New influencers emerge on Web 2.0 investor communities

This is a guest article by Zack Miller, New Rules of Investing

THE recent emergence of online investor communities that are registered as investment advisers with the US Securities and Exchange Commission is producing a new brand of influencer that investor relations professionals need to pay attention to because they could challenge traditional Wall Street analysts in shaping investor opinions.

In my last post, How new finance websites affect investor relations, I detailed several strong trends that are changing the way investors make investment decisions. These evolutionary changes will affect the way investor relations is carried out and will define future criteria for success in the IR field.

Driven by a move to truly fair disclosure, mass adoption of social media like Facebook and Twitter, and the proliferation of financial content written by professional bloggers, we’re seeing entirely new practices emerge for making investment decisions.  One of the more important game-changers for the IR field is the rise of the expert investment community.

What are expert investment communities?

Expert investment communities are affinity groups of successful investors who create and share their analysis of the markets and stocks within a social network. These types of groups used to exist offline in the forms of neighborhood or office investment clubs.

But with the advent of social networking tools, global online communities are sprouting up, bringing with them experts with deep knowledge and influence in specific sectors, trading strategies, individual companies, and geographies.

Typically, expert communities work like this:

• Investors sign up at sites like Covestor, Vestopia and Cake Financial and are required to link up their online community accounts to their actual investment accounts;
• The investors’ recommendations to buy or sell stocks are verified against real trades in their brokerage accounts;
• Investors are encouraged to write about their trades, explaining the strategy backing each move;
• Top performers in the online community across different strategies and risk profiles are ranked on a variety of criteria; and,
• Other investors can peer into each others’ activities — learning, interacting, and bettering their own investment processes.

This trend is one worth watching.  While we’re still in the early adoption phase of growth, firms like Covestor have tens of thousands of subscribers, which is more than 50 or 100 times as many clients that many money managers work with at various professional firms around the world. This amounts to many billions of dollars in accounts being tracked.

While this is just a small piece of all assets under management globally, expect these numbers to grow. And as the competition for assets continues among asset managers, expect some larger investors to bring their assets under the community umbrella for tracking.

Investor relations professionals should not make the mistake of dismissing these communities as just another form of stock message board. What distinguishes these sites is that are inherently more trustworthy and transparent since they plug into members’ actual investment accounts to monitor the success of their investing.

In addition, while the communities are comprised of professional investors and arm-chair analysts alike, the sites continuously raise the bar on participation because they layer performance on top of all opinions generated in their sites.

Which are the major new investment community sites?

Covestor: Think of Covestor as the eBay of expert investing communities. Anyone can set up an account, hook it up to an investment account and begin trading and writing. Top performers typically significantly outperform stock indices, even if it’s just over the short term. While investors’ trades get logged, so too are their trading journals. Investors are encouraged to write about their portfolios and their trades. The whole point here is to provide a platform that verifies actual performance and identifies outperformers.

Cake Financial: A sort of different animal than Covestor, Cake Financial has tracked over 1 million client transactions. Rather than creating a playing field for investors to compete, Cake aims to help individuals make better sense of their portfolios and the performance of their investments. While top investors do get bubbled to the top, Cake also takes a horizontal view of its participants and produces community-wide statistics as well (I will write about this in a future post). When investors research an individual stock, Cake provides the community view of that security as a benchmark.

kaChing: Recently launched, this site has been the most active financial applications in the Facebook community. Unlike Cake and Covestor, kaChing has lowered the participation bar by allowing everyone to participate without linking in real trading dollars. It uses virtual investment dollars. However, individuals managing their own portfolios can pay a subscription fee to kaChing to mirror a particular community member’s portfolio. This incentivizes vast participation in the kaChing community of portfolio managers, both professional and amateur. According to TechCrunch, “of the 350,000 portfolios on kaChing, 1,500 have actually generated positive returns over the past seven months.”

Community investor websites like Covestor allow members to track trades of other members. Those being followed are paid as if they are professionals.

How are investors using these sites?

The trend is for these sites to register to become licensed investment advisors and investors using these systems will be able to choose to either pay to follow specific members’ moves, like subscribing to a premium investment newsletter, or the investor can open an account with these sites and turn their portfolios over to the portfolio managers participating on these sites.

Once the regulatory hurdles are behind them, these expert investing communities will act as a clearinghouse of sorts for both well-known and undiscovered asset management talent. As the financial turmoil works its way through the industry and assets become harder to attract, look for these sites to grow with even more raw and mature talent.

Some portfolio managers have told me as well that they are using these sites for idea generation and to peer into what their competitors are doing.  This voyeurism will continue to drive more professionals looking for good ideas to the sites.

How IR can prepare and respond to this trend

Embrace social media: With significant trend wind behind these expert communities’ backs, these early successes promise more significant adoption in the future.  IR professionals need to understand these communities work, how investors are using them, and how their usage leads to making investment decisions.  Social media is a double-edged sword for investor relations.  The central locus of contact with a select group of asset managers has become much more diffuse.  Professionals who know how the investment landscape has changed and how to use it to their advantage will find opportunities with social media to create very focused and targeted financial communications.  Keep in mind these are not just geeky daytraders who are populating these communities — professional money managers are participating alongside armchair analysts.  IR needs to ensure that their online disclosure information is in a format that yields to the needs of investors who likely are basing the vast majority of their research on online resources.

Encourage long tail stock ownership: While targeting institutional investors is still a powerful primary strategy to make an impact in IR, these expert communities are providing a tremendous opportunity for investor relations in that all of a sudden, there are entire communities open to finding good, well-reasoned investment ideas.  The long-cycle process of convincing a large fund to invest can be supplanted with a newer model of convincing numerous smaller investors of an opportunity.  Because these sites operate via social networking technologies, if one influential investor decides to invest, there can be viral ripple effects throughout a broader base of investors.  IR can focus on connecting with top performers or influential figures within these expert communities to spread the word and diversify the investor base.

Market research: Because traders in these communities are encouraged to write about their trading, there is a tremendous amount of opinion to be mined within their web pages.  Understanding the reason behind the investment is paramount to modern IR professionals.  Instead of getting some polite niceties kicked back at you during a roadshow or from an expensive investor perceptions audit with professional money managers, all walls come down to give you and unfiltered view of why investors are choosing to pull the trigger on certain stocks.  This treasure-trove of information should help to make your communications sharper and more targeted.

Zack Miller is a financial advisor, former hedge fund analyst and editor of New Rules of Investing. Sign up to subscribe to his blog today.