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The Anatomy Of A Market Change

The phrase ‘market change’ gets thrown around a lot in the financial world. We often hear about how the ‘stock market is changing’, how ‘traditional’ investing is becoming ‘alternative’, and how ‘long-only’ fund managers are struggling to keep up with the shifting demands of their ultra-wealthy clients.

Whatever the context, the phrase usually implies that something valuable has been lost, and that something new has taken its place. The question is: What is replacing what was lost? What happened to make the market change? And more importantly, is what changed for the better, or for the worse?

The Rise Of The Quantitative Investor

A market change usually occurs because of some sort of external event — either a company announces a major new product or service, or they report bad news about their current operations. These types of events cause asset prices to fluctuate, which in turn leads to an increase in volatility and the potential for big gains (or losses.)

When the S&P 500 Index experienced record-breaking gains in 2017, it was largely driven by an increase in the price of Bitcoin and other cryptocurrency, as well as the rise of interest in initial coin offerings (ICOs). The price of both Bitcoin and the S&P 500 climbed to record levels at the same time, leading many to believe that there’s a causal connection between the two. Since then, the price of both has dropped significantly, though it is still near record levels compared to earlier this year.

ICOs are crowdfunding campaigns where entrepreneurs (mostly) use cryptocurrencies like Bitcoin to offer investors the chance to purchase a stake in a company. The most popular ICOs tend to be the ones that offer the chance to invest in novel, high-quality products or services that haven’t even been conceived of yet. The hope is that these products or services will solve a problem that the investor is facing, or that they offer a unique perspective that will benefit the investor somehow.

In the case of the S&P 500 Index, the advent of the quantitative investor certainly played a role in the increase in demand for high-quality investments. Thanks to the rise of the quant, more sophisticated investors have become aware of the advantages that proper investment research can offer, as well as the potential for profits that come with higher-quality investments. This trend has turned the tables of traditional, buy-and-hold-investing on its head:

  • Holding a stock for the long term can no longer be considered a sure thing.
  • The potential for gains has increased, while the risks have decreased
  • More people are looking to take a hands-on approach to managing their money

The Demographics Of Today’s Investor

Traditional investors have always been a feature of the financial world, but their presence has typically been confined to certain demographic groups. Investors whose primary vehicle for financial engagement is a mutual fund or similar buy-and-hold-oriented vehicle are often considered ‘traditional’ — individuals whose primary investment method has been around for decades. This type of investor tends to have higher net worths, more education, and be more settled in their habits.

On the opposite end of the spectrum, you have day traders who are best suited for short-term, high-volume market activity. Day traders are often considered to be among the most ardent and sophisticated investors, as well as the most transient. This group tends to have lower net worths, less education, and more sophisticated investment vehicles — like computer algorithms that allow them to enter trades in small sizes and take advantage of short-term price movements. The appeal of day trading is that it allows for high-risk, high-reward speculation, which often proves to be profitable in the long run. Nevertheless, this type of investment approach comes with significant drawbacks:

  • Prices move fast, and it can often be difficult to get an accurate read on what is going on in the market at any given time
  • You never really know if the winning streak is going to end quickly or if it will continue for the rest of the year
  • There’s a lot of competition, as all eyes are on the small slice of the market that handles the most prominent transactions
  • A lot of work is involved in studying the market, analyzing the data, and ensuring that all the calculations are accurate

By and large, most people fall somewhere in between these two extremes — an investor who is highly engaged in the market but who also understands the importance of taking a step back and analyzing the big picture. The key question is: How do you want to allocate your money? Are you looking for a steady return with minimal risk? Or are you seeking the potential for large gains in a short amount of time?

The Battle For Clientele

The rise of the quant is largely responsible for the changing face of the investment world. Thanks to advancements in technology, easy-to-use platforms, and the increasing number of people seeking investment advice online, it is now possible for anyone to participate in the stock market — at least, to some extent. This democratization of the financial markets has had a profound effect on the way that clients perceive their interactions with financial advisors.

Prior to the advent of online marketplaces, the buyer-seller relationship that existed between an advisor and a client was, for the most part, a strictly one-way street. Clients would come to the advisor for guidance and help navigating the complex world of investing, only to have the advisor do all of the heavy lifting. With the increased competition and the expanding functionality of online marketplaces, this paradigm has shifted. Nowadays, clients expect the advisor to do some of the work themselves, while also providing the tools for the client to carry out their own investigations and make their own decisions. The advisor-client dynamic has therefore changed from a largely transactional relationship to a more collaborative one.

The shift from a one-way street to a two-way street has several positive implications. First, investors can now engage with an advisor directly rather than having to go through layers of intermediaries. This is particularly beneficial for individuals who want to participate in the stock market but who don’t have the time to do all of the research themselves or aren’t skilled enough to analyze the vast amounts of data that are now available. Second, advisors can no longer rest on their laurels and expect that all of the work will be done for them. Instead, they must constantly be on their guard, analyzing markets, identifying potential opportunities, and mitigating risk — all while keeping the interests of their clients at the forefront.

The Battle For Mindshare

Another major change that has occurred as a result of the rise of the quant is the change in the type of advice that is being sought. In the past, the mainstream investor would come to the advisor for guidance and help with selecting a retirement plan or an investment portfolio. Today, savvy investors are coming to the advisor for sophisticated, hands-on advice that goes beyond the scope of selecting a retirement plan or an investment portfolio. This is driven in part by the new wave of millennials entering the workforce, as well as the ongoing trend of people wanting to take a more active role in shaping their financial futures. The question is: How do you want to approach investing? Are you seeking to simply ‘get in and get out’ as quickly as possible? Or are you looking for the potential for large gains in a short amount of time?

It is clear that the way we think about investing and the way we want to approach investing are changing. Thanks to the advent of the quantitative investor, there has been a sea change in the way that clients want to engage with financial advisors, and in turn, in the way that financial advisors want to engage with clients.