FinTech Innovation From Robo Advisors To Goal Based Investing and Gamification

FinTech
Innovation
©
Contents
Preface xiii
Acknowledgments xix
About the Author xxi
PART ONE
Personalize Personal Finance
CHAPTER 1
The Theory of Innovation: From Robo-Advisors to
Goal Based Investing and Gamification 3
vii
viii CONTENTS
PART TWO
Automated Long-Term Investing Means Robo-Technology
CHAPTER 2
Robo-Advisors: Neither Robots Nor Advisors 21
CHAPTER 3
The Transformation of the Supply-Side 39
Contents ix
CHAPTER 4
Social and Technology Mega Trends Shape a New Family of Taxable
Investors 61
CHAPTER 5
The Industry’s Dilemma and the Future of Digital Advice 71
PART THREE
Goal Based Investing is the Spirit of the Industry
CHAPTER 6
The Principles of Goal Based Investing: Personalize the Investment
Experience 85
x CONTENTS
CHAPTER 7
The Investment Journey: From Model Asset Allocations to Goal Based
Operational Portfolios 109
Contents xi
CHAPTER 8
Concluding Remarks 145
Bibliography 147
Index 151
Preface
xiii
xiv PREFACE
Preface xv
Organization of the book

xvi PREFACE
Part One – Personalize Personal Finance
Part Two – Automated Long-Term Investing Means Robo-Technology

Preface xvii
Part Three – Goal Based Investing is the Spirit of the Industry

Acknowledgments
xix
About the Author
xxi
FinTech Innovation: From Robo-Advisors to Goal Based Investing and Gamification,
First Edition. Paolo Sironi.
© 2016 John Wiley & Sons, Ltd. Published 2016 by John Wiley & Sons, Ltd.
PART
One
Personalize Personal
Finance
CHAPTER 1
The Theory of Innovation: From
Robo-Advisors to Goal Based
Investing and Gamification
1.1 INTRODUCTION
3
4 FinTech Innovation
The Theory of Innovation: From Robo-Advisors to Goal Based Investing and Gamification 5
1.2 A VIBRANT FINTECH ECOSYSTEM

FIGURE 1.1
1.3 SOME DEFINITIONS, LADIES AND GENTLEMEN

1.4 PERSONALIZATION IS KING

FIGURE 1.2
1.5 THE THEORY OF INNOVATION

FIGURE 1.3
1.6 MY ROBO-ADVISOR IS AN IPOD

$
1.7 WHAT INCUMBENTS SHOULD CONSIDER WHEN

THINKING ABOUT FINTECH INNOVATION
1.8 CONCLUSIONS
PART
Two
Automated Long-Term
Investing Means
Robo-Technology
CHAPTER 2
Robo-Advisors: Neither Robots
Nor Advisors
2.1 INTRODUCTION
21
2.2 WHAT IS A ROBO-ADVISOR?

FIGURE 2.1
2.3 AUTOMATED DIGITAL BUSINESSES

FOR UNDERSERVED MARKETS
FIGURE 2.2
2.4 PASSIVE INVESTMENT MANAGEMENT WITH ETF s

$
$ $
TABLE 2.1
$
$
$
$
$
$
$
$
$
FIGURE 2.3
TABLE 2.2
2.5 ALGORITHMS OF AUTOMATED PORTFOLIO

REBALANCING
2.6 PERSONALIZED DECISION-MAKING, INDIVIDUAL

GOALS, AND BEHAVIOUR
2.7 SINGLE MINDED BUSINESSES

TABLE 2.3
2.8 PRINCIPLES OF TAX-LOSS HARVESTING

𝐶𝐿𝑆𝑇 𝑋𝑆𝑇 + 𝐶𝐿𝐿𝑇 𝑋𝐿𝑇

TaxAlpha =
𝑉𝑃 𝑂𝑅𝑇
ST LT
ST LT
A
B1
B2
B1 B2
$
$ A
$ B1
A
B1
TABLE 2.4 $
A 1
$
1
B1 5 $
B1 1 $
A
B1 B2 5
$
$ 1 $
5
1
5 $
2.9 CONCLUSIONS
TABLE 2.5
CHAPTER 3
The Transformation of the
Supply-Side
3.1 INTRODUCTION
39
3.2 THE INVESTMENT MANAGEMENT

SUPPLY-DEMAND CHAIN
FIGURE 3.1
FIGURE 3.2
3.3 HOW INTERMEDIARIES MAKE MONEY

FIGURE 3.3
3.4 ISSUERS OF DIRECT CLAIMS (DEBT OWNERS)

FIGURE 3.4
3.5 THE INSTITUTIONALIZATION OF THE PRIVATE

BANKING RELATIONSHIP
TABLE 3.1 $
∗∗
$
$ $
FIGURE 3.5
FIGURE 3.6
3.6 THE DIGITAL FINANCIAL ADVISOR

3.7 ASSET MANAGEMENT IS BEING DISINTERMEDIATED

FIGURE 3.7
3.8 ETF PROVIDERS AND THE PYRRHIC VICTORY
FIGURE 3.8
3.9 VERTICALLY INTEGRATED SOLUTIONS CHALLENGE

TRADITIONAL PLATFORMS
3.10 CONCLUSIONS
CHAPTER 4
Social and Technology Mega
Trends Shape a New Family
of Taxable Investors
4.1 INTRODUCTION
61
4.2 GENERATIONAL SHIFT (X, Y, Z, AND HENRY s )

Social and Technology Mega Trends Shape a New Family of Taxable Investors 63
FIGURE 4.1
FIGURE 4.2
4.3 ABOUT TRANSPARENCY, SIMPLICITY, AND TRUST

4.4 THE COGNITIVE ERA

FIGURE 4.3
4.5 CONCLUSIONS
CHAPTER 5
The Industry’s Dilemma and the
Future of Digital Advice
5.1 INTRODUCTION
71
5.2 WEALTH MANAGEMENT FIRMS: GO DIGITAL OR DIE

FIGURE 5.1
FIGURE 5.2
5.3 ASSET MANAGEMENT FIRMS: LESS PASSIVE,

MORE ACTIVE
5.4 ROBO-PLATFORMS: LESS TRANSACTIONS,

MORE PORTFOLIOS
5.5 DIGITAL-ADVISORS: EMPOWERED CUSTOMIZATION

5.6 ROBO-ADVISORS: BE HUMAN, BE VIRTUAL, TAKE

CARE OF RETIREMENT
FIGURE 5.3
$
5.7 CONCLUSIONS: CLIENTS TAKE CENTRE STAGE,

AT LAST
PART
Three
Goal Based Investing is the
Spirit of the Industry
CHAPTER 6
The Principles of Goal Based
Investing: Personalize the
Investment Experience
6.1 INTRODUCTION
85
The Principles of Goal Based Investing: Personalize the Investment Experience 87
6.2 FOUNDATIONS OF GOAL BASED INVESTING

FIGURE 6.1
6.3 ABOUT PERSONAL NEEDS, GOALS, AND RISKS

FIGURE 6.2
FIGURE 6.3
FIGURE 6.4
TABLE 6.1
6.4 GOAL BASED INVESTING PROCESS
FIGURE 6.5
6.5 WHAT CHANGES IN PORTFOLIO MODELLING

FIGURE 6.6
FIGURE 6.7
6.6 PERSONAL VALUES
6.7 GOAL ELICITATION

$
$
FIGURE 6.8
6.8 GOAL PRIORITY
6.9 TIME HORIZONS

FIGURE 6.9
6.10 RISK TOLERANCE

$ $
$ $
6.11 REPORTING GOAL-CENTRIC PERFORMANCE

TABLE 6.2
+ + +
− + +
− + +
+ + −
+ + +
+ + +
− + +
$
FIGURE 6.10
TABLE 6.3
+
+
+
+
+
+
−
+
FIGURE 6.11
6.12 CONCLUSIONS
CHAPTER 7
The Investment Journey: From Model
Asset Allocations to Goal Based
Operational Portfolios
7.1 INTRODUCTION
109
The Investment Journey: From Asset Allocations to Operational Portfolios 111
7.2 MAIN TRAITS OF MODERN PORTFOLIO THEORY
FIGURE 7.1
7.2.1 Asset diversification and efficient frontier
𝑉 𝑈 = 𝑉 1 𝑤1 + 𝑉 2 𝑤2
1 2
𝑅𝑈
𝑅𝑈 = 𝑅1 𝑤1 + 𝑅2 𝑤2
1 2
𝑈 𝜌𝑈
√
𝜎𝑈 = 𝜎12 𝑤21 + 𝜎22 𝑤22 + 2𝑤1 𝑤2 cov(1,2)
cov(1,2)
𝜌(1,2) =
𝜎1 𝜎2
√
𝜎𝑈 = 𝜎12 𝑤21 + 𝜎22 𝑤22 + 2𝑤1 𝑤2 𝜎1 𝜎2 𝜌(1,2)
√
𝜎𝑈 = 𝜎12 𝑤21 + 𝜎22 𝑤22 + 2𝑤1 𝑤2 𝜎1 𝜎2
√
( )2
= 𝜎1 𝑤1 + 𝜎2 𝑤2
= 𝜎1 𝑤1 + 𝜎2 𝑤2
√
𝜎𝑈 = 𝜎12 𝑤21 + 𝜎22 𝑤22 − 2𝑤1,0 𝑤2 𝜎1 𝜎2
√
( )2
= 𝜎1 𝑤1 − 𝜎2 𝑤2
= ||𝜎1 𝑤1 − 𝜎2 𝑤2 ||
√
𝜎𝑈 = 𝜎12 𝑤21 + 𝜎22 𝑤22
𝑅1 𝑅2 𝜌1 𝜌2
𝜌(1,2)
𝜌(1,2)
1 2
𝜌(1,2)
FIGURE 7.2
FIGURE 7.3
7.2.2 The Mean-Variance model portfolio
th
𝑅𝑗
𝑗
𝑗,
𝜎𝑗 th (𝑖,𝑗)
{ }
∑ ∑ ∑
min 𝜎𝑈2 = min 𝑤𝑗2 𝜎𝑗2 + 𝑤𝑗 𝑤𝑖 cov(𝑖,𝑗)
𝑤 𝑤
𝑗∈𝑈 𝑗∈𝑈 𝑖∈𝑈 ,𝑗≠𝑖
∗
𝑅𝑈
∑ ∗
𝑅𝑗 𝑤𝑗 ≥ 𝑅𝑈
𝑗∈𝑈
∑
𝑤𝑗 = 1
𝑗∈𝑈
𝑤𝑗 ≥ 0
∗
𝑅𝑈
⊂
𝑈
∑
𝑤𝑗 ≤ 𝑏
𝑗∈𝐴
7.2.3 Final remarks about Mean-Variance
7.3 MAIN TRAITS OF BLACK-LITTERMAN

7.3.1 The equilibrium market portfolio
𝑀
𝑗
𝑉𝑗
𝑤𝑀
𝑗 =
𝑉𝑗𝑀
th 𝑓
𝑐𝑎𝑝𝑚
𝑅𝑗 = 𝛽(𝑗,𝑀) 𝑅𝑀
cov(𝑗,𝑀)
𝛽(𝑗,𝑀) =
2
𝜎𝑀
[ ]
𝑅𝑗 = E 𝑅𝑗 − 𝑟𝑓
[ ]
𝑅𝑀 = E 𝑅𝑀 − 𝑟𝑓
Σ
𝑐𝑎𝑝𝑚
𝑗
⃖⃖⃖⃖⃖⃖⃖⃖⃖⃗ ⃖⃖⃖⃖⃖⃖⃖⃖⃖
𝑐𝑎𝑝𝑚 ⃗
𝑤 𝑐𝑎𝑝𝑚
= (𝜆Σ)−1 𝑅
𝑅𝑀 − 𝑟𝑓
𝜆=
𝜎𝑀
𝛽 (𝑗,𝑀)
7.3.2 Embedding professional views
( )
⃖⃖⃖⃖⃖⃖⃖⃖⃖
𝐹𝑐𝑎𝑝𝑚 (𝑅) ∼ 𝑁 𝑅 ;Σ
𝐹𝑣𝑖𝑒𝑤𝑠 (𝑅) ∼ 𝑁 (𝑄; Ω)
Ω
Ω ∞
⃖⃖⃖⃖⃖⃖⃖⃖
𝑝𝑜𝑠𝑡⃗ ⃖⃖⃖⃖⃖⃖⃖⃖⃖
𝑅 =𝑅
7.3.3 The Black-Litterman optimal portfolio
( )
𝑝𝑜𝑠𝑡 1
max 𝑤𝑇 𝑅𝑈 − 𝜆𝑤𝑇 Σ𝑝𝑜𝑠𝑡 𝑤
𝑤 2
7.3.4 Final remarks on Black-Litterman

7.4 MEAN-VARIANCE AND MENTAL ACCOUNTS
7.4.1 Final remarks on Mean-variance and Mental Accounts

7.5 MAIN TRAITS OF PROBABILISTIC SCENARIO

OPTIMIZATION
7.5.1 The PSO process

FIGURE 7.4
7.5.2 The investor’s risk and return profile

FIGURE 7.5
FIGURE 7.6
FIGURE 7.7
7.5.3 Generation of scenarios and scenario paths
∈
Γ
7.5.4 Stochastic simulation of products and portfolios over time

Ψ𝑈
∈ ∈
FIGURE 7.8
7.5.5 Potential and admissible portfolios: Allocation constraints
𝑈 ,𝐻,𝑡
Φ𝑈
Φ𝑈 𝑗,0,0
∑
Φ𝑈 ∶ 𝑉𝑈 ,𝐻,𝑡 = 𝑉𝑗,𝐻,𝑡 𝑤𝑗,0,0
𝑗∈𝑈
∑ 𝑉𝑗,0,0 𝑤𝑗,0,0
𝑎≤ ≤𝑏
𝑗∈𝐴
𝑉𝑈 ,0,0
Ψ𝑈
Φ𝑈
Ψ𝑈
Ψ𝑈
7.5.6 Adequate portfolios: Risk adequacy

Θ𝑈 Ψ𝑈
𝛼 𝜆𝐿
Γ
Γ
{ }
𝜆𝐿
Γ ∶ 𝜆𝑡 |𝑡 ∈ Γ
FIGURE 7.9
𝜉𝛼𝑈 ,𝑆,𝑡 𝛼
𝑈 ,𝐻,𝑡
𝜉𝑈𝛼 ,𝑆,𝑡 ≤ 𝜆𝐿
𝑡 ∀𝑡 ∈ Γ
𝜉𝑈𝛼 ,𝑆,𝑡
𝛼
𝜆𝐿
Γ
7.5.7 Objective function: Probability maximization

Φ𝑈
Ψ𝑈
Θ𝑈
Θ𝑈
FIGURE 7.10
∈Γ
∈ ∈Γ
𝜆𝐴
𝑈
Γ Θ𝑈
{ }
∑ ( )
Θ∗𝑈 ,𝑆,Γ ∶ max 𝑘𝑡 𝑃𝑈 ,𝑆,𝑡 𝑅 > 𝜆𝑡𝐴
Θ
𝑡∈Γ
𝜆𝐴
Γ
Γ
{ }
𝜆𝐴
Γ ∶ 𝜆𝑡 |𝑡 ∈ Γ
TABLE 7.1
Φ𝑈
↓
Ψ𝑈
↓
Θ𝑈
↓
Θ∗𝑈
FIGURE 7.11
FIGURE 7.12
7.5.8 Final remarks on PSO
7.5.9 Conclusions
CHAPTER 8
Goal Based Investing and Gamification
8.1 INTRODUCTION
137
8.2 PRINCIPLES OF GAMIFICATION

TABLE 8.1
8.3 GAMIFICATION OF WEALTH MANAGEMENT

8.4 THE MECHANICS OF GAMES

FIGURE 8.1
8.5 CONCLUSIONS
Concluding Remarks
145
Bibliography
147
148 Bibliography
Bibliography 149
150 Bibliography
Index
151
152 INDEX
Index 153
154 INDEX
Index 155
156 INDEX
Index 157

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FinTech

About the Author xxi

Concluding Remarks 145

Organization of the book

Part One – Personalize Personal Finance

Part Two – Automated Long-Term Investing Means Robo-Technology

Part Three – Goal Based Investing is the Spirit of the Industry

1.2 A VIBRANT FINTECH ECOSYSTEM

1.3 SOME DEFINITIONS, LADIES AND GENTLEMEN

1.4 PERSONALIZATION IS KING

1.5 THE THEORY OF INNOVATION

1.6 MY ROBO-ADVISOR IS AN IPOD

1.7 WHAT INCUMBENTS SHOULD CONSIDER WHEN

2.2 WHAT IS A ROBO-ADVISOR?

2.3 AUTOMATED DIGITAL BUSINESSES

2.4 PASSIVE INVESTMENT MANAGEMENT WITH ETF s

2.5 ALGORITHMS OF AUTOMATED PORTFOLIO

2.6 PERSONALIZED DECISION-MAKING, INDIVIDUAL

2.7 SINGLE MINDED BUSINESSES

2.8 PRINCIPLES OF TAX-LOSS HARVESTING

𝐶𝐿𝑆𝑇 𝑋𝑆𝑇 + 𝐶𝐿𝐿𝑇 𝑋𝐿𝑇

3.2 THE INVESTMENT MANAGEMENT

3.3 HOW INTERMEDIARIES MAKE MONEY

3.4 ISSUERS OF DIRECT CLAIMS (DEBT OWNERS)

3.5 THE INSTITUTIONALIZATION OF THE PRIVATE

3.6 THE DIGITAL FINANCIAL ADVISOR

3.7 ASSET MANAGEMENT IS BEING DISINTERMEDIATED

3.8 ETF PROVIDERS AND THE PYRRHIC VICTORY

3.9 VERTICALLY INTEGRATED SOLUTIONS CHALLENGE

4.2 GENERATIONAL SHIFT (X, Y, Z, AND HENRY s )

4.3 ABOUT TRANSPARENCY, SIMPLICITY, AND TRUST

4.4 THE COGNITIVE ERA

5.2 WEALTH MANAGEMENT FIRMS: GO DIGITAL OR DIE

5.3 ASSET MANAGEMENT FIRMS: LESS PASSIVE,

5.4 ROBO-PLATFORMS: LESS TRANSACTIONS,

5.5 DIGITAL-ADVISORS: EMPOWERED CUSTOMIZATION

5.6 ROBO-ADVISORS: BE HUMAN, BE VIRTUAL, TAKE

5.7 CONCLUSIONS: CLIENTS TAKE CENTRE STAGE,

6.2 FOUNDATIONS OF GOAL BASED INVESTING

6.3 ABOUT PERSONAL NEEDS, GOALS, AND RISKS

6.4 GOAL BASED INVESTING PROCESS

6.5 WHAT CHANGES IN PORTFOLIO MODELLING

6.6 PERSONAL VALUES

6.7 GOAL ELICITATION

6.8 GOAL PRIORITY

6.9 TIME HORIZONS

6.10 RISK TOLERANCE

6.11 REPORTING GOAL-CENTRIC PERFORMANCE

7.2 MAIN TRAITS OF MODERN PORTFOLIO THEORY

7.2.1 Asset diversiﬁcation and efﬁcient frontier

7.2.2 The Mean-Variance model portfolio

7.2.3 Final remarks about Mean-Variance

7.3 MAIN TRAITS OF BLACK-LITTERMAN

7.3.1 The equilibrium market portfolio

7.3.2 Embedding professional views

𝐹𝑣𝑖𝑒𝑤𝑠 (𝑅) ∼ 𝑁 (𝑄; Ω)

7.3.3 The Black-Litterman optimal portfolio

7.3.4 Final remarks on Black-Litterman

7.4 MEAN-VARIANCE AND MENTAL ACCOUNTS

7.4.1 Final remarks on Mean-variance and Mental Accounts

7.5 MAIN TRAITS OF PROBABILISTIC SCENARIO

7.5.1 The PSO process

7.5.2 The investor’s risk and return proﬁle