The robo-advisor “New Black” for the 3Is: Incumbents, Insurgents, and Investors

By Efi Pylarinou

As I was “parsing” through the dozen aggregators of investment and capital markets news that I review, I saw a couple of additional streamlining of ETF offerings with lower fees: Low cost Beta strategies that entail fees of 9bps instead of 25bps or even 45bps. Essentially, x3 to x5 times slashing costs for customers-investors. The shrinking of margins in investment products that compete in Beta-land, continues and there is no way back.

What does this mean for financial service providers


what does it mean for the customers and the prospect users?

Looking at the financial service providers of inexpensive Beta financial products (like such ETFs that I like to abbreviate as “Bets”), we need to examine separately the Incumbents and Insurgents. In the case of insurgents, standalone Fintechs, the “Bets” are their sole offering whereas in the case of the incumbents, it is a growing part of their broader offering. Simply said, insurgents calculate their projected revenues using a 10-25bps fee assumption right from business inception, whereas the incumbents are finding themselves reducing their fee assumption from maybe 45bps down to the lower 10bps level (or somewhere in between) but at the same time project a growing pool of assets shifting in the category. For incumbents, in most cases, the quoted AUM under their robo-advising platforms were internal shifts of existing customers-assets. Charles Schwab launched with an 80% internal shift of AUM; Vanguard with a 60% internal “subsidy” at launch; and Blackrock’s recent FutureAdvisor integration, is to serve their existing institutional clients which means 100% internal assets at launch.

The other big trend in the robo-advisor space is that incumbents (like Fidelity) are integrating them in ways that make them software tools of all sorts for advisors with whom they partner. This is significant in the US market that operates largely with advisors hunting for customers and serving them via various partnerships with the incumbents (brokerage, custody etc). The US market, has had this structure of intermediaries and it doesn’t seem to be changing it through this disruption wave. On the contrary, the market (a self-organizing creature) is empowering the advisors by feeding them with Fintech APIs, UX interfaces etc.

Hey, RIAs you better join the big ones (RIAs associations and Incumbents) to get access to all these tools. Even though it is not clear that this will add value to the bottom line (i.e. increase AUM), you cannot afford to stay out of it because it will result in reduction of AUM (i.e. the trend is to increase allocations to better UX and better reporting etc). Advisors are publicly ranked (e.g. Barron’s annual Top 100 advisors) not on performance!! Believe it or not, publically available advisor rankings are mainly based on AUM simply because performance is not taken into account (this is disclosed in fine print on the rankings announcements). Internally, the incumbent institutions that serve large advisor networks, do use thorough evaluations that include performance and risk management measures; but these are not publically available (a subject worth discussing on another ocassion).

Over the next year, we need to monitor whether the implementation of these robo-platforms from the incumbents and the advisor network that is tightly linked to them and uses some of these tools, will bring a meaningful increase in the AUM. The market is out there, the unadvised assets are up for garbs. How much will actually be grabbed by the incumbents and their advisor network that is tightly linked to them?

From the insurgents point of view, the burning issue, the metric that is vital, is revenues. What does it take to get to $20mil revs, that can comfortably allow for IPO plans (either a traditional IPO or quasi-IPO)? With a 25bps average fee structure per annum that means a target of $8billion AUM. And since this fee structure is under threat to be squeezed towards the 10bps level; the AUM needs to heading towards the $20billion target. Bear in mind, that growth of AUM through performance is tough in this environment. Even with a “dream” presumption of 10% performance growth per annum from performance, the value added to the bottom line of revenues is marginal. It all boils down to acquiring additional AUM! Insurgents are finding that cost of customer acquisition, whether they are stealing clients from incumbents or fishing them from the plains of Kansas (unadvised), is the actual challenge. Scalability of the insurgent businesses has proven sticky and heavily financed by the VCs in select cases. That is the reason; the “market” is testing out the B2B approach with incumbents and the freemuim conversion potential to AUM.

The “New Black” in robo-advisor space is:

  • Incumbents – I see mostly re-positioning:
    • Internal shifts of AUM towards lower cost beta products
    • Increase of robo-advising AUM
    • Fintech-ish software tools provided to partnering advisor network
    • Fintech-ish software tools to existing institutional clients
  • Insurgents – I see lots of partnerships with incumbents and shift to B2B:
    • Competing on low cost and mobile UX interfaces
    • Offering freemium reviews of existing portfolios with the goal to convert them into AUM; the B2C strategic approach
    • White label partnerships for B2B clients of incumbents
  • Customers / Investors – I see first excitement to be saturated and awaiting for the next level:
    • Cost: Better off for “Bets” investing aficionados
    • Financial inclusion: improvement but long way to go
    • Portfolio optimization and Risk-adjusted performance: negligible improvement
    • Inconvenience: Mushrooming unbundled investment services.

What is your point of view on the “New Black” in the robo-advisor space? The US is clearly the most mature market in terms of financial education and tradition of investing wealth in financial products. On the other hand, it has particularities that may impede the “revolution”: the strong and traditional RIA network is one particularity; the rigid disclosure laws for fiduciary responsibility, is another one; and the low mobile use compared to large developing countries.

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