It’s the fees stupid! is one thing that old and young can agree on
One conference session that I ignore is the one that tells me that Millennials use mobile phones and that explains their adoption of new financial services. The conference session usually starts with a middle aged exec telling a story about his/her teenager(s) and their use of mobile and how we must build a User Experience (UX) that meets what those teenagers want . All the UX talk disguises the harder truth about Millennials which is that they got sideswiped by the Global Financial Crisis and are saddled with student debt and hobbled by a weak job market. In short, its the fees stupid!
At the other end of the age barbell, pensioners got sideswiped by prolonged ZIRP/NIRP and they don’t buy the idea that they should take on a lot more risk, so they get out their bifocals to look hard at the small print showing the fees. They will adopt the same services as the Millennials if they deliver better Fee Adjusted Return On Capital (FAROC).
Millennials and Baby Boomers agree on one thing – It’s the Fees Stupid!
UX design and mobile technology is the essential tool that abstracts complexity to make a service easy to use, but ease of use is not the end objective – the objective is lower cost delivery to enable lower fees.
Whether the fees are for ATMs or Fund AUM or Overdrafts or whatever, we are in the cheap decade (or two). Cheap wins. That is a very uncomfortable fact if you sell expensive products/services. Grasping that fact is tough for both FinServ (incumbent Financial Services firms) and Fintech startups, because the low fees do not support expensive marketing.
In this post, we focus on low fees for asset management. The same low fees trend is also hitting consumer banking, but that is another story.
Low fees leads to a marketing challenge
In ye olden days, marketing a fund was easy. You charged high fees and paid intermediaries a big chunk of those fees to gather assets.
When your fees are a few Basis Points, the intermediaries cannot make enough money. So you look at selling direct using digital technology. After all, Facebook and other free social media services did this and did not spend a dime on advertising. So why do we see so many ads for B2C Fintech startups? The answer is simple – there is a friction chasm between free and cheap (even very, very cheap). Consumers will adopt a new free service easily when the only cost is a bit of their time, but as soon as the service asks for money (even a very, very small sum of money) the consumer hesitates and that leads to much lower conversion and much higher CAC. You need a trusted brand to get people to entrust their hard earned money and creating a trusted brand costs time and money – lots and lots of time and money.
Of course there is a spectrum of solutions for B2C Fintech marketing but the simple reality is – it ain’t easy and it needs deep pockets.
So Fintech looks to partner with FinServ – in short, B2B2C. This can be a good strategy as long as their is realistic thinking on both sides (a subject we explore in this post).
The simple reason you cannot beat Vanguard on fees
The asset management business has been selling expensive for a long time. The pitch has been that Hedge Funds are better than Mutual Funds which are better than Index Funds and Private Equity is better than Public Equity – in short, the more expensive the better. Given the necessary budget, customers will always prefer the more expensive car because there is kudos as well as utility, but it does not work that way with money. Customers might get kudos in the country club for using Hedge Funds and Private Banks and Private Equity, but Fee Adjusted Return on Capital (FAROC) is what enables customers to keep paying those country club fees.
Millennials with tiny sums to invest are going to low fees. So are middle class Baby Boomer retirees searching for yield. In between, there are a lot of folks who will retire with much less money because those entrusted to look after their pensions paid a lot of fees to fancy asset management businesses (see this story about Ohio) and those pension managers will get told not to do this by regulators. Even Warren Buffet is advising his heirs to invest via index funds.
Vanguard has been singing this tune for 40 years.
John Bogle established the first Index fund in 1976 and initially raised $11 million. Vanguard now manages approximately $3,400 billion in assets, dwarfing the number two Index player, BlackRock, with about $451 billion in Index assets and making the leading Robo Advisers with $2 billion to $5 billon look like they have an impossible catch up job.
The VC funded model of innovation does not allow for 40 years – VC GPs need to get liquidity within 10 years. One can argue that the startups can move faster now because 40 years of Vanguard singing this tune has got the message across and so consumers are receptive to low fees. Yes, they are and the conjunction with a relatively impoverished Millennial generation and Baby Boomer retirees starved of income by ZIRP/NIRP, makes the message even more attractive.
There is nothing wrong with the low fees message and value proposition. It is delivering on that value proposition and making a profit on that delivery that is the challenge.
Delivering low fees is a volume game and Vanguard is winning that volume game by a big margin. The more volume they get, the lower their fees will become, because they have no shareholders to please and it is almost zero incremental unit cost. I would not want to compete against that. It is worse than competing against Saudi Arabia as an oil producer.
The puck is going to Low Cost Alpha and Absolute Returns
Every trend that crosses to the mainstream leads to opportunity opening up elsewhere. As passive investing goes mainstream, the opportunities for active stock pickers gets better. It is simple supply and demand. Fewer stock pickers leads to more inefficient markets and that means bigger opportunities for few remaining stock pickers.
(I am using the term stock picker loosely, it could be any asset class and could be short as well as long).
It is still a Fee Adjusted Return on Capital (FAROC) game. It is just that the Return is a bit higher and the fees are a bit higher.
Traditionally this has been a game for Hedge Funds i.e. selling a high fees + high returns proposition. This is where the new follower model of Invest Then Gather Assets is replacing the traditional model of Gather Assets Then Invest and that model allows for lower fees. In this post, we look at how this is impacting the high fees VC business, but it also applies to what we now call Hedge Funds (which invest in every style, the only common factor being the compensation model).
Hedge Funds used to mean hedging i.e. going against the market trend to ensure good absolute returns uncorrelated with the market. Sophisticated investors use these techniques, using quant based risk management. This is now being democratised by what we call Robo Adviser 2.0 startups. The simple mission is to lose less when the market declines so that your absolute return (not tied to an Index) is good. Fees is the focus of the democratisation. The end game is the same – Fee Adjusted Return on Capital (FAROC).
Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.
very interesting point of view :o)
very interesting point of view
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