February 4, 2017
Rise of robo-advisory
Let’s first talk about what happened in the last 3-4 years – so much of excitement and enthusiasm about robo-advisory startups. Believers said that robo-advisors continuously trade securities and other assets based on long-term predictions they are able to build based on a real-time stream of data and machine learning capabilities. In 2016, assets managed by robo-advisors were estimated to increase by 68% annually and reach ~$2.2 trillion in five years. Other estimations suggested that robo-advisors will be managing $8 trillion globally by 2020. No wonder there was so much craze around the field of robo-advisors during the last two to three years. Led by startups such as WealthFront and Betterment and then dozen others. Due to such convenient and low-priced service offered by this technology, great initial uptake by consumers, a number of startups turned towards it.
Traditional investment firms didn't want to be left behind. Back then, wealth management firms went through a dynamic shift—from a traditional approach to a trendy one—attracting millennials by introducing robo-advisory platforms. Robo-advisor services quickly provided (at least claimed) customers with well-diversified investment portfolios suitable for their risk tolerance and long-term investment objectives.
The growth and development of the robo-advice industry not only had positive financial implications as a result of lower fees but also automated systems facilitated inclusion for mass market consumers with < $200K. Consumers could afford a tailored advice for better use of their funds.
Hundreds of startups tried to shake up the investment world with the so-called robo-advisor offering, and without worrying that all this could be replicated by someone. The incumbents not only took notice but also embraced and latched on to the opportunity. Vanguard launched a robo-platform in 2015 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 started catching up as well. Some people even estimated that robo-advisors will account for more than 5% of investment portfolios by 2020.
These robo-advisors essentially have the same function (more evolved though) as the simpler programs that investment professionals use to aid them in their investment decisions. The main difference lies in the manner in which individuals have their money invested – with investment professionals, they merely utilize the programs 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.
What seems to be the problem? Pure play robo-advisory startups like Betterment and WealthFront could not grow beyond few billion dollars AUM as they have been struggling on scaling their services. I suspect that there will be a lot of bloodbath this year and next in the B2C space. CAC is so high in this space. Morning star said "With their low fee rate, robo-advisors need near industry-leading expense efficiency and substantially more scale to be profitable. Using a range of comparable companies, we estimate that the break-even client asset level for robo-advisors is from $16 billion to $40 billion, which is 8–20 times the current client asset level of leading robo-advisory firms." Betterment seems to have crossed $5 B in AUM but others are still below $2-3 B for the most part.
In addition, robo-advisors only had the ability to manage financial portfolios and lacked the ability that investment professionals have to assist customers with their tax, retirement, and estate planning needs. Some people argued 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 but a desire to invest. Industry insiders believed that while people liked the automated features, they also wanted access to a human advisor for questions, support and guidance.
According to some studies, it has been suggested that millennials are unlikely to use a purely automated financial advising system. According to a GfK survey, only 10% of all participants said they would be likely to trust a computer algorithm more than a human to give them financial advice – with a full 50% disagreeing with this statement. Furthermore, 38% agreed that they would pay more for access to a person for help with financial services; and 45% said they would not be willing to forego live customer service in return for paying less. Looking across a range of financial products, consumers are least open to completely automated customer service for investments and mortgages. Studies like these are potentially troublesome for pure-play robo-advisors that prides themselves on being the best investment option for low-earning millennials.
Though Betterment was a company that started out as a fully automated robo-advisor, it has now integrated humans into the mix, leading to a hybrid wealth/investment management system. This approach layers in-house financial advisors on top of portfolio technology. It helps them to increase the fees for their offering as well. The new hybrid system is slated to bring in a new category of customers and could also increase Betterment’s average account size significantly.
This new-found formula of success – robo-advisory laced with the human element – seems to be gaining traction with big companies and startups alike eager to incorporate the same into their offerings. The Debate Finally Seems to be ending: Its not Robo-Advisors Vs. Humans. Its Robo-Advisors + Humans!
Alex Medana, Founding partner and CEO of FinFabrik says "The "Robo" revolution which doesn't have a lot of "robot" in it was very much needed to address a combination of high fees and low transparency in the investment industry. As solutions based around Artificial Intelligence mature, the next revolution will move from decision-trees workflow to dynamic analytics and recommendations catered to the individual needs and goals real-time.
Until then, the hybrid model of "Human + Robot" brings the best of both world i.e. the relationship, empathy and trust of the human engagement improved by the analysis and calculation speed and power of the machines."
Would this lead some of the B2C players to move away from competing in this market to a more B2B play providing tech to traditional financial advisory companies and established B2C brands/banks?