Episode #249: Ben Savage, Clocktower Technology Ventures “Financial Services Has Had A Smaller Share Of Venture Capital Dollars Pointed At It…Since The Inception Of The Venture Capital Industry”
Guest: As Partner, Ben Savage manages Clocktower Technology Ventures and is responsible for all of Clocktower Group’s private market activities.
Date Recorded: 9/2/2020
Sponsor: Ikon Pass
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Summary: In episode 249 we welcome our guest, Ben Savage, Partner at Clocktower Technology Ventures. In today’s episode, we’re diving into VC and innovation in the financial services industry.
Ben has had an interesting path, and having spent some time at Bridgewater along the way, we spend a bit of time on high level thoughts about investing, allocation, and risk parity strategies.
We get into the heart of what Clocktower Technology Ventures is all about. We talk about the small allocation of venture capital dollars financial services industry has received relative to tech and life sciences, and get the lowdown on why this pocket of the startup world is so compelling. We even get the rundown on a couple of portfolio investments, and what makes them so exciting.
All this and more in episode 249 with Clocktower Technology Ventures’ Ben Savage.
Links from the Episode:
- 0:40 – Sponsor: Ikon Pass
- 1:12 – Intro
- 2:16 – Welcome to our guest, Ben Savage
- 3:52 – Ben’s background and migration to the west coast
- 7:51 – Inside the House of Money: Top Hedge Fund Traders on Profiting in the Global Markets (Drobny)
- 8:05 – Overview of risk parity investing philosophy
- 10:45 – Right way and wrong ways to invest
- 15:15 – Investing in bonds
- 20:38 – Clocktower
- 23:51 – Macro focus of Clocktower
- 26:20 – How Clocktower sources funds
- 27:31 – Mood of the macro community today
- 30:45 – Overview of Clocktower Technology Ventures fintech investments
- 36:20 – Why there is room for investment and innovation in fintech
- 44:30 – Why certain companies/industry don’t need to focus on a shiny new app
- 49:01 – Themes in financial services Clocktower finds interesting
- 54:32 – Landed
- 1:03:17 – Traditional lenders competing with Landed
- 1:07:21 – Another investment they are excited about – M1
- 1:12:28 – Best idea right now
- 1:23:53 – Most memorable investment
- 1:28:22 – Best way to connect: Clocktower Ventures; LinkedIn
Transcript of Episode 249:
Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
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Hello, podcasts friends. Another banger for you today. Today’s guest is a buddy of mine, a partner at Clocktower Technology Ventures, an LA-based VC firm focused on FinTech. In today’s episode, we’re diving into VC and innovation in the financial services industry. Our guest has had an interesting path and having spent some time at Bridgewater along the way, we start out with a little bit of time, high-level thoughts about investing, allocation, risk parity strategies. We get into the heart of what Clocktower Technology Ventures is all about. We talk about the small allocation of VC dollars financial services industry has received relative to tech and life sciences. And then we get the lowdown on why this pocket of the startup world is so compelling. We get into the rundown of a couple of their portfolio investments and what makes them so exciting going forward. Please enjoy this episode with Clocktower Technology Ventures, Ben Savage. Ben, welcome to the show.
Ben: Thanks, Meb. Good to be here.
Meb: This is a little weird. You’re probably walking/running distance from each other. Normally, we used to do, like, a quarterly brainstorm down load at Gjelina, which I miss. Is Gjelina open right now? Do you know?
Ben: I believe, with everything in LA, you can’t sit down inside the store, and I think they’re running all the takeaway through GTA and Gjusta, but I don’t know for sure.
Meb: For the non-Angelenos out there, this is one of my favourite restaurants on the planet, most like quintessential LA restaurant, it’s so great. The one positive of the coronavirus situation, at least down where I am, is the proliferation of outdoor seating, which I really hope stays after all this settles down and they just keep it all because LA, despite how nice it is, never had that much outdoor seating. Was that the last time I saw you or was it…
Ben: I think it must’ve been, yeah. It’s possibly ran into each other somewhere on the west side.
Meb: You guys had your office opening when you were popping bottles of champagne and hanging out with Peter Teal and everything else, but that was like over a year ago.
Ben: Yes, that’s right.
Meb: You guys have great listeners. They have a great… I used to be calling it somewhat of a FinTech coworking space, but probably not so much coworking going on right now.
Ben: Yeah. We’re not sure what’s gonna happen with that whole space that we have and with that industry generally. Maybe we’ll turn it into an open-air seating for restaurants or something. The whole world’s going to have to do something with this stock of office space that’s going to get unused for the next decade.
Meb: We’re debating what to do with ours. So, all right. Well, this is gonna be fun today. We’ll probably brainstorm lots of my terrible ideas I’ll pitch you. Usually, you’re the nice filter on getting to tell me why they’re horrific and they usually are, but for the listeners who don’t know you, let’s do the quick one-minute background. You’ve been all over the place, grew up, I think, in the south, been out here for a while, stops in Palo Alto and Connecticut on the way. Give us like the one-minute summary.
Ben: Sure. So, I started my career at the apex of the dotcom bubble, graduated from college in 1999, and joined an investment bank, but in their venture capital practice. And so, decided to become a VC at, like, the all-time highs in August 1999, spent six years, three in New York, three in California, running around, chasing venture capital.
Meb: Which one would’ve been first? New York or California?
Ben: Three years in New York first, ’99 to ’02 in New York. And I got off a plane in San Francisco in August of 2002 and was, like, the only net migrant into the Bay Area that year, I think.
Meb: I would have been the same exact time from the East Coast. I think I got there in ’01. And the only positive thing about being there during that decimation was you could buy anything off Craigslist for like $5, every flame out internet company. If you wanted 100 Herman Miller chairs, you could go just pick them up for free, but that was about it.
Ben: Yeah. And it’s so funny to think about San Francisco circuit 2002 relative to San Francisco today. I mean, the most expensive tech company venture capital office space in San Francisco now is like this area around South Park. And it was just like a bombed-out, desolate place. You probably could have bought the actual land around South Park for not that much money then. And it’s really incredible how much that first bubble you never would have imagined it would be so much bigger than it is and it has become.
So, I spent three years running around the Bay Area before deciding, “Hey, if I’m gonna go be a venture capitalist, I should go learn the secret handshake in that industry,” which, at the time, maybe was a business school degree from Stanford. So, that’s where I went after that. And I got to Stanford and decided to switch gears a little bit with market investing, did that in business school, and then joined a big hedge fund on the East Coast on the back end of that. I spent two years there before, kinda, getting an entrepreneurial bug in financial services and started a FinTech company in 2010, which was pretty early to be starting FinTech companies, actually. Did that for a few years and then moved out to Los Angeles for personal reasons. And I hooked up with my partner today, a guy named Steve Drobny, and started building Clocktower Group, which has been a great ride. And we launched our venture practice in 2015. So, I had this unusual career hole where, from 2005 to 2015, I stopped doing venture capital and did school, public markets, and some entrepreneurship, and then came back to being a VC after 10 years away from it, which is an interesting way to get perspective on something I’ve discovered, tried and recommended for everyone in all careers, but as an investor, it actually turns out to be pretty handy.
Meb: Well, there’s gonna be a lot of threads we’re gonna pull on today. And one of those will be some increase intersection with some of the things you’re talking about. I was smiling as you mentioned, a little hedge fund on the East Coast because they were in the news today. Bridgewater was making some announcements about they’re fiddling around with their risk parity a little bit. It’s a short article, but they were moving out of traditional bonds more into, I think, tips and gold, like, I scanned the article, but anyway, they’re always in the news. So, for better or worse, and I’m sure your NDA will expire in about 2156. So, let’s skip over that.
Ben: Well, we’ll skip that, but risk parity, we can talk about if you want. I mean, it’s the right answer. So, we can certainly talk about that.
Meb: Oh, wait, I remember. This is our first discussion when we met many, many years ago, pre you guys joining forces with Drobny. Well, we have a lot of common threads with our very first book listeners, we had the same publicist for Steve’s book, which was “Inside the House of Money.” I think that was the first great book, a classic macro book and his follow on too. Anyway, we had the same publicist and he used to work down the street from us, but now you guys move up into the North. Anyway, so, risk parity, give us the overview, its philosophy, I think, for investing that certainly makes a lot of sense. Give us your thoughts on it.
Ben: The deep insight of risk parity is that what you really wanna be exposed to is not stocks, and bonds, and commodities, but some underlying set of core drivers of investment results. And you can imagine lots of different ways of getting at risk parity based on lots of conclusions about what those core drivers, the core fundamental reasons that there are long-term returns to be captured from investing, which is to say the core drivers of risk premiums.
What you really wanna do is build a long-term asset allocation portfolio, where you are essentially harvesting those risks premiums in a thoughtfully constructed portfolio over time. And I think I’m sort of a believer that there is, like, a right and wrong way to do investing, right, which is, I think, sort of, a controversial point of view. There’s lots of different ways you can make money in markets. And many of those are, in fact, right ways to do it. But there, I think, at a very, very high level, there’s, sort of, like a right way and a wrong way to do it. And there are constraints that go into what’s the right way to do it for everyone. And those constraints will lead to Meb having a different end portfolio than Ben, but the underlying principles of how we’re gonna do that, I think there’s just a right way and wrong way to do it. And they’re fairly straightforward, and I’m hugely indebted to Bridgewater for helping me think about that and they’re very public about what they think the right way is and they’re largely right about that.
Meb: One of the interesting takeaways I always thought from their work on risk parity was this concept of not having to accept assets at the pre-packaged volatility and leveraged levels that you get from just nominal or notional exposure. If you have stocks, they already have debt on the balance sheet, same thing with real estate. You could de-lever and lever them up. Same thing with bonds. Then it becomes more about correlations and all sorts of other regime, sort of, dependent returns, which, I think, is other types of investors have used that inside a methodology, like the commodity trading advisors, I think, of the ’70s and ’80s started to think about that in a different way. They were more actively trading, but similar mindset.
Ben: But an early way to access the idea of, like, a momentum risk factor, right?
Meb: And I think that’s one of the insights, though, is once you, like, see it, once you understand that’s hard to unsee.
Ben: That’s right.
Meb: Now, but like you mentioned, they totally implement it in all sorts of different ways across the board with all the different philosophies. You mentioned some right ways and wrong ways to invest. Can you expand on that a little bit because I wanna hear what they are?
Ben: I think what you’ve written about many times in the past on asset allocation is among the right ways to do it too. Some very high-level investors should think about what is their risk tolerance, how much risk do they wanna take, and what does the distribution of that risk look like? Investors should be thinking about what their liabilities are, where are you gonna spend money? At what points in your life are you gonna spend money? How are you gonna spend money? What are you gonna spend money on? What are their assets today? Like, what is it that is your source of income, the industry that you’re involved in, places you live, the things you own that are assets, as well as consumptive goods? And there’s, sort of, a calculus that falls out of that, that dictates a little bit of, like, what your investment stance should be, what kinds of things you should be investing in.
What I’ve just said, sounds a little bit motherhood and apple pie, but there’s, within that, a lot of nuance in, sort of, how to do it correctly. And I would say one thing that investors often over-focus on is not the thing I just described of figuring out what your goals are, but people tend to jump right into, “Wait, what should I own? What’s my portfolio? What’s the best portfolio for me?” instead of doing the harder work upfront, actually, of saying, “Well, wait. The best portfolio for you is clearly an answer to a question or it’s a second thing to get at.” It’s not the first thing, which is, “Well, what are your goals?” If you know what the goals are, if you know what the liabilities are, and you know what you’re trying to achieve, it’s actually, I think, in some ways, not quite as complicated to put together what the optimal solution is and how you construct a portfolio. And I think it is actually a blend of passive structures and active structures.
And I generally do think within the passive structures piece of it, anyway, some form of risk parity is almost certainly the right way to do it, that there is a set of risk premia in the world that, on a passive basis, can be captured through long-only index type exposure to assets, and rather than looking at the, sort of, naive native form that you can buy assets in, it’s actually almost like a FinTech problem, if you will. If you can look through the equity markets and say, “You know what, the U.S. equity market is actually really different than the European equity market, and there’s a different set of underlying risk factors I’m getting exposed to if I were to put $100 bucks along the S&P versus $100 along the FTSE or whatever it is, the UK Index, but I wanna really build diversification, not between the European stock market and the U.S. stock market, but between the underlying factors, whatever you believe those to be.” Maybe it’s value, and growth, and momentum, or maybe it’s inflation and economic growth, or maybe it’s monetary policy and fiscal policy, or who knows whatever it is.
That part, I think, there’s reasonable people can, kind of, disagree about what you believe those underlying factors are in the world, but the principle of saying, “I’m gonna build a diversified portfolio on some underlying set of drivers,” rather than, as you point out, this kind of, “Hey, things happen to exist as packaged, sort of, stocks and bonds,” which are somewhat arbitrary set of conventions based on the way we’ve set up the securities rules around the world is much less good than if you can drill through it and, kind of, know what the data would tell you about the underlying true sources of economic risk in markets.
Meb: Yeah. You know, it’s funny, risk parity. We’ve always had a long interest in it, and the Risk Parity ETF came out recently. I think it’s a shop up near you, old school financial planner. They raised almost a billion so far. Advanced Research Investment Systems, RPAR, R-P-A-R. Anyway, there’s a lot of mutual funds, a lot of the big institutions. It’ll be interesting to see how they all navigate. One of the simple takeaway is usually, often though, at least historically, the criticisms, and feel free to comment on your thoughts there was that you end up with a lot more in bonds. And if that ends up being an inflationary environment, people are always pulling their hair out about that concept with risk parity. Any general thoughts? Is that something not to worry about?
Ben: I think the reason people, in theory, find a, sort of, levered bond portfolio unattractive, I think, is, number one, there’s sort of this sense that, like, bonds don’t have the same return profile as equities. And so, why would I wanna own this thing that doesn’t have it? Well, to some extent, you still have that with leverage and you can also, obviously, move duration around. I mean, literally, I think, as of last week, the single best performing asset class this year is actually unlevered 30s moreso, than, like, equity markets.
Meb: Hey, you wanna get weird and pull up the zero-coupon bonds. That’s what people like. You want to see bonds look like stocks.
Ben: Yeah. And so, that’s, I think, one theoretical reason. And the other is look, in, sort of, an interest rate spike, kind of, environment, bonds get hurt. I think there’s a misconception that somehow the long-term returns of holding a portfolio of, say, like, bond futures or rolling a portfolio of concentration, a bond portfolio would have, like, really negative long-term results if you’re rolling it into a steepening yield curve. And that’s just not really true. And there’s lots of evidence from history of this. And that is because of the risk premium that we were talking about. If there is, in fact, a risk premium in holding duration, which I think very clearly there is, an index of that stuff will make money even if over a 20-year time scale, you expect rising yields in real terms. And so, I think people just, sorta, get it wrong, that for some reason, they don’t wanna hold the bonds, and as a result lose out on a lot of the diversification power of bonds. And clearly, again, if you, sort of, zoom it back to a risk parity construct, there is a correlation benefit that you get from holding bonds. There’s no question of that.
If you can neutralize the return penalty from holding bonds by levering them up, things are gonna work out just fine for you. And I think if you were to go and look back, and I don’t really spend much of my time on this anymore because now, I really just do the venture stuff for us. But, you know, there have been, over the past decade, a lot of critics of risk parity as a construct. Like GMO has famously been a hard critic of this. I think risk parities held up quite well and that this, sort of, anxiety about bonds not delivering on the return side of the equation and exposing you to some kind of horrific adverse shock event, at least for the past decade, has largely proven totally false. And I suspect, if we were to look back at this question 30 years from now, risk parity will have outperformed traditional diversified asset class portfolios. It may not have outperformed 100% equities, but 100% equities have their own issues, which is really about volatility and risk. I suspect a risk parity portfolio levered to whatever the forward volatility will be of equities over the next 30 years will almost certainly outperform that portfolio.
Meb: I was smiling as I was just thinking, why would anyone wanna invest in anything other than U.S. stocks, S&P 500 over the past 10 years? But bonds is funny because, at least possibility, I think we were to go back and are probably first happy hour or lunch we had and say, “Look, X amount of years later, you’re gonna live in a world where most of the sovereigns are actually negative-yielding,” I would have said, “Dude, bullshit. There’s no chance of that.” But so, you at least got to consider the possibility that U.S. bonds trade negative at some point. Unlikely, whatever, but in a hard deflationary environment, it’s at least possible. And I don’t think really much else hedges as well as bonds doing that environment. So, anyway, we could talk about macro for hours.
Ben: It’s funny you say, “Why would anyone wanna own anything other than U.S. stocks?” Let’s imagine that in 2010, to just pick an arbitrary time, and I’m not actually sure what the math on this is, but I’d say “Okay, for the next decade, you get to put on one of two trades. You can either buy the S&P or you can buy bonds levered to the same volatility as the S&P.” I think the bond trade might win over that time period. If you actually levered the vol of bonds to the same vol that [inaudible 00:18:48] have shown over that decade, I’m not sure, but it’s probably not as big a gap as you might think, partially to your point, because no one would have predicted a decade ago that bond yields would end up negative 50 bits, or whatever they are in nominal terms. I think no one also would have predicted that Apple would be worth $2 trillion. So, it’s hard, but the value of bonds is systematically under-appreciated, I think, by investors and that in itself creates opportunity. I mean, you’ve mentioned inflation-protected bonds at the very beginning of our conversation. Those are a really good example of an asset class that is, for sure, underappreciated by investors broadly and I would suspect has better risk-reward characteristics as an asset class than most other asset classes today as a result.
Meb: Yeah. You’re starting to see flows into those ETFs. A good example is thinking about the stocks and bonds as we tell people back in March when stocks were taking a big puke, was that stocks and long-term bonds just in the U.S. had the same returns for 40 years. And it’s not even levering the bonds. It’s just the fact that bonds had a great run. And my favourite example, mainly because [inaudible 00:19:57.876] getting so much crap lately in the press, is that back in the early ’90s, there was a period we talked about valuation with stocks a lot. And we say, “Look, stocks are expensive now and people hate on the CAPE ratio.” But I said, “Look, let’s run a fun experiment that if you exited stocks, whenever they were above average valuations historically and just sat in bonds, the article shows if you had exited stocks when they were expensive, you would have missed out like a 1,000 percentage points in stocks.” But I said, “That’s a good thing because if you sat in bonds, you’d be in the same exact place and you would have missed out on these huge bear markets.” And so, again, a lot of people, they see it as no alternative, but in a world of you have all these other assets that tend to do well. Anyway, we could talk about this for a while, but let’s talk about what you’re doing now. How long ago was, Clocktower five years you joined?
Ben: No, it’s at least seven. Yeah. It’s either seven years, eight years, something like that.
Meb: It feels like 20, 30 already, but it’s only 9 months in, 8 months in.
Ben: I know, this is the longest year ever.
Meb: Sitting at home will do that. We were joking before the podcast started, listeners, Ben said he did almost 200,000 miles last year on an aeroplane and this year, it’s a 0?
Ben: I got one trip before pandemic. I went to Miami at the earliest part of March. And it was actually a very strange experience because the pandemic was just starting to, like, really penetrate America’s consciousness. And because we actually have an office in China and my partner actually originally grew up in Wuhan, although he lives in Manhattan Beach for a long time now, we were paying attention to the virus. So, I was flying to and from Miami with a mask on the whole time and was, like, the only person on the plane and getting weird looks from people. And you could actually walk into a drug store and just buy masks back then. I had done that, and looking back, the virus was clearly in circulation and people had it in that first week of March in South Beach, but you didn’t know. It just felt like a slightly odd time rather than almost like the end of civilization, which in some ways it was.
Meb: My last trip was to an investing conference in Jackson Hole and came back sick as a dog. I’m still convinced I had it. Antibody tests at the place I took it says I didn’t have it, but then a week after, it was a naturopathic spot, and the week after, I took the test. I got a marketing email from the naturopathic doctor that I had the antibody test marketing a…cure is the wrong word, but a solution for killing coronavirus that involves water and electricity. And I don’t know what that means, but I’m a little worried about my results, but who knows? Okay. So, you guys have been at it for almost a decade. Tell the listeners what Clocktower is, what y’all’s focus is, kinda, what your mandate is, what’s the progress?
Ben: So Clocktower Ventures is the financial innovation venture capital platform within Clocktower Group. At Clocktower Ventures, what we do is, in some ways, very simple. We back entrepreneurs and innovators who we think can reinvent financial services in a way that’s better for everyone. And we’ve been very fortunate over the 5 years to be a small part of the journeys of 80 companies, give or take, in FinTech, some of which are super exciting and changing the world and some of which are on the way to changing the world and just haven’t gotten there yet, but are still super interesting. Clocktower Group, more broadly, we are essentially an asset management boutique with three platforms, the venture platform, we have a global macro investing platform, where we allocate to and help launch hedge funds that trade global macro strategies, and then we have a similar platform to that in China, where we allocate to and invest in hedge funds that transact exclusively in onshore Chinese capital markets. And as I mentioned, we have a team of folks in China that support that business.
Meb: What’s the macro focus? Is it discretionary, fundamental, quant, all the above?
Ben: It’s really all of the above. I think the way we would articulate the thing that Clocktower Group does that’s, sort of, differentiated is that, first and foremost, we try to generate alpha through the power of relationships. We think that if you cultivate an ecosystem of partnerships, the team, sort of, the right people, in the right places, in the right ways, you build partnerships that actually matter. You can unlock insight, you can unlock ideas, you can unlock opportunities, you can unlock access, all of which can be, sort of, harvested in the right way to generate durable, sustainable alpha out-performance in these markets relative to the approaches that other folks might take. And we anchor all of that with the idea of a top-down way of looking at the world, a macroeconomic perspective, and use that almost as a north star to anchor who is in this ecosystem, this community of partners that we’re pulling together for this, kind of, really fun, stimulating, interesting engagement about the world at large.
So, whether it’s financial services, which you, kind of, can’t be a macro person and not know financial services, or its technology and China, which are probably the two really big generational macro themes of our lives, all those things tied together and just thinking top-down about the world. And then we wrap around all of that. I think a little bit more sophistication about human capital than perhaps many other investment managers do because, while we’re trying to wield the power of great relationships to generate alpha, we do that with actual people, and all of our businesses are things where we’re ultimately investing in people, seeding hedge funds, allocating to hedge funds. It’s really about the human capital managing those entities as investors, and then venture capital, especially at the early stages, which is where we play, it’s very much about picking the right teams. The ideas matter, the market that you’re going into matters, the way you execute matters, but at the end of the day, companies are just people, and at the very early stages, in particular, we would all day long back someone we think is remarkable, even if we don’t particularly like their idea, than someone we think is mediocre, well, we’re in love with their idea. And that’s how we think about it.
Meb: That applies to the macro and the VC business, or is that your specifically to one?
Ben: Yeah, I mean very much so in the VC business. The macro side, I probably shouldn’t speak for my partners who drive that business more than I do.
Meb: And do you guys accept submissions? Is it purely relationship driven? How do you source the, kind of, funds you’re looking for?
Ben: The opportunities that we seed, yeah. I mean, certainly, we are open to introductions. I mean, you never know where the next great investment talent is gonna come from. As a practical matter, I think because we are so relationship-driven, we’ve, kind of, hit a scale point where we are connected to the global macro community at this point. I think we have a, sort of, central stage role in that ecosystem around the world of the hedge fund folk, and the investment folk, and the academics, and the policymakers, and the analysts who think macro, but we’re constantly meeting new people. And that’s part of the fun of, I think, Clocktower Group. In aggregate, all of our businesses are really built around just constantly renewing your excitement and interest in the things you’re focused on by just interacting with smart people who have interesting perspectives that maybe you haven’t heard before. That’s, kind of, the cool thing about all of our businesses, I think.
Meb: Well, yeah. I mean, both of those areas, and I won’t speak to China because I have much less experience, but macro and startup are just endlessly fascinating about what’s going on and for similar, but slightly different reasons. One last macro question, then we’ll hop over. What do you see as the general sentiment and mood surrounding macro community? And that can either be from the, sorta, institutional investors, sorta, interests sentiment. We’ve had this long romping U.S. bull market. And depending on what you mean when you say macro, that could be a big headwind or not, but any general thoughts on, sorta, the macro landscape?
Ben: Macro is the classic original hedge fund strategy. And macro, for a very long time, was in assets by far the largest hedge fund strategy. And then, really, sometime around the late ’90s, you had this moment where security selection and stock picking, kind of, outran macro as the thing in hedge funds. The global financial crisis looked for a moment like it was gonna maybe reset that scoreboard, and macro had a, sorta, a day in the sun around 2007, ’08, ’09. And then it’s actually been, to your point, a pretty extended period where equity markets have been so strong, hedge funds, in general, have underperformed, and macro within that has not done super well. I think the version of the future that we’re starting to look at, the post-pandemic future, I suspect, sets itself up in a much better way for macro outperformance relative to other alpha strategies given the surge in uncertainty. Not so much in volatility over that too, but in uncertainty about the future, and the prospect of a much wider set of outcomes around inflation, a much wider set of outcomes around interest rates, a much wider set of outcomes around currency prices and commodity prices. All of that is a really, I think, interesting setup for macro over the next decade to find some more time in the sun. And I think you’re hearing that from allocators and seeing it in the performance of managers.
Meb: There was a fun, old tweet I had many years ago where you’re talking about, like, the really old school guys. When you think of macro, I think of Soros, I think of Bacon, all these guys. And I said, “There’s like five family trees.” And this isn’t macro, but you’ll see in a second. And I said, “I wonder if you could trickle down all five of these, which one would have generated the most AUM progeny.” There’s the famous Tiger Cubs of Robertson, and that’s mostly long-short equity, security selection. There’s the Richard Dennis Turtles, which ended up being a lot of the macro trend followers. There was Commodities Corp, which put out a lot. Rubin’s Goldman Sachs, sorta, arb desk, and lastly was anything Soros-related. And it’s interesting because we’re now onto, like, the grandkids and great-grandkids from some of those, but a lot of these old school macro guys, super fun to see what a lot of them spawned over the years in many different styles within that bucket too.
Ben: I think that Goldman risk arb desk, though, might be the most, might actually be the biggest just because of the quanta of firms that have, sort of, grown out of that lineage, although I’m not sure.
Meb: I once tracked all the names in an Excel file and it got to be like dozens, but I’ll post it in the show notes, listeners, if I can find it. All right. So, let’s talk FinTech, which is usually the topic you and I are brainstorming about over the years over wine and beers and everything else. You guys have invested in a lot of companies. Give us, sort of, your mandate, what are you looking for, what have been the themes? FinTech, I think, can mean a lot of different things. What’s the, sorta, seed, is it a series A, what’s the size check, all that good stuff? Give us the overview and then we’ll break it down.
Ben: Yeah. And it’s funny. I try not to use the word FinTech, actually, because, to me, a better way to capture it is just financial services innovation. And that’s really what we focus on. We cover the entirety of the financial services landscape. We categorize that into seven sectors, insurance, payments, banking, lending, and credit, kind of, all is one, personal finance, capital markets, and investment technology, all of which are, kind of, classic financial services things. Then we would add two other categories. One is real estate, to the extent, it’s a financial asset rather than a physical extended asset. And then the last is what we call the enterprise financial stack, which is essentially anything that would run up to a CFO, and a handful of other things attached to enterprises as financial entities, not just operating entities. You, kinda, add all that up, it’s about 20% of GDP, 20% of market cap, roughly. And depending on how you think about the real estate, it could be bigger than that.
That’s a pretty big swath of reality that we’re staring at ultimately. And part of what makes, I think, that really interesting and it’s sometimes missed by folks when they, sort of, hear FinTech is just how much heterogeneity there is within that. It’s an enormous part of our economy and our reality, what financial services drives. And the, kind of, simplest thesis that we had when we launched our business and continues to really be the thesis today is that if you look at the dollars that get pointed at innovation in our, sort of, financial system, like, just take the venture capital dollars in any given year, and you, sort of, allocate those dollars against sectors of the economy. Oregon’s market cap. I mean, there’s a pretty good correlation between GDP share and market cap share. It gets distorted over time as we decide that one sector of the economy is more valued than another for like a decade or something, but long, long-term, there probably should be some equilibrium across those things. What you can see is that the venture business, historically, has had two core focal points. It’s tech, hard tech, semiconductor or software, what people would have called TMT, tech, media, and telecom, and then life science. Both of which are comparably sized slices of the economy and of market cap to financial services.
Financial services has had a much, much smaller share of venture capital dollars pointed at it for, really, forever since the inception of the venture capital industry as a modern scaled up industry, which really occurred in, kind of, the 1990s. You can go back even further, but it’s very hard to get the data. So, if you imagine almost like an innovation quotient where you said, “What are the dollars of venture capital relative to, say, the market cap of the tech sector, or the dollars of venture capital relative to the market cap of life sciences, or the dollars of venture capital relative to market capital financials?” Or, even better, if you looked at it in GDP terms because, right now, if you looked at it in market cap terms, you get some funky answers. And you call this an innovation quotient of sorts. The innovation quotient for financial services when we started five years ago was almost in full order of magnitude smaller than the innovation quotient would have been in tech and life science.
In other words, as a percentage of venture capital, the weighting that went into financial services was so much lower than the weighting that went into tech and healthcare. And we, sort of, looked at that and said, “This doesn’t make any first principles economic sense.” There’s no really obvious reason why the financial services industry, which is just as valuable as the life science industry, just as valuable as the tech industry over a very long period of time, is so much more resistant to innovation that you would see so many fewer dollars being pointed at it. And it just didn’t make much sense. Now, then you start to, sort of, digging into it and we can dig into a little bit and talk about why that might’ve been, but we said, “Look, this feels wrong. This feels especially wrong in an environment where technology has gotten so much better, that all of the traditional scale barriers to launching new businesses are falling very, very quickly through things like the cloud, which takes what otherwise, in 2002, would have been an enormous amount of fixed costs to launch a business and turns them into variable costs.” And that applies across all kinds of categories. You would expect to see more innovation happen in financial services over the next 20 or 30 years than we’ve seen over the last. And corresponding to that, you would expect to see an enormous flow of capital into financial services innovation over the next 20 or 30 years.
And it’s on a very simple level. If I told you, “Hey, a bunch of people are gonna wanna buy something over the next 20 or 30 years.” A pretty good trade is to buy it before they do. In some sense, what I think is the story of FinTech over the past five years is that you can just see a steady increase in the flow of capital pointed at financial services innovation over the last five years. There is still a relatively small supply of high-quality companies in financial innovation. So, the valuations increase. More people wanna buy FinTech than there are sellers of FinTech at the moment, FinTech companies.
Meb: What is the general thesis? Because I agree with you and I’m spinning in my head because I’m like, “Okay, it’s an industry with some of the largest profit margins, parts of FinTech in the entire world of all the industries. It’s a massively scalable industry sector.” Is it just like the lack of sexiness historically versus tech and life science? What are some of the reasons behind why the dollars aren’t there? Or is it simply because the tech and life sciences were the historical profit centres that generate a lot of the money that flowed through and just continued where it was from the origins of VC? Any of those, check the box, multiple choice?
Ben: Yeah, for sure. I mean, we have a bunch of different, sort of, arguments as to why historically, there was less innovation in financial services that accreted to, kind of, new capital sources than in other verticals. But I think you can, kinda, boil it down to almost three naive simplifying categories, one of which was scale. So, financial services, I think, in many ways, continues to be a business where you want really big scale to generate really big profits. Functionally, what a community or a regional bank does is not that dissimilar than what a very large money centre bank might do in terms of servicing customers, but at every part of that journey, having more scale unlocks better margins. And so, over a long period of time, the really big banks have been able to get bigger and bigger partially through M&A, but partially just through essentially having more resources to throw at customer experiences.
And so, if you think about the mobile banking app that Citibank is gonna build versus the mobile banking app that a, sort of, regional bank is capable of building, you’re gonna get a different experience, and that’s gonna matter over time. So, the scale point at which financial services started to make sense used to be very, very high. And I think for a variety of reasons, that scale point has come down radically over the past five years. It was already lower five years ago as a function of developments in the tech world, and the FinTech world has carried that ball much, much further over the past five years to where like you and I could start a company today, and within five weeks, we could probably accept deposits for, like, the Faber Savage bank card product. It’s a killer name.
Meb: Great name, actually. Savage Faber may be better, but either way that’s a…
Ben: Yeah, yeah, sure. Savage Bank has already trademarked it. Like that product, I could launch it in five weeks, leveraging other people’s infrastructure now. I would have a slightly lower margin relying on all these people to launch that card than I would if I, like, went out and registered a bank and got chartered, which is, by the way, borderline impossible now, and built all the infrastructure myself and so forth, but that would take a lot of time and a lot of capital. That’s what you would have had to do 10 years ago if you wanted to take deposit. Today, it’s five weeks and it’s not even that much money to launch this kind of thing. That’s an enormous change in the competitive landscape. So, a tremendous number of barriers to entry essentially decayed when things go to the cloud, when we are able to virtualize more and more of the margin structure and, sorta, operating stack of financial services. In many ways, frankly, it’s very similar to what happened with semiconductors, where you went from intensely vertically integrated development of silicon.
You had to own foundries yourself, you had to have that entire value chain to get chips built, to today, where a designer, by himself, on a laptop can, like, design silicon and actually end up with physical chips without that much stretching it a little bit, but they outsourced the entirety of that value chain over a long period of time. And that’s functionally what we saw occurring with the financial services.
The second big driver is regulation where, post-global financial crisis, the actual costs of regulation went up for all the incumbents because they had, sort of, legacy issues and because they had such a big footprint. It counterintuitively opened the door to more innovation in financial services. And actually, in most jurisdictions outside the United States, regulation, in aggregate, went way down. We were one of the few countries that the response to the GFC was, “Oh, my God. We need more regulation.” Most places went the other way and said, “Well, we need more innovation. We need less regulations so that we can have a more flexible and nimble banking system.” And on the back end of the global financial crisis, in particular, I think there were enough shifts in the regulatory regimes that became, sort of, clearer for people to see ways to start competing because you’re not burdened by say, like, SIFI rules and some of the bank rules.
And there also appeared what I think at the time was basically a short regulatory arbitrage window where a lot of the early FinTech companies were able to be lenders because the banks just evacuated being lenders because they were so tied up with dealing with regulation and balance sheet rules. So, for instance, Lending Club and Prosper, which are, kind of, the standard bearers of that early wave of FinTech, nobody would have tried to build that kind of business pre-global financial crisis because you would have said, “Well, how are you gonna compete with the banks? They already make these loans.” The banks just don’t make those loans anymore. They stopped making them because of the regulatory issues. And then finally, the third thing we think about is trust. Financial services at the root are a trust transaction. If I invest my money in one of your ETFs, Meb, I’m trusting you in some way to be a good steward of my capital. If I choose to deposit my money in Faber Savage Bank Corp, I would be trusting that entity to be a good steward of my money to deliver me a good experience. It’s very easy to forget, you and I are both old enough to remember when, like, it was a little nerve-wracking to plug your credit card into some website to buy books online. Today, no one would even think twice about that. We just trust that that’s going to work. And younger people, in particular, have a staggering amount of trust with companies and startups that they’ve never heard of in 30 minutes, and just a handful of clicks, they might wire 80% of their life savings into some account to buy a cryptocurrency that they’ve never heard of before.
This is a real change in consumer behaviour. And you would never have seen this, I believe, around financial services if it weren’t for actually two trust-decaying events, which were the dotcom crisis first and the global financial crisis second where Wall Street totally failed everybody. They completely destroyed what were really, at that point, almost 100-year, sort of, stores of trust that had been built up in some of these brand names. The brand names still carry some weight, like the JP Morgans and Chases and Citibanks. The world actually still have way more brand equity than, I think, a lot of FinTech VCs would like to admit, but the willingness to trust totally new entrants in financial services is, kind of, a new thing over the past decade. And I think we felt that that was coming and that was another of the barriers to entry that just decayed and continues to decay, which leads to this surge of innovation in financial services.
Meb: Wells Fargo, maybe the final straw in the legacy banks. It’s interesting because listeners of the podcast have, kinda, got to ride along as I’ve talked about private startup investing over the last five, six years. And there’s, like, five themes that I look at, and none of them are specifically FinTech, but the one category that is, by far, the biggest, which ends up being FinTech and real estate and some of the financial services you’re talking about is almost like this concept of what I call a frustration arbitrage, where you have these old calcified industries that just still, like, often are such a antiquated, terrible user experience. And everyone almost, like, agrees on it. Usually, there’s like, “This is terrible. I don’t know why it’s still this way, but nothing is quite bubbled up or evolved.” But over the past decade, and even now, you’re seeing so many innovative…it’s almost like just a Cambrian explosion of opportunities and ideas, hopefully, that will get rid of it, because some of these have such, like, low NPS scores on the…just the interaction is so miserable. Anyway, tell us about a few of the themes that you guys are looking at. Any of the, sorta, sub-trees, branches of the tree under financial services you think are particularly interesting? And you guys have invested in how many, 50, 100 companies at this point?
Ben: Eighty companies, give or take, across our platforms.
Meb: And the average stage is what, seed, series A, B, where?
Ben: It’s seed A and B. I mean, generally, what we would say is anything let’s call it less than 200 million of enterprise value, we’re gonna take a look at it. I’ll dive into some things, but I just wanna pick up on one of the things you mentioned there, Meb, that there has been, it seems like, especially from a consumer’s perspective, this explosion, a flowering of innovative technologies, innovative experiences, and industries that, sort of, feel stodgy. But one of the things I sometimes wonder about for the stuff that’s outside of financial services, but also even within financial services is, like, is all this actually, kind of, high return investments from society’s perspective, is it actually the best use of resources? And the example I sometimes talk about is train travel, like Amtrak. It’s an interesting thing to me. We’ve all gotten so accustomed to the incredibly high-quality experiences, let’s say, Amazon and Apple deliver to us. Amazon, in particular, has pushed the consumer UX to just such an extreme degree that you literally can talk to a box in your kitchen and the next day, like, toilet paper shows up at the front door, but you, sort of, go, “Wait, do we need that type of experience in everything we’re doing in our lives?”
And I sometimes think about, say, Amtrak, this quasi-governmental railroad, it’s literally a monopoly. There is no competition. You cannot get on a passenger train effectively anywhere else in the country outside of Amtrak. And so, you, sorta, go, “What’s a better use of Amtrak’s capital? Are they better off actually just making the trains themselves more comfortable and more useful, or should there be like an Amtrak mobile app on my phone that’s got a beautiful user experience so, I can, like, buy tickets and do whatever I need to do on my phone?” And I sometimes think, you know, maybe they should just put the money in the trains, as opposed to building the cool app, so that I can, like, buy my Amtrak ticket with bitcoin or whatever they’re gonna get to down the line, and they’re not literally there yet. But this idea that every business we interact with, every experience we have has to start approximating this, like, really high-quality customer service expectation that we’ve now rendered as consumers from the Amazons and things like that sometimes doesn’t make sense to me.
And we actually see this in financial services, that insurance, which is a great example, historically, has not had such a good financial services experience. And we mentioned Net Promoter Scores in insurance are generally pretty bad, dealing with claims and engaging with insurance companies, not that awesome. But claims, to me, is an interesting use case of how often do you really have an insurance claim? When you have those claims, is it really the end of the world if you have to go to your desktop versus doing it on your phone? Is it really worth it for insurance companies to spend a bunch of money to create a mobile phone claims experience, as opposed to doing it with phone calls or going on a desktop? They’ve all done it. So, they’ve all made some competitive assessment that it is important to do that. But relative to other places that could potentially be more productive uses of capital for some of these companies, I wonder about these investments. And in particular, I wonder if we get a truly deep recession at any point that some massive amount of spending on technology that lots and lots of companies have made on enterprise SaaS, for instance, just get unwound very quickly. As somebody around the board of directors looks at their chemical manufacturing business and says, “Why are we spending this much money on a CRM software? It feels crazy. And there cannot possibly be a high enough return on investment for this CRM package just because we think our customers need to have an Amazon-like experience with us. For crying out loud, we need chemicals.”
And there’s a part of me that thinks that shoe might drop over the next five years, which would have some pretty real consequences on how we think about a lot of businesses. In FinTech, in financial services, I actually think it largely goes the other way because there’s such a gap around financial services experiences. And it is so central to our lives. It’s generally the kind of thing that we engage with every day, whether we realize it or not, that I don’t think it will occur in financial services, but I think it might very much play that way in other verticals.
So I just want to touch on that before we dive in, but you asked some of the themes that we think are interesting. At some level, there’s interesting things happening across all seven of the verticals that we care about. I would say, at a really high-level, a couple of the ideas that are more horizontal that I think are intriguing, one of which is the broadening of credit and the availability and access of credit somewhat universally is something that, I think, becomes really interesting over time. Historically, if you wanted to borrow money for anything, there was some central place that lent you money. It could have been a bank and you went there and got some, kind of, term loan. Whether that term loan was a mortgage, or a business loan, or, in the old days, kind of, a personal loan, most people got credit through a credit card, which was, of course, issued by a bank and provided them some form of credit to buy things on a day in, day out basis.
Credit cards really are more of a convenience type of credit than they are, like, durable credit in the sense of an extension of your purchasing power, but that’s like the big picture. Fast forward to today, and credit has been federated and distributed everywhere. You can get credit at the point of sale in almost any industry, whether it’s physically at a point of sale. Like you can walk into most jewelry stores and they’ll lend you on the spot, or it’s online through the buy now, pay later stuff that is, of course, trading at totally crazy valuation multiples. You can get credit in almost any outlet anywhere, any time. It’s like everyone is a lender at this point in time. And what’s, sort of, interesting on the flip side of that is like everyone is a source of capital to these lenders, interestingly enough.
There’s been so much of an appetite to capture all of these types of credit, partially because, for our conversation earlier, sovereign duration and corporate duration, the yields have come down so much that access to point of sale credit or the generally high-risk credits are just much more appealing. So, there’s this huge surge of capital seeking places to find yield. So, credit proliferates very, very broadly, but also technology just facilitates credit in lots and lots of places for more and more people all over the world. This is, generally speaking, a good thing. We want people to be able to borrow. It changes their purchasing power, changes their livelihood, facilitates more efficiency in the economy. Like if you think about a production possibilities curve and to, some extent, saving and borrowing is about time variation of preference, which leads to good outcomes for society. You want to see this sort of thing occur, but it really changes the texture of transacting for consumers and businesses when credit is federated everywhere, and it removes a great deal of friction from the economy.
If I wanted to go buy a tractor for my small business 10 years ago, I probably didn’t have that cash lying around. I would have had to figure out how to borrow money from it. Maybe if it was a captive tractor dealership, like John Deere had some captive financing company and could lend me money, but maybe I had to go to, like, my local bank that understood my farm, borrow the money to go buy that tractor. It was just, sorta, complicated.
Meb: Is this a good thing? I’m walking towards a conclusion because then, on one half, I’m like, “All right. It’s definitely good for the economy. Everything is lubricated more.” Is it a net benefit to the consumer and businesses, or is it just resulting them levering up and buying a bunch of junk they don’t need?
Ben: I personally think it’s very clearly a net benefit, but you can take the case of consumers, right? Until you have the development of standardized credit metrics like FICO scores in the, sort of, 50, 60, 70, it was fairly difficult for individual people to get credit and all kinds of, like, externalities, ranging from redlining and all the horrible outcomes that occurred with this more centralized control of credit in home buying and consumer purchasing, led to actually less freedom and flexibility for people, and it led to just less efficient marketplaces in general. It seems to me that it’s almost certainly better to have more credit out there, but at the same time, sure. You give people weapons that are occasionally gonna shoot themselves. And so, it’s totally possible that consumers and businesses will choose to lever up and up and up with more and more credit, and then you’re confronted with, sort of, the broad over-leverage problem that a lot of economies continue to face, and that arguably trigger global financial crisis. That probably gets solved in other ways, notably inflation. I think we’ll end up solving some, sort of, structural over-leverage problem, but people are also more responsible, and I think we’re inclined to believe, and that most people aren’t really going to get themselves wrong-footed with leverage. And actually, when you look at the behaviour of younger consumers, in particular, on the consumer side, anyway, you really don’t see.
But we’re very fortunate actually in the west. We have really good bankruptcy laws and things like that that help solve and clear these problems out of the system. Countries like Japan, countries in the Middle East, where they haven’t had these kinds of solutions because they haven’t wanted to face the pain of, at least on the corporate side, like real bankruptcies and workouts, tend to have less dynamic, slower moving, slower growth economies in the end. Capitalism is very much about birth and death of companies. In order for there to be an invisible hand that really works, you can’t have the same 500 companies in the S&P every year. It has to turn over. Some of those companies have to lose over time. So, you want more opportunity for credit and things, but I think it’s an interesting mega trend in the sense that financial services, ultimately, is about transactions. More transactions means more financial services and makes, I think, more efficiency in the economy and allows for, sort of, greater human welfare.
Meb: Feel free at this point to now, pick any, to the extent you can or want to, you can include any case studies of the companies you’ve invested in, if you think they’re particularly instructive. I know we’ve invested in at least one company together, maybe more. Are there any, sorta, case studies, ideas, you don’t have to name the companies if you don’t want, but, sorta, has able to walk through something specific that you think is an opportunity or something that somebody is developing as a wonderful product or service?
Ben: Yeah. Which is the one company we were in together before I do this?
Meb: Do you have to guess? Stackin’?
Ben: Oh, Stackin’? Great. That makes sense to me. I love that business. So, I’ll tell a story about a company of ours that I love talking about for a variety of reasons. The company’s called Landed. And what Landed does is helps local school teachers buy their first home. So, you can understand why I feel good talking about it. It helps local public school teachers buy their first home in the more expensive locations. So, in Palo Alto, California, in Manhattan Beach, California, in Miami, wherever it is where real estate is expensive and you’re a public school teacher, Landed helps you buy your first home. What does Landed really do? At the end of the day, all they do is serve as an equity co-investor in your house. The way the mortgage industry has developed in the United States, every mortgage roughly looks the same. It’s actually an incredibly simple capital structure for a given house. You’re gonna own 20% of the total capital, that’s 100% of the equity, and then you’re going to borrow probably 80% loan to value, that’s your mortgage. That’s the 100% cost of your house. In expensive, like, ZIP codes, most people who are sort of essential professionals, educators, as a good example of this, probably can afford the debt service cost to buy a single-family home, especially today when rates are very low, although that does have a price impact. So, over time, it, sorta, nets itself out.
The servicing cost, which is analogous to a rental cost, people who work in that community can generally afford it, but that 20% can be a real problem because not everyone has a parent who’s capable of gifting them money or signing for it. A lot of times, especially early in careers, people just haven’t been able to save in order to get there. And maybe you have 5%, maybe you have 10% of the cost of the home for a downpayment, but you don’t have the full 20. Landed shows up and says, “All right, Meb. Here’s how this is gonna work. You’re gonna post 10% of the cost of your house, we’re gonna post another 10,” and I’m simplifying the way this works, “and then we’ll go to the bank and we’ll get to that 80%, that’s the mortgage, and you’ll end up in the house. And here’s what happens. Over time as your home appreciates in value, we, at Landed, will take some of that equity appreciation because we paid half of the equity. We won’t actually take half the appreciation. We’ll take less because we have to find a way to make this work.” So, it’s actually net good for you. And we don’t really worry too much about it declining over time because while on a given house, property values might actually decline over time, if Landed can build a diversified enough portfolio in areas that have expensive land costs, which is a proxy for basically net migration into that area over time at values for the Landed equity slugs that they’re buying. And so, there’s two things ,I think, that are happening here at Landed that are really interesting. One is that this is a financial product that does great in the world.
Meb: So, that’s not just a use case, like it’s legit. You’re focusing on teachers.
Ben: The business is 100% focused on teachers on day one. Over time, you can imagine this expanding to all kinds of categories, municipal employees, police and fire, nurses turn out to be a really large category. There’s a lot of nurses and they’re not paid what they should be. There’s a lot of different things that you could imagine, and Landed, actually, in theory, could run this program on behalf of companies. So, like farm workers is another category where you can imagine it.
And to some extent, by the way, what Landed does, universities have done this for their faculty for decades. Princeton, and Stanford, and Harvard all do this, where you’re Stanford tenured faculty, they actually do it on the mortgage side, they’ll lend to you at a discount over time, and they actually forgive some of that loan over time to help you buy your property because around Stanford, it’s expensive. In Princeton, New Jersey, it’s fairly expensive. Those big and sophisticated university endowments have done this kind of thing and there’s a couple of companies that do it. Landed isn’t the only one, but Landed is very focused on the educators as the way of doing it because an educator turns out to be a really good borrower. It’s a very stable job, it’s pretty hard, actually, to get fired as a teacher, they tend to like their job, they’re attached to the community, so they’re going to be there. They’re gonna pay their mortgage. They’re generally responsible sort of people. It’s actually a great borrower. It’s just, how do you get the down payment?
So, the first thing that happens here is, in the same vein I was talking about, sort of, extending credit in lots and lots of places to people who might otherwise not have access to it, this is a form of credit, because the equity, the instrument that Landed technically buys, it looks more like a piece of mezzanine debt than it does true equity, the way that, kinda, payoff profile works, but the second thing is precisely that. If you think about single-family owner-occupied residential in the United States, it’s a massive asset class. It’s, in fact, one of the very largest asset classes, and it has this radically simple cap structure. Everybody’s house is just a single-tier of common equity and a single-tier of senior secured debt. You couldn’t possibly imagine that little financial sophistication and an asset class of this size. Companies that are much smaller than many people’s home values have much more complex cap structures than this relatively simple way of approaching it.
Now, there’s a tremendous degree of sophistication on the debt itself, packaged up into mortgage bonds, where there’s a very elaborate degree of sophistication. But the equity side of home ownership is almost totally unsophisticated. And so, part of what I think is really interesting about Landed is that they’re taking what is otherwise a very, very simple capital structure and just beginning this journey of complexifying it, of securitizing it, of hypothecated it. And what we see, not just in Landed, but in many, many FinTech, prop-tech startups that are getting formed now is a much greater degree of liquidity and of sophistication on the equity side of single-family residential. And then the narrative I sometimes tell is, like, this is one that will really, I think, raise that same question you asked, is this net good for people or not?
If we fast forward five years, I have high conviction, Meb, you’ll be able to be in your house one night, you drink a bottle of wine, you go to some website, and you discover that your house is trading for 30% higher than what you think it’s worth, you click a few buttons, and bang, you’ve sold 15% of your home equity to somebody on the other side of that trade. It could be an investor or it could be another individual, who knows? And you’re gonna wake up in the morning and, sort of, turn to your wife and say, “Hey, honey, guess what I did last night? I made this great trade. I sold 15% of our house.” And maybe you were a little drunk when you did it and your wife’s gonna be like, “What on earth are you thinking?” And you, sorta, go, “Is this actually a good thing for society if people can do this?” Maybe we want to put a speed bump around that, maybe we want to put a guard rail around it. There’s no principled reason. From a technology perspective, selling and trading the equity in your home should really be that much more difficult than selling an equity in the trading in Microsoft stock.
Meb: Well, I really like this idea, this concept of, for most people around the country, their house is their largest piece of the net worth, and it’s not even close. And tying back to the very beginning of our conversation about diversification, even at its core, about living a life that is not exposed to just one single asset, it seems obvious that you wouldn’t necessarily want to have 100% even if you could afford it. I like that general concept. What is, sort of, the customer acquisition? Is it direct to consumer or is it mostly partnered through corporates and organizations, like all the various teachers’ unions, or counties? How do they acquire customers?
Ben: Partnering with school districts is a big way for them. Sometimes, in the beginning of the business, they would actually go partner with almost like PTAs, and in some cases, the balance sheet for this would come from local families. Now, there’s enough proof points. It’s an institutional asset class and they raise funds and so forth from charitable foundations. There’s a lot of capital that, sort of, has, like, a double-bottom line mandated to say, “Hey, I’m going to give you a real estate asset that’s going to put educators in houses.” It’s not too hard of a sell, although it’s still, I think, harder than it should be, but it’ll get easier over time.
Meb: Do you think the traditional lenders…have you seen the evidence that they’re adopting this option on their own too as a feature or are they just like, “No, we’re just doing conventional mortgages, and that’s it”?
Ben: You’re saying the teachers themselves?
Meb: No, like, if you went to Bank of America or any of the incumbents adopting this idea.
Ben: I think it’s still pretty early. This is a highly regulated market mortgages, and it’s still early. There are lots of interesting FinTech solutions around home buying now that have reached a degree of scale, even open door, which is, sort of, famously this iBuyer, where it just will instantly give you a quote on your house and you can transact fairly quickly is a good example of something that many people have heard of, which started quite small, has gotten quite large, but it’s still actually quite small in the big picture of home transacting. And there are now a wide range of, call it, second and third derivatives on the open door model where there are now FinTech startups, where not only can you sell your home to something like an open door very quickly, but you can sell your home to the same firm that will bring an agent to help you find your next home and will help you secure that mortgage, will let you bid on that next home as if you’re cash-only buyer because they’ll essentially guarantee you’ll get your mortgage. They’ll navigate the rent back of the house you’ve just sold to them in that time period. It’s an end-to-end experience for you as a homeowner selling one house to buy another all with the same company. And there’s a cost for you to do that, but you can see that that journey is, sort of, better delivered, actually, through one partner than forcing you as a homeowner to figure this out on your own.
And there are going to be lots of innovations around this. Whether it’s schemes where you can, like, rent to own your house, I think there are gonna be…there already are, to some extent, companies that will try to monetize portions of your home. So, for instance, let’s say, you buy a house in Los Angeles, for instance. Any garage can basically legally be turned into an apartment. They call it an ADU, an additional dwelling unit. So, there’s a company I stumbled across the other day, they will do that for you and essentially own part of the economics of the apartment attached to your house. Like, so, your former garage, you don’t totally own it. You do, but you don’t because they have an economic interest in it. That’s, like, not a bad trade for a lot of people.
Meb: It’s like a clean out all their crap in the garage and get rid of it and probably sell it too.
Ben: Yeah, that’s right. Live lighter.
Meb: It’s a dual recycling, reduced consumption, potential revenue generator.
Ben: So, we haven’t seen [inaudible 01:05:58.678] offer, “Hey, not only will we lend you on the mortgage, we’ll also, like, buy part of your house.” They probably should be in that business, but one of the challenges of it is you get some adverse selection. Most of the people who are gonna go that route are actually your least attractive borrowers. There’s something, sort of, unique about educators and, to some extent, essential workers, where they’re actually really good borrowers, holding stable jobs that are attached to that community, that you really want to lend to them. If you run, like, a radio ad that says, “Hey, you can buy a bigger house than you otherwise would have been able to, and I’ll post half the equity for it,” you’re not gonna get the borrowers you want.
And so, part of what we like about Landed too and relative to the peer group anyway of startups is that I think they’ve solved some of this adverse selection issue, but it’s just an example. I think they’re all gonna be successful businesses because mortgage and home ownership is such a large industry, and we’ve structurally stacked the deck through taxes where people should own their own house. It’s important in the way we’ve built the economic system in this country. There’s going to continue to be a relentless demand to own a home and there are going to be more and more ways of achieving that goal that look slightly more exotic.
Meb: Yeah. The home ownership whole stack. You’re seeing so many cool companies in that space. What else? You got any other case studies? Any ideas that you’re particularly hot about? Are there any portfolio companies that have been surprise rocket ships? Take the open-ended question any way you want. Anything you’re particularly excited about?
Ben: One of our most recent investments that we did, which is actually, so far, the largest investment we’ve ever made, is in a consumer stock-broking company called M1, which I think the world of, I love the experience of M1. I think actually for many folks who are, sort of, your audience, it’s probably a pretty perfect kind of app. M1, I think, takes some of the aspects of what, say, a Robinhood does and some of the aspects of, let’s say, Wealthfront or Betterment do, kind of, blend them together into a brokerage account for self-directed, long-term investors who want to build portfolios for themselves that they believe can outperform. M1 makes that incredibly easy to do, with zero commissions, automatic rebalancing, heavily through ETFs, but also through single stocks, if that’s how you wanna do it, in a really beautiful application. And they’re adding to it, over time, just ongoing automation tools for individuals who wanna take charge of their own finances and financial services.
I think there’s something really powerful about that. One of the ways we think about it is that we are investors in a whole bunch of consumer-facing FinTech companies, many of which offer so-called challenger bank solutions to consumers, some of whom are less affluent and some of whom are more affluent. For an M1 customer, if you have a big brokerage account, whatever big means, I’m not gonna put a number on it, but you’re, sort of, actually investing an account at some scale. M1 unlocks for you a whole bunch of use cases that, I think, over time will become really compelling reasons to switch.
So, one of the examples I love, it’s a little bit to home ownership which one of the management team folks that M1 told us about that they did themselves every year, if you’re a homeowner, you have to pay your taxes. It’s a big check, actually, to write your property tax bill when the bill comes due. And most people don’t necessarily have that cash, like, lying around to write their check. Sometimes they save up in order to pay that bill, sometimes they borrow to pay that bill. M1, in theory, on an automated basis, would let you pay your homeowner’s taxes at the beginning of the year when it’s required to pay it by borrowing against your stock holdings because they can essentially make you a margin type loan. It’s not actually a margin loan because you don’t use it to go buy more stock. It’s just a secured loan against the value of your stuff, which is the, kinda, thing that the big banks would do for their ultra-high net worth clients, like, all day long, but it’s actually, sort of, annoying to do on, like, E-Trade. M1 one makes this really easy.
And then they can set an automated repayment schedule of that loan over the course of the year. They could do it out of the dividend stream and earnings streams that your stock portfolio is gonna generate. They could do it out of a bank account that you would attach to M1 and they actually now have their own debit account that you can do and partner with it. And this is actually a more efficient way for you as an investor to stay invested all the time rather than having to sell some relatively substantial chunk of your portfolio on a random day to have to go pay this tax bill. It may not actually be the right time to be under-invested and to then have to, sort of, buy back in over some period of time. It’s better to stay invested through the whole thing. Borrow against it at a fairly low yield because the loan is actually secured by your portfolio. And to do this in an automated fashion is, I think, the, kind of, interesting innovation that, over time, M1 will continue to roll out.
And we’ll see this not just with M1 and lots of sorts of businesses, the idea of automated financial services. People are calling it self-driving wallets. I think Wealthfront actually trademarked that term, although lots of people talk about it. I just prefer to talk about automation in finance, whatever that looks like. I think that’s going to be a very big fanatic. And M1 is interesting to us because it takes a lot of the best features in the consumer wealth management space, consumer-broking space, and stitches them together with automation, that creates some real power for you as a user. I think this is really cool.
Meb: We definitely have some investors that have tracked some of our portfolios and allocations on M1 over the years. Really nice user interface. Beautiful. That’s one of the biggest things with all the recent generation of the apps is just how simple they work. I joke half-heartedly that I want to transfer money from Vanguard or to Vanguard, I can’t even remember which, and it was so complicated that it almost made me think that they did it on purpose. They’re like, “This is a check against you doing things too active,” because it took, like, three months. And I joked that that was some of the most alpha I’ve ever generated in my life was because they, somehow, took me three months during a volatile period in markets. But, yeah, M1 is great. We could sit here and talk about all 80-ish of your other companies, and I would like to.
Ben: I’d love to do it.
Meb: We should do this weekly. We started asking a new question on the podcast, which I’m gonna tweak a little bit for you, but you can, kinda, choose which way you wanna answer it, which is simply what’s your best idea right now? And so, the concept being, if it’s an investor, they could be like, “I wanna invest in emerging market value for the next 10 years.” I think risk parity is a great allocation. You can take this in what is a unfunded idea no one has solved yet that you really like. You could take it as a current idea you just love, the bee’s knees, or your own interpretation.
Ben: You want an investment idea, right, not like a movie pitch?
Meb: Well, we’re LA guys. So, I’m listening. That’s like when you put under the umbrella of worst ideas on the planet, the ones we see is restaurants and movies.
Ben: I could imagine a sitcom about a financial podcaster.
Meb: I actually invested in a fund that co-invests with podcast hosts. That’s one of my favourite ideas. Kinda, what you’re talking about with the housing, it takes emerging podcast hosts that are seeing traction gives them access to a bunch of resources, but also takes a little bit of the equity off the table. Anyway, I like that idea. We’ll have to check in to see how this guy’s doing. I tried to get him on the podcast. No, that would be a terrible sitcom. But anything come to mind? You’re getting good ideas? Are there any burning ideas in the back of your head that you’re like, “Man, I just wish someone would find this. I can’t find anyone to do it.”
Ben: Yeah, we have lots. I mean, we actually keep a list of ideas that we wanna incubate. And those ideas I’m not gonna dig into here because I think one day we might actually do some of these things.
Meb: Do you do any in-house? Is Clocktower doing any, sorta, labs?
Ben: We haven’t so far.
Meb: We talked about this last time we were together. This was one of our things we went on for hours. I said, “I’ll fund it with you.”
Ben: I know. We’ve literally been kicking this around for years. You have to be focused and we’re already.
Meb: I think the problem was that your ideas and my ideas, there was zero Venn diagram overlap. So, I said, “We’re gonna have to split the office into two. We’ll get the funding and we’ll just smash them together.” All right. So, any you can talk about?
Ben: I guess I’ll give maybe a couple really big picture ideas that maybe I can stitch together into something. So, I think one idea that we’ve talked a lot about is, and I mentioned this a little bit about how we think about the world at Clocktower Group is that, fundamentally, I think human beings, well, we all get richer, we get wealthier is really what it comes down to. Over very, very long periods of time, like on a historical timescale, what is it that causes us to get wealthier? It’s not like there’s more atoms in the world. And yet somehow, things are improving. We’re all getting wealthier over time. And essentially, it comes down to we are somehow able to add more and more value to the things we already have. My professor at Stanford, Paul Romer, would, sort of, talk about it as like recipes. We just get better and better recipes for combining things in the world to make things that are more useful to us over time.
And I think this idea of recipes is powerful. It’s not just physical recipes, like we can extract more energy from a gallon of oil today than we could have a million years ago, and a 2 by 2-inch semiconductor today does way more than a 2 by 2-inch semiconductor did 30 years ago, whatever it is. It’s also in more abstract, intellectual thinking that techniques we develop, algorithms we develop, ideas we might have on how to do things in markets are all more valuable than it used to be. And one of the really, sort of, big ways that human beings have created wealth in the world is essentially securitization. We take risks, we figure out how to bind them together in some contractual form, and then trade those risks, and essentially, reallocate them in ways that create net surplus. This is functionally what insurance does from a first principles economics point of view. You take a bunch of risks, pull them together, it reduces anybody’s individual exposure to it. There’s an economic surplus attached to that.
So, one of the big mega trends we think about is securitization of risk, creation of new assets over time, and, in particular, a convergence of what today we would call private markets and public markets into something that looks more like one broad-based thing. As a practical matter, when we look at the world and you go, “Are there areas of reality that have not been securitized as yet and can unlock a lot of value?” I think human capital is this massively unsecuritized asset. There’s not a good way, really, to extract the value of human capital. Today, what we do is we pay people for their labour, by and large. That is actually not that efficient for a whole bunch of different reasons. Partially, the incentives are bad, partially, it’s tied to some very narrow time window. The value of Meb’s labour 10 years from now, it’s unknown. We don’t know what it’s gonna be worth. We don’t know what your contribution to, sort of, the economy in the society, etc., in the year 2030 is gonna be. Well, we could put some boundaries around it. We could try to value that thing. We don’t know what Apple’s earnings are going to be in 2030, either, but we certainly try to put valuation to that. And the question is, if we could put some theoretical value to, like, Meb’s earnings in 2030, you want to be able to monetize it in some way, shape, or form, and do something with it today to either invest, to buy a yacht, I don’t know what you wanna do with the present value of your 2030 earnings, but maybe you should be able to do that. And there’s a lot of interesting ideas around this concept of, like, the value of human capital being securitized.
So, a big one is this idea of income sharing agreements, where a prominent company called Lambda School, we’re not investors in it, they teach you how to be a computer engineer. It’s, kind of, like a trade school in some ways, but the way you pay them back, it’s not fixed. It’s essentially variable and it’s a function of what you’re gonna earn. And it’s set up in a way that’s not punitive and horrible for you. It’s actually very much configured to be to your advantage, but Lambda School has a nice business around it.
Meb: I love, love, love the concept of ISAs across the board for some unknown reason, and it may be the just general narrative and marketing description of them. For some reason, it causes people to lose their minds, like some of the critics. There’s like, “You’re incentivizing people to be slaves.” They just go crazy on Twitter, and I said, “Look, all it needs is a little better marketing angle dipping into policy, Andrew Yang talks a lot about universal basic income,” and my slant, I said, “Look, consider an idea instead of phrasing it like that, because it seems like a handout. It’s like a welfare check,” I said, “Why not consider it something like a freedom dividend or something that say, ‘Look, you’re actually just getting a very small portion of the business of the country and have it be paid out as a ownership in, essentially, stocks.'” But my whole point goes back to the old, like, death insurance, life insurance. ISAs, to me, didn’t seem such a reasonable and not that complicated, wonderful thing for most young people to consider. And they’ve been around for forever. It’s so weird that people react so strongly in a negative.
Ben: They feel squishy because it’s like, I think, it’s really a downside skew thing. If I write you an ISA, I essentially lend you money. If I don’t do that, well, nobody feels bad about it, but, let’s say, I make out, like, a bandit, and you become a billionaire, that’s not even not even good example. I just do really well and you don’t do really well. That seems to set people off. That’s the part that gets a little squishy.
Meb: But they cap it, I think, as well. There’s, like, a max ceiling that you hit anyway.
Ben: The laws around it are unclear, but I think the broad idea, whether it’s an ISA or some other structure that doesn’t exist yet, who knows what it is? This idea of securitizing human capital, I think, is really important idea and crucially unlocks an asset class that would actually be bigger than any asset class that exists in the world today. The value of human capital, in theory, should be bigger than the value of all the physical capital in the world and all the securitized capital that exists so far. So, you can imagine more than a doubling in the size of financial markets if we got enough securitization of human capital in a way that made sense. So, I think that’s one really important idea that hasn’t yet been explored fully enough and that we’re interested in exploring.
An idea that’s less about FinTech but I’m going to connect it to ISA idea, assuming that my partner Marco [inaudible 01:20:59] has been talking about for a little while, which is that, if you were to make a decade forecast about relative returns between the United States and emerging markets, his view is that emerging markets are likely to outperform over the next decade for a variety of reasons, including some currency consequences of this. I think, in particular, the human capital in emerging markets is almost certainly under-securitized and would be an incredible value opportunity. And as powerful as it would be for an American to be able to say, “Take, instead of some student loan, that’s a fixed rate and potentially very punitive, a much more nimble, sort of, income share agreement, sort of, idea.” Imagine if you could do income shares in emerging countries and deliver people who, otherwise, really don’t have access to high-quality credit at attractive rates, capital, that they can invest in themselves, that they could invest in businesses, that they could do all kinds of things with, where they themselves can look at much, much higher, sort of, return on investment use cases than Ben or Meb could.
And I think there is some unbelievably large opportunity here that you see in businesses or in nonprofits that are like micro-lending enterprise. Like I’ve been a lender on Kiva since I was in business school, where my friend Jessica Jackley helped set up Kiva and I first learned about it. It’s such a wonderful idea. And Kiva has done as a nonprofit rather than for-profit as a micro lender, but there are plenty of for-profit micro lenders. And I think that’s really just the tip of the iceberg, that there’s so much capital that gets concentrated in, like, Tesla that maybe it would be better for the world if that capital ended up in human capital rather than in Tesla stock down the line. And instead of saying, “Hey, the thing that everyone wants to talk about is the $2 trillion value of Apple.” It’s like, “Well, what about the value of, like, all these people in these emerging nations? Let’s figure out a way to securitize that, to monetize that, make that the hot stock in the world, add that to everyone’s portfolio.” Like if every endowment in the west said, “We’re just going to take 1% of our portfolio and put it into some asset class nominated by, like, human capital in frontier nations.” As a for-profit thing, not a donation, some, sort of, for-profit thing. Maybe it ends up just being plain vanilla student loans, but I think we could do it in a way that was responsible. And that was something like an ISA. What a difference that would make in the world. I’d love to see that happen.
Meb: Good. When you guys send Ben your pitches, CC me, please, because I’m very interested. I love those ideas and invested in a couple of companies that have been doing the ISAs. But agree, it hasn’t seemed like other than Lambda School, there hasn’t been quite the exact messaging or fit to where it really feels like it’s gonna… But given what’s going on in the education space this year, there seems like there’s gonna be a lot of disruption in turnover and innovation pretty soon. Our classic question so that you can apply this personally, you can apply it across your company or both, what’s been your most memorable investment? It could be good, it could be bad, it could be in between. Anything come to mind?
Ben: In some ways, the most memorable investment is the thing that I’ve…
Meb: Stockpiling masks in March when you got back from Miami, selling them on eBay?
Ben: Well, I mean, right. Yeah. I’ll tell this story. I was very fortunate to be a seed investor in an apparel business called Bonobos. And Bonobos was founded by two close friends of mine, Andy Dunn and Brian Spaly. And the first Bonobos office was my apartment in New York City. So, we all graduated from business school in 2007. Andy Dunn moved into my apartment with a couple thousand pairs of pants, and I would get up in the morning, go downstairs to get on the bus to go to Westport, Connecticut, and coming up the stairs would be the first employees of Bonobos. I’d get home at night, they’d be pick packing and shipping boxes of pants in my kitchen. I’d wake up on a Saturday morning and find strangers trying on pants in my living room. So, it was, sort of, an interesting experience to be around an e-commerce company very, very early.
As I look back on that time, I think one of the really cool things about it was seeing the forefront, like the earliest beginnings of this wave of e-commerce direct to consumer startups. Bonobos was really one of the first ones of those. And I was a very small investor. They were friends of mine. I, sorta, saw what it was like to operate a startup literally in my apartment. But really, it was just incredible to see the beginning of how powerful direct distribution was going to become of consumer businesses online. And in some ways, I wish I’d paid more attention to it because I probably could have started investing like crazy in all that startups which, to their credit, the guys who actually built that company were smart enough to do and I was not. But I think there’s something really fun about that kind of investment. Like I was just, kind of, backing friends. I didn’t know anything about what they were really doing. But watching that blossom was just really satisfying. And eventually, there’s something cool about, like, walking into a Nordstrom department store and seeing the pants for sale or just wandering around the world for a while and seeing people wearing the clothing, I was like, “Hey, that’s, kinda, cool.” But really, it was this idea of, “We’re going to distribute directly to consumers something that was built purposefully for the web.” And now you see that over and over and over again in new consumer categories.
It’s trained me to, sort of, think, “Well, what is something that I’m seeing now that doesn’t feel like that big of an innovation,” because, to be honest, at the time, it really didn’t feel like that big of an innovation to me, and yet it really was. It was an fundamentally new business model in some ways or at least the perfection of a business model that had been talked about since the beginning of the internet. And so, whether that’s in FinTech or just in investing broadly, I think there’s a lot of power if you can identify something and constantly ask yourself, “Hey, this looks different. Is it actually the beginning of a big change, a big inflection, or not?” Because markets are pretty good at picking up on trends, but they’re not very good at catching inflection points. It takes markets a while. And if you can teach yourself to identify an inflection point, you can do extraordinarily well. I don’t know that I figured out how to do it, but it’s at least something I spend time thinking about.
Meb: I definitely spent a day scrambling for clothes once in New York City, wandered into a Bonobos, tried to buy some clothes and they’re like, “Sorry, got to ship them to your house.” I said, “What do you mean?” I said, “Can I try them on here? So, that’s no good. I need them today.” But you touched on something that I think is just this massive, sort of, dislocation on investing in a lot of startup private companies. Obviously, the optimism, the excitement, the energy, changing the world versus the constant negative news flow of bombardment in public markets. It’s just every day. It just feels like it’s terrible news all day long. It’s a nice barbell to, at least, have a little balance, because I feel like if you’re an equity investor in public markets, you spend all your time just getting hit over the head with negatives, but whereas often on the early stage, it’s such a optimistic state of the world. It’s a little easier to live through the pandemic times. Ben, where do people find you? They wanna find more, send you their terrible ideas, all this good stuff?
Ben: We’re online at clocktowerventures.com. That’s probably the best way to do it. And there should be contact information there. I’m on LinkedIn. You can always reach me directly on LinkedIn. We do our best to respond to everything. We, obviously, get fair number of imbalance, and so, we’re not perfect at it, but we’d love to hear from anybody listening to this.
Meb: Well, by the time this hits publish, my Nuggets, your Celtics will have already advanced to the next round. So, congratulations to both of those teams, knock on wood. Thanks so much for joining us today, Ben.
Ben: Thanks for having me. It’s always a pleasure. And we’ve been talking about doing this for too long and it’s great to finally pull it together. It’s been a delight to be here and I hope we can do it again.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. My current favourite is Breaker. Thanks for listening, friends, and good investing.