, Business

PRISM, Snapchat & Alpha – investing in an open environment

Investing has become rather more complex in recent years due to significant policy interference and the peaking of the credit supercycle. Unfortunately, there may be some more complications as our personal information technology rapidly evolves and certain investment processes challenged.

The rise of the surveillance state and the shifts in our daily usage of portable personal computers (smartphones) are likely to lead to some intriguing changes in how we communicate and invest.

The original iPhone was released just over 6 years ago and heralded an explosion in the so-called “app economy” whereby new features could be built and deployed on top of mobile platforms, expanding their functionality in an elegant manner. While initially underpowered, Apple’s innovation in building its platform has led to rapid iterations to the point at which smartphone technology is approaching a plateau and true commoditization – much as flat-screen TVs have become commoditised as they reached high definition – with margins similarly suffering. Quad core processors, retina displays at a higher resolution than the eye can see, all-day battery life and increasingly compact systems on a single chip mean that within 3-4 years, it will likely be difficult to find a phone that does not have smartphone capabilities as prices crater (tablets face a similar issue).

This sets up a scenario where most of the world has access to on-demand personal computation in their day to day communication and interaction.

The nature of this communication may shift in part due to the revelations around the PRISM program of the United States and similar programs across other developed nations, cataloguing and recording as much of our interconnections as possible for posterity and other purposes. While public response has been largely muted, there has been sufficient outcry to accelerate the development and usage of more secure communication systems.

Another element at play has been a push to privacy as the first generation of Facebook users have come to realise that their potentially embarrassing posts and pictures become public fodder, particularly as Facebook auto-magically tags them.

This initially led to more conservative posting, but recently we have seen ephemeral messaging explode in popularity, led by Snapchat, which has handily defeated Facebook’s knockoff, Poke, offering end-to-end encryption and supposedly self-destructing, irretrievable pictures and text (although this is not quite the case so far).

Indeed, Snapchat now accounts for a significant portion of images sent across the internet and has just raised $80m at a valuation of $800m with only 5m users, mostly in the teen demographic, who value being able to “capture the moment” and send sillier/less considered messages to each other. It is assumed to be a more convenient alternative to more permanent messaging services and social networks.

While Snapchat is not quite the finished article, its adjustment of end-user behaviour as it percolates to more mature users and accelerated privacy development due to the PRISM issue, will lead to increased use of cryptography and encryption on consumer devices. This is particularly pertinent as the PRISM leaks revealed that using anonymizing measures to hide your internet activity could pique interest in your activities.

As encryption becomes ubiquitous and anonymizing services find their way onto most mobile phones, the availability of sensitive data to interested parties is likely to increase dramatically, particularly as more companies allow employees to use their own devices for corporate communication.

This has wide-ranging implications, but one of the things it can affect is fund manager “alpha”, or investment edge. Many fund managers generate “alpha” by getting close to company management and trying to have superior insight into how things are going. Overwhelmingly this is by legal means, but as recent prosecutions have shown, less upright methods can be used.

Even for clean investment managers, we may see some sharp changes soon. Many companies pay brokers primarily for corporate access in developed markets, even though this can be restricted by most developed market regulators who advocate paying brokers for research and best execution. This is likely to be disrupted as there should be no “edge” from private meetings with companies, with the likely outcome being that any meetings between investors and listed corporates will have to be recorded and posted online, something made easier by today’s technology.

With freer flow of insider information, it is inevitable given the potential rewards that more unscrupulous individuals will try to capitalise on this to deliver excess returns. This makes things more difficult for other fund managers who have scruples as the advantage they may have from superior understanding of the business model of the company and its operating environment is reduced, even as any edge they may have from superior corporate access may be regulated away.

Over time this may actually increase the efficiency of the market as stock reactions rapidly incorporate information and reflect in their price movements ahead of public announcements, as can happen do in certain less developed markets where insider information flows freely. The onus is upon fund managers to ensure that their investment processes are sufficiently robust and transparent across the cycle to handle these shifts and understand exactly where their investment edge lies to generate alpha in an increasingly challenging environment.

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