The Future of Financial Services
Robo-Advisors: Product vs. Platform
How platforms and distribution channels will determine the products which asset managers must offer to remain relevant in a changing world
Grappling with fee pressures, traditional asset managers are seeking to remain relevant by offering products and services that capture the attention of a morphing investor base. Yet, as has long been the case, it is distributors that are on the front line and appear to be the driving force behind consumer choice and engagement
A common analogy being used for the future of financial advisors and/or active money management is that of the tax preparation industry. Back in the early 90s, Intuit bought a small San Diego based tech company called Chipsoft. At the time, Chipsoft were busy marketing their individual tax-preparation software Turbotax and Macintax for individuals, also Turbotax Proseries for professionals. We all know how that played out. So, we go back to the argument that “people are always going to want people” and find ourselves looking at the retail and travel industries to quickly quash the idea that the status quo will soon be restored given shifting preference to avoid human interaction. Does the same apply to money management?
Do people care about people, or do people care about cost?
Simplistically and historically, cost seems to have been the defining factor. But, it must also come with benefits such as convenience, quality and reliability or trust (we’ll come back to this key point below).
Many have compared the concept of robo-investing to that of self-driving cars; in theory, a self driving vehicle is great, no driving, right? But in practice, handing control of any everyday part of your life to a computer likely won’t come naturally to most. And, who can you look to if things don’t go to plan?
So, does the same apply to your money?
After hundreds of years of happily interacting with other people for all the needs in our lives, we’re now happily substituting those same people for cheaper digital offerings. As touched upon when looking at ETFs vs. mutual funds and the future of the asset management industry as it is known today, we concluded that consumers were focused on the cost of acquiring exposure to financial markets, as well as the opportunity cost of poor performance.
Whilst this trend will force asset managers to amend their product offerings, the driving force of change will be distribution. After all, it was now over a year ago that Robinhood surpassed E*Trade in terms of total users. Is it fair to say also that this gives them increased influence over their customers’ investment decisions? Supposedly also true is that one in two new brokerage accounts in 2018 were opened at Robinhood; the platform claiming to be “democratizing access to the American financial system”.
So, whilst the distribution landscape has remained relatively unchanged for several decades, it seems at an inflection point in terms of what products are being sold and to whom. A standout thought from the Boston Consulting Group’s 2018 report on innovation in asset management:
“Asset managers will need to fully embrace innovation and technologies such as AI, machine learning, big data, and analytics. This will be especially true in investment management and distribution.”
Firstly, as we’re seeing in across many financial sub-sectors, playing catch up isn’t cheap, and cost aside, it’s also certainly not easy. Take the example of Adyen in the payment processing space, fair to say their competition may be better off doing as they did and starting from scratch. Building a platform and tools designed to serve the modern day business and customer.
Secondly, whilst many of the pure play newer entrants are still very small e.g. SoFi, Robinhood, Wealthfront, Betterment, Revolut etc, digital first businesses with scale must be also be a major concern; Apple, Alibaba, Amazon, Baidu, Facebook and Google, among others, seem to like the idea of increasing margins by cutting out the middle men. Plus with financial services usually comes the richest and most valuable data.
What has brand got to do with it?
Per the following examples, clearly it’s not just about creating an offering. It’s about brand and brand adoption. Following in the failed footsteps of huge Swiss money manager and global investment bank UBS, South Africa’s most well known investment house Investec, recently announced plans to close its robo-advisory platform ‘Click and Invest’, highlighting that digital transformation requires far more than a mere bolt-on offering to existing infrastructure.
Some theories that have been discussed include the potential for companies such as Facebook or Twitter to provide distribution services, partnering with banks (as we have already seen many examples of), or simply acquiring a servicing firm to create an integrated distribution capability to load on to their existing platforms.
One major head start large-scale tech companies have is a halo effect obtained from products and services which actually benefit consumers. And mostly for free. On the other hand, consumers don’t like traditional financial services companies, those which have long charged them fees for services they cannot live without. Many also caught out by complexities created to allow for such fees to be charged and hence the emergence of firms focusing on literacy and transparency.
Consider this…
We can look back almost 6 years to when Tianhong Asset Management was acquired by Alipay (Ant Financial). Alipay was seeking a platform to offer users an option to earn a return on idle cash in their wallet via the Yu’E Bao money market fund — unsurprisingly now the world’s largest money market fund in the world with $168 billion AUM. Given the mass adoption of “super-apps”, Asia is a proxy for how financial services can be commoditized as part of a larger, “in-app” service offering. Again, it comes back to the data which is why companies like AliPay (Ant), WeChat Pay (Tencent), GoPay (Go-Jek) and GrabPay (Grab) have ventured beyond their core business lines and into payments/financial services. I digress. Whilst this trend still seems a way off in the US/Europe, surely it’s on the minds of asset managers and traditional distributors?
Whatever happens, in a world of increasing transparency, advisors and distributors alike must ask themselves if they can still attract customers when customers (and competitors) are equipped with perfect information
Traditionally, advisors (IFAs, RIAs) have sought to distribute products such as mutual funds, due to the high commissions charged on buying in and selling out of such instruments. Again, as touched upon when looking at why investors are looking to ETFs for market exposure, simple arithmetic can tell you how much transaction costs can cost you over the course of saving for retirement. As is often the case in this space, NerdWallet, as always, do a stellar job of summarizing what it all means here. Many advisors are testing the waters of subscription models to at least seem more conscious of cost, but for those who still believe that human advisors are overpaid and in extreme cases redundant, it’ll be tough to convince them otherwise.
Which then begs the question as to whether or not robo-advisors are taking market share from the traditional advisors and/or channels or if they are simply creating what can be deemed as a greenfield opportunity?
And what seems to be the outcome is that digital advice is finding it’s own place in the market — sat quietly behind full-service.
Arguably this is another case of the rising tide; per Barron’s “Best Stock Apps for New Investors” the example of a 40 year old software developer from Texas gives us some insight:
“Christopher Mosqueda, made his first stock market investment in December, after hearing about Robinhood on a podcast. He’d previously avoided advisors/brokers due to the fees, particularly given his lack of experience and without a lot of money to put to work.
Robinhood charges no fees and offered one share of Chesapeake Energy as an incentive to sign up. He’s now a convert and considers himself a long-term investor with an eye on his daughter’s future education costs.”
To address the idea of whether this is a case of robo removing human, it’s perhaps worth highlighting that the term “advisor” as it relates to “robo-advisors”, is misleading. Supposedly the end goal for “robo-advisors” is to become more comprehensive “robo-traders” and “robo-planners”, trading around large market moves (many robos already rebalance portfolios) during times of market turbulence and offering more specific advice around retirement, 529/college savings, tax etc.
The middle ground should also be addressed i.e. who is the target audience of either or both? Per the above example, you have a new user who has actively avoided seeking advice and a new offering, a model which creates access to investing with no financial prerequisites and conditions e.g. minimum balances or financial literacy. It’s this that is drawing a new audience.
Not escaping the laser focus of performance, will robo-advisors be as closely watched as their human peers?
As we’ve argued for above, convenience and cost are key selling points in favor of robo-advisors. But, as also outlined, reliability and trust are musts too. Certainly when technology is involved and where many fear the unknown. After all, it is performance which has largely underpinned the move to passive from active and in turn robo from human, and will likely define the longer-term success of either/both.
Referencing a very handy guide on these specifics, a quarterly report published by BackendBenchmark offers insight on performance vs. benchmark and leaves us with a mixed bag of results.
There are only a handful of the 45 listed robo-platforms with 3-year trailing returns (annualized) vs. benchmark (often the typical time frame used to gauge performance) as of the end of the fist quarter 2019;
Acorns -1.40%;
Betterment -0.70%;
Personal Capital -1.82%;
Schwab -0.74%;
SigFig +0.26%;
Vanguard -0.16%; and
WiseBanyan +0.03%
Of course the benchmark is then called into question, but simply using the S&P 500 as a proxy for what could otherwise be a simple investment in an ETF wrapped tracker fund, this throws off a similar outcome (a typical robo portfolio would look something like 60/40 equity/fixed income FWIW).
Robo-advisors, similar to those in human form, tend to charge a management fee (if they don’t, like SoFi, then they’re working to make money from you another way). According to NerdWallet base fees among robos can range anywhere from 0% to 0.90% of assets held on the platform (typically 0.25%) vs. the median financial advisor charging 1%, higher for smaller balances and typically come with hourly fees and/or retainers. Both will have to pay the expense ratios on funds held and/or commissions charged on trading (again but for certain very generic products used to entice and retain customers e.g. Fidelity ZERO funds.
“Premium robo-advisors, also known as “humans when needed” — a slight twist in the tale
Clearly as a much needed ploy to gain scale, hybrid or premium service offerings are beginning to surface among the robos. Case in point Ellevest Digital vs. Ellevest Premium and Betterment tiered services, which both offer access to real people and advice depending on needs. I’m sure these are not the only examples, but the idea being that for a fixed fee, or better, with a certain minimum balance, you can have a hybrid offering. Schwab will be very pleased with this trend.
Also to be considered if what newer market participants will do in any time of major market turmoil — it will be interesting to see how such “investors” react in times of stress and surely test the durability of the robo-only model. At a guess, users will be seeking answers on the day they inevitably have to endure a meaningful market sell-off and for many, the sight of double digit negative figures preceding the % return on invested assets, will cause many to panic sell.
Building on the above mentioning of hybird services and tiered offerings, Bank of America announced plans to add human advisors to its robo-advice platform, creating a hybrid offering of their own, aimed at the mass-affluent market.
To Conclude:
“Has WebMD replaced your doctor?”
Whilst the extreme view is that robos will manage the money off all but the super high net worth individuals, the hype is very much just that, hype. That’s not to say that robo platforms cannot develop to offer more of a use case, but evidence suggests that these platforms are better suited to being tools and systems which add to the efficiencies of traditional brokers such as Schwab. To be seen is whether or not M&A plays a part in the future of new entrants, but valuations will unlikely ever lend themselves to a take-out.
What is clear is that platforms that are creating a more inclusive ecosystem for everyone to invest, have no interest in high fee low performance products and will be leaning on ETFs to gain market exposure. No doubt, that robo-advisors will eventually scale and also add to their capabilities at which point we may have to revisit the question of whether or not human advisors have a place at all, but for now, there is not doubt that there is room for all.
Further, perhaps the most interesting topic to address is the end goal. Why are we seeing so many new entrants quickly pivot to offer additional products and services? Why also are we seeing robo platforms add human advisors and why is Mr Schwab more than happy to leverage his existing platform to suit those who want to test-drive these new platforms?
Take this data: in Schwab’s April activity report we can see that the company currently looks after $3.7 trillion of client assets. They have 12 million active brokerage accounts and received 2 million inbound client calls (in one month).
Similarly, whilst new entrants to the investment space are offering proprietary products, the likes of State Street (SPDR), BlackRock (iShares) and Vanguard are likely very pleased with new distribution platforms seeking to seel their funds and ETFs. Take Acorns, they use a simple combination of Vanguard and iShares products across 5 portfolio offerings.
So whilst customers are unquestionably flocking to robo-platforms (and digital bank offerings etc), the real assets are still found on the incumbent’s balance sheets and the winners remain the same (the above ETF giants and not to forget the index owners). Robo-advisors are opening the world of investing up to the masses, which is great news, but ultimately, once you’ve real financial planning to be done, as things stand, you’re likely to outgrow the robo.
