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What We Learned About Robo-Advisors in the Last 19 Months

Prove
February 17, 2021

Hundreds of startups are trying to shake up the investment world with robo-advisor offerings. Incumbents have not only taken notice but also embraced and latched on to the opportunity. In 2015, Vanguard launched a robo-platform and now manages $41 billion in assets. Fidelity launched Fidelity Go, BBVA launched a robo-advisor in partnership with Future Advisor, and others such as Charles Schwab and BLACKROCK aren’t lagging at all. We will come back to the effectiveness of each model next year but some people estimate that robo-advisors will account for more than 5% of investment portfolios by 2020. That can get anyone in this space excited enough to leave their job at the incumbents and start on their own. But let’s take a few steps back:

Problem statement(s)


Before we go any further, we would like to highlight some of the issues faced by consumers in wealth management or investments. First of all, if you have less money to invest, it will usually mean substandard advice. This is because the investment size is directly proportional to the quality of the advice in this space. Fees have traditionally been very high; this has either kept people away from investing or has made them to go for bad advice.

Another thing to notice is that quant models and quantitative trading simulation tools have existed at larger scale investment vehicles (hedge funds, etc.) but not accessible to the common man. Wealth management is broken at the banks, which means it doesn’t work well in the current model while the bank account is still the source of funds. And there are other issues such as conflict of interests and more.

Hype and busting the myth

Many people see the new products/startups and incumbents as a David and Goliath story, and that one of them would always win. Robo-advisors (and the hype surrounding them) are seen as competing head-to-head with traditional financial planners and provide online algorithm-driven portfolio advice without using human, financial planners. First instituted in 2005, robo-advising has secured a sizeable piece of the financial planning market since then and continues to advance significantly, breaking ground on new investment possibilities.

Industry giants like Vanguard and Charles Schwab, along with FinTech startups like Betterment and Wealthfront, are currently on top of the robo-advising market in the US that is projected to control over $2 trillion in assets by the year 2020. These robo-advisors essentially have the same function as investment professionals’ programs to aid their investment decisions. The main difference lies in how individuals have their money invested – with investment professionals; they merely utilize the algorithms as a step in their personal decision on how to invest an individual's assets, while robo-advisors make all decisions autonomously and invest money solely based on algorithmic outcomes.

In addition to this difference, robo-advisors only manage financial portfolios and lack the ability investment professionals have to assist customers with their tax, retirement, and estate planning needs. Some people argue that the most important economic difference between traditional and robo-advisors is their target market, with robo-advisors separating themselves by offering investment options with very low fees and minimum balance requirements that appeal to individuals with limited capital a desire to invest.

Apart from that, I think it’s about co-existence. When ATMs came into the market, all the tellers didn’t lose their jobs. In fact, in the long-term, teller jobs increased as per the data. Similarly, here with robo-advisors, I see a good co-existence with traditional advisors taking place – because there are issues with the robo-advisory model as well; too much machine and too less human touch. Industry insiders believe that while people like the automated features, but also want access to a human advisor for questions, support, and guidance. Studies have suggested that millennials are unlikely to use a purely automated financial advising system. According to a new GfK survey, only 10% of all participants said they would be more likely to trust a computer algorithm than a human to give them financial advice – with a full 50% disagreeing with this statement. Furthermore, 38% agree that they would pay more for access to a person for help with financial services; and 45% say they would not be willing to forego live customer service in return for paying less.

This study is potentially troublesome for an industry that prides itself on being the best investment option for low-earning millennials. But then it is yet another study, and looking at the trend of larger asset and investment managers buying smaller robo-advisors, we could argue otherwise. For example, could pure-play tech robo-advisor give way to hybrid investment advice and management platform?

Other challenges for robo-advisors

High acquisition costs associated with robo-advising. According to the Finametrica and Morningstar reports, robo-advising companies have to spend between $300 and $1000 on average to acquire a new client. This issue lies in the exact thing that makes robo-advisors an excellent alternative for many investors: low fees. Unfortunately, when customers have to pay as little as $100 a month for their services, it can take robo-advisors up to a full year just to recoup the money they spent securing a customer. This has led some to speculate that the large influx of robo-advising companies will eventually dwindle, through bankruptcies and acquisitions, and leave only a tiny handful of industry leaders in the segment. Of course, the companies at play are working to adapt their business models to fit this developing issue. Time will tell how successfully they can weather their unfavorable acquisition cost numbers.

There was good news as well for this growing segment. In May, SigFig Wealth Management LLC successfully raised $40 million from investors at an undisclosed valuation. SigFig is a robo-advising company that, in addition to its funding efforts, secured a deal with UBS earlier in the month to develop a robo for its 7,000 advisors. Both of these events mark significant milestones in the robo-advising marketplace because they represent the willingness of established financial institutions to partner with robo-advising companies and put their money on the line by investing millions in their business.

In early May, the industry received another potential boost when FutureAdvisor, another robo-advising company, began to offer free online access to 529 plans, Coverdell Educational Savings Accounts, UTMAs, and UGMAs, with the hope that consumers will sign on to advance the platform. It is believed that FutureAdvisor is the first robo-advising company to offer their own 529 plan, breaking the mold of such companies targeting only young investors with low incomes. The company is hoping to offer a free and simple alternative to a process that can be complicated to yield positive results to attract new customers to their platform.

Many in the FinTech world argue that robo-advising is an excellent option for its target market of lower-earning individuals who are interested in capitalizing on low fees to build their own investment portfolio. While people have theorized that there are problems with the model, the numbers continue to indicate some success in the segment. Until anything tangible arises showing a crack in the armor of the robo-advising industry, I would expect it to continue growing. It seems to have found a very sustainable position in its market. While some of the smaller unsuccessful companies involved may fail (or get bought), there’s no reason to believe that the solid players won’t continue to thrive as they can operate long enough to break even on their customer acquisition expenses and generate continued revenue. On top of this, the work of FutureAdvisor to break into the 529 plan market shows that the industry may be attempting to reach further into the pockets of traditional financial investors, a promising sign for a growing segment. If they keep gaining traction with their target market and expanding their practices successfully, robo-advisors could be here to stay in a big way.

Betterment continued to go from strength to strength and raised a $100-million round in March this year, and so did Personal Capital ($75 mn in May). Nutmeg also raised a USD 37.71 million round this month; Asia isn't behind either. Robo-advisory companies like Hong Kong's 8 Securities (robo called Chloe) are charging <1% of a client's assets under management, versus fees as high as 5% charged by traditional wealth managers. Then there is Theo (pioneers) from Japan, Bambu (B2B) from Singapore, and many more exciting startups that we track in MEDICI. Also, earlier this year, BBVA Compass teamed up with FutureAdvisor to offer clients access to investment advice, and U.S. Bancorp followed suit. So, even though robo-advisors were a FinTech phenomenon in the beginning and talked about by innovative startups, it is only now that finance's most prominent players are getting into the game. We will keep tracking it on an ongoing basis globally and keep you updated!

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