I had coffee with a friend last week. He's been working on wall street for most of his career. Over the past few years he has built a fast growing business inside a large asset management firm that allows the largest institutions (pension funds, endowments, insurance companies) to invest with the leading hedge funds without giving them custody. Instead of wiring funds to the hedge fund, they keep custody of their capital and the hedge fund makes the trades for them. This arrangement is both less expensive and more attractive to the large institutions. If another financial crisis hits and the gates come down on the hedge funds again, that will not impact these large institutions because they have custody of their capital and securities and can liquidate the securities themsleves if they want.
This is identical in many ways to the way our portfolio company Covestor operates in the retail side of wall street. We have had a Covestor account for something like three or four years now. I select model managers on Covestor to trade our account but all of our cash and securities are at an online brokerage account that I control and can trade in any time I want. When I "unsubscribe" from a model manager, Covestor automatically liquidates all the securities bought for us by that model manager. If I just want out of the whole thing, I could sell all the securities myself. The only publicly traded securities that the Gotham Gal and I own outside of securities that have come from our venture capital investments are in our Covestor account.We don't have the time to trade stocks for ourselves and we don't want to give custody of our money and securities to anyone else.
Both of these companies are taking advantage of a trend that we are seeing in the world of finance and that is the decoupling of custody and advisory. As I have said many times, money is just "bits on a wire" and the wires are starting to connect all over the place. Many banks and brokerage firms are putting in place APIs, including read/write APIs in some cases, that allow money to move and securities to be traded by third parties who don't actually have custody of the account.
I think we will see this play out all over the world of finance in the next ten to twenty years. It was with this in mind that I suggested last thursday night that the venture capital business will not look like it does now in 25 years. I think the idea of a 10 year fund where the VCs have custody of the LPs' capital and make all the decisions is not going to be the norm. Companies like our portfolio company CircleUp and AngelList are building important new platforms and paving the way with regulators to allow the same kind of thing that is happening in the stock market to happen in the venture capital market. And that's a good thing. Change is good, even in my own business.