nick: awesome well thanks so much for your time today guys it was a pleasure speaking with both of you.

Patrick: oh you can also find us on Facebook and Instagram it’s and NVSTR official investor official.

Nick: awesome we’ll check you out there.

Patrick: okay thank you awesome.

Bernard: thanks Nick.