If you’re someone who was born during or before the 1990s, you would have definitely heard about the 2008 financial crisis; maybe some of you have even faced negative consequences as a result of the crisis. According to the US Department of Treasury, 8.8 million people lost their jobs and $19.2 trillion was lost in household wealth. Extensive research has been done to understand where it all started and how we can make our financial system strong. Was it because of some greedy investment banks trying to earn huge profits? Ignorant investors who never knew what investment product they were buying? Real estate advisors who sold floating-rate loans to NINJA category, or the credit rating agencies who gave a high rating to such complex derivative products? Or was it because of the high frequency and algo-trading software which made things bad to worse in a fraction of a second?
The world of investment management is changing rapidly
Investors need personalized services aligned with their financial goals and appetite in a transparent market environment. To serve the financial goals of the clients, companies are building dynamic models using machine learning and artificial intelligence which can give customized services to investors. Along with AI and ML, the application of blockchain in capital markets can revolutionize how trades are settled by reducing it from T+2 days to seconds and milliseconds. This reduction in the time of trade settlement can drastically increase the volume of transactions on the stock exchanged. This is necessary as investors are becoming impatient; the churning of the portfolio has gradually increased in past couple of decades. According to Jeff Kleintop of LPL Financial, the average holding period of a stock has fallen from eight years in the 1960s to around five days in 2010.
There are more than 100+ robo-advising companies around the world providing customized portfolio and wealth management services to HNIs as well as small ticket investors with Betterment LLC alone having AUM as high as $8 billion. Usually, the fee which they charge is in the range of 0% to 0.75% of the transaction value. Comparing the costs for an investor, we can open a robo-advisory account for as low as $0-10 with a lot of startups and get customized, goal-based investing solutions, which is not in the case of traditional investment techniques. However, with such low fees charged by startups, they are far away from profitability and require a huge volume of transactions to be processed along with increasing their AUM multifold times.
Another major product differentiation is auto-rebalancing of the portfolio. Failure to re-evaluate a 3-year-old investment in mutual funds and reallocation based on the latest market conditions may cause one a loss of an aggregate of 1.5%-2% in the long run. You may not bother about it by being naive and will end up losing the 2% of additional earnings which you might have earned if you would've gone for a rebalancing of the portfolio. But with robo-advising, this auto rebalancing is already taken care of on your behalf. With traditional CRMs failing due to the marketing model, the constant interaction with the portal helps customers easily solve their queries.
With VCs pouring money into the FinTech sector globally, the securities, capital markets, and wealth management companies alone secured a total of $4.7 billion in 2016. Along with these startups, global investment banks are also innovating their processes using Hadoop, machine learning, and artificial intelligence to stay in the race ahead. JPMorgan Chase & Co has used machine learning to predict when clients might need to raise capital through a secondary equity offering.
Is WealthTech the future of investing?
Before you make a call, take a look at these some events that have happened in the past:
- In 2010, Knight Capital lost $10 million per minute, amounting up to $440 million within a span of 45 minutes when a trading software went rogue.
- On May 6, 2010, the US markets crashed and remained inaccessible for 36 minutes, only to regain 900+ points the same day.
- On October 8, 2010, a single algorithm named ‘Virgin Slut’ sucked up 10% of the US market’s communication capacity, putting out 4% of the quote activity. The ‘slut’ part of the algorithm's nickname is due to this unusual ubiquity, but what's even stranger is that the algorithm did not actually carry out a single trade that day; hence, the ‘virgin’ part of the nickname.
However, that does NOT that mean that the markets are creating a bubble and the WealthTech industry will burst with a prick of a needle and we will move back to the traditional dealers putting in orders manually into the terminal. Maybe the technologically advanced companies using AI have brought its weird market behavior for a short run, increasing the risk for investors. But the dealers themselves are also not very efficient and error-free.
- In September 2006, a Bank of America trader’s keyboard was set up to execute an order when a rugby ball landed on it and executed the $50 million trade ahead of schedule.
- In June 2005, a Mizuho Securities Trader sold 610,000 shares at 1 yen instead of 1 share at 610,000 yen at a loss of approximately $225 million.
- In October 2002, a Bear Stearns trader caused a 100-point drop in the Dow Jones Index after entering a 4-billion-share sell order rather than 4 million.
- In May 2001, a Lehman Brothers dealer in London wiped £30 billion off the FTSE when he inadvertently keyed in £300 million for a trade instead of £3 million, causing a 120-point drop in the FTSE 100.
Industry experts claim that WealthTech and robo-advisory companies are here to build the infrastructure for the future, like Google, Facebook, PayPal, etc. When Facebook succeeded, for example, there were several other social networking sites like MySpace, Foursquare, Orkut, etc., which – although initially gained traction – failed soon enough. Is the same going to happen to the WealthTech industry where the initial players will fail ahead but provide the necessary infrastructure for the future upcoming revolutionists? Or will a small group of them rise up as global players, building a monopolistic and competitive industry? Or will it be a lot of small players in a highly segmented market operating at low margins? Whatever the market structure could be, the investors will be the ones who are going to benefit. The interesting thing to notice here: how the FinTech and WealthTech community evolves, plots the journey and learns from any failures by innovating constantly.