The Updown Serious Investing

From Wall Street Journal Online

The best money manager in Fargo, N.D., may be busy making artificial limbs.

Michael Filloon, 35 years old, makes his living building prosthetics, but spends much of his spare time on UpDown.com, a Web site that blends a stock-market simulation with the social-networking interface of a site like Facebook.

Since joining UpDown in September, Mr. Filloon -- known as "Legmaker" on the site -- has fetched a 7.95% return on a portfolio that began with one million (virtual) dollars. Over the same span, the S&P 500 has declined 9.09%.

UpDown user Michael Filloon

For Mr. Filloon, investing is a passion, one that was awakened when he began managing his own real-life portfolio several years ago. He likes to use UpDown, which also allows members to write financial analyses that other users can read and evaluate, as a place to test-drive new ideas. He says he spends "three hours a day, weekends closer to five, my downtime at work," on the site. In another life, he says, he might have tried to work on Wall Street.

As Mr. Filloon and other UpDown users execute trades and swap tips, the site's three founders are taking notes. They hope to begin investing $1.2 million from an angel investor in about three months, using strategies gleaned from the site's savviest members, says Chief Executive Michael Reich, a 32-year-old MBA candidate at Harvard Business School. Within about a year, Mr. Reich says that UpDown hopes to launch "either a mutual fund or a hedge fund" using the best portfolio strategies from the site. UpDown now has more than 15,000 members.

At least one other site, Marketocracy.com, has successfully experimented with a similar approach. An index of 100 model portfolios from that site serves as the strategic starting point for the Marketocracy Masters 100 mutual fund. It has returned 70% from its inception in 2001, compared to 37% for the S&P 500 over the same span, with dividends reinvested. Among the users whose fantasy holdings are included in the index are a former forklift driver who now focuses on trading full-time and an ex-software developer who moved on to a hedge fund, said Mark Taguchi, president of Marketocracy Research.

Still, experts say collecting a group of amateur portfolios into a real fund in order to reap attractive returns presents challenges, such as separating merely lucky investors from truly talented ones. Given UpDown's relatively short existence, some of the site's top performers could be the beneficiaries of a few well-timed bets that won't yield a consistent model for making money.

Left to right: UpDown co-founders Georg Ludviksson, Michael Reich, and Phuc Truong

Another potential pitfall for an UpDown fund is that there is no hazard in going too far out on a limb. Since members aren't investing real money, they may tend to take risks that they wouldn't pursue if a mistimed bet could have real negative financial ramifications.

"It's hard to tell whether people at the top are doing well," said Jeffrey Kubik, an associate professor of economics at Syracuse University's Maxwell School. "There's almost no gain to playing it safe and earning a market return, [so] you may take big risks and hope that you're lucky." He says fetching high returns over a short period "may not tell you anything about what people can do in the future."

Some UpDown users acknowledge a tendency to roll the dice more than they otherwise might.

"Your own money isn't on the line, so you can try more-speculative things," said Mr. Filloon, who said that his UpDown portfolio includes many Chinese companies with listed shares in the U.S. for months -- something he only began to add to his real-world portfolio last week.

Sumit Saigal, a Harvard classmate of Mr. Reich's, says that on UpDown he acts on instinct much more often. "It's good for somebody who's more risk-averse than they should be, but bad for someone who likes risk too much," he said.

UpDown is relying in part on models built by the Harvard Business School associate professor Randolph Cohen in its effort to find budding investment wizards.

Mr. Cohen, who has no stake in UpDown, and two colleagues published a paper designed to evaluate a fund manager's skill by comparing him or her to pros who consistently outperform the market. Using mathematical models, the paper explored how similar an upstart manager's holdings and trading patterns were to those of distinguished managers.

Mr. Reich hopes that by using adaptations of Mr. Cohen's models to evaluate UpDown users they can make up for the fact that the site's members don't have long, stable records of reeling in solid returns for real investors.

Marketocracy founder and Chief Executive Ken Kam said that the key "is not the wisdom of crowds, but the long-term track record. It took a long time for us to be confident enough to put money behind [members' track records]." More than a year passed between the launch of Marketocracy.com and the opening of the Masters 100 fund. And Mr. Taguchi notes that Marketocracy also relied on an algorithm to evaluate and select portfolios for its index until 2005.

Over time, Mr. Reich believes UpDown's results and data will improve.

"We would be happy to have five years of data but we should be okay without it," he said. "And in the long run, we'll hopefully rely on the histories of managers from our own site."