This post by Lauren Foster was originally published on CFA Institute's Enterprising Investor.
If you’re in the business of advising clients on how to invest, Randy Cass, CFA, has some advice for you: The future of the investment management industry is online and you will render yourself obsolete if you don’t figure out how to add value beyond just overseeing portfolios.
In fact, he sees a turning point on the horizon, a “Turing test,” when artificial intelligence (AI) wins and clients can no longer determine whether their online wealth manager is human or computer.
“In two years, I will bet you, you will think you’re being managed by an individual and have no clue that the messages, emails, prompts, and alerts you’re getting — because they’re so personalized and customized — are actually being generated by a system,” Cass told delegates at the CFA Institute European Investment Conference. This will free advisers to focus on all those other areas where they can add real value.
The good news is that advisers who can add value for their clients are secure. “In fact,” Cass said, “the commoditization of portfolio management and asset allocation is probably the best thing that could ever happen to them.”
Fast Forward: Three Years Ago to Today
To put this all in context, here’s a quick recap of the past three years or so: When Betterment and Wealthfront, the two largest independent US robo-advisers, started attracting media attention, the story was largely about a new type of business model that shared some commonalities, Cass said. The start-ups were digital, almost entirely online, invested in passive exchange-traded funds (ETFs), and offered a lower cost alternative to traditional wealth management channels.
In the interim, several things have happened: Betterment has emerged as the clear leader among the independents, with over $7 billion in assets under management (Wealthfront comes in at around $5 billion); industry giants Charles Schwab, Fidelity, and Vanguard have all launched robo-advisers; the growth rates of the robo-advisers have slowed dramatically; and venture capital funding has dried up.
Two years ago, the notion that an independent, stand-alone digital franchise or robo-adviser could emerge and create a sustainable brand that would carry forward to the next 30 or 40 years — based on the amount of money Wealthfront and Betterment were raising — seemed inevitable, Cass said. But that is no longer the case.
“The fear that an independent robo-adviser will dismantle the wealth management industry from the inside out is gone,” he said. “You’ve hit a point in the industry where the stand-alones are facing rising costs for customer acquisition and declining revenue over a lifetime for each client.”
Cass would know. From his perch in Canada, he has watched the digital trend play out in the United States and has even joined the fray. In 2014, he founded Nest Wealth, an independent digital wealth platform that is now the largest robo-adviser in Canada.
The “Uberization” of the Financial Services Industry
Cass took issue with what some have called “the Uberization” of the financial services industry in the wake of robo-advisers.
“I don’t think that’s it at all,” he said. “Uber didn’t change anything about the way the product was distributed. I didn’t have to pick up the phone, I had to push a button on my phone. I still got a driver, I still got a car, and I couldn’t move from Point A to Point B unless the driver and the car took me there.”
The better analogy, he said, was the travel industry:
“Think about what Expedia did to the industry of travel agents that used to sit at the middle of that industry. Think about how it took a distribution process that could only be handled by specialists with certain licenses and turned it into something that anyone with a computer and a few minutes of their time could do. I want to find the best price on my flight: not a problem. I want to find the best price on a hotel: takes me two seconds.”
To underscore his point, Cass asked the audience who would advise someone to become a travel agent. Not a single hand went up.
In the past, if you asked a firm what clients were paying for, the firm would say they were paying for “a bundle of services,” including succession planning, estate planning, and taxes, said Cass. But if you asked the clients what they were paying for, most would have told you it was to get someone to handle their investment portfolio.
“What digital advice has done is create an entirely new distribution process that takes that person performing that service out of the equation,” Cass said.
Robo-advisers have commoditized the single thing that most people thought they were paying their financial advisers to perform, Cass said, adding, “Robo-advisers are not doing anything new for investors. We are just delivering it in a new way, and because of that, able to charge a heck of a lot less for it.”
Not a “Millennial Story”
Cass said the media has (mostly) gotten the robo story right. “This is a story about convenience,” he said. “It’s a story about convenience to investor management whenever they want it. It’s a story about equality, about being provided the same level of sophistication that investment managers give to those that have $1 million or $2 million in their assets.”
But what the media has gotten completely wrong is this: It is not a story about millennials.
“You come to someone with a value proposition that says ‘I’m going to give you greater convenience, less headache, and I’m going to let you keep more of your money by paying less.’ That’s nothing for millennials,” Cass said. “Millennials don’t have money. Millennials are less than 20% of our business right now. We have more baby boomers on our system than we do millennials.”
From an industry perspective, “This is a story about one thing and one thing only,” Cass said. “It’s a story about margin compression.” According to Cass, that is “the only reason the industry is reacting like it is, and [why] you’re seeing companies come out with dramatic new plans to deal with what’s going on.”
It’s the Margin Compression, Stupid
There are only three reasons why financial firms upgrade their technology, Cass said: regulation, margin compression, and customer demand.
“Every bank and every financial firm that says they have a digital advice channel coming out are not upgrading their technology and integrating their systems because they feel like they want to do this,” Cass said. “They are doing this because they have to do this, because the legacy of robo-advisers might not be a stand-alone brand that we all look at in 50 years, like we look at Schwab now. But it sure as hell will be a different margin structure than exists in the industry today.”
He added that he didn’t know what was going to happen in the industry over the next five years, but he was certain about one thing: We have “gone past the point of no return” when it comes to margins. In a nod to his earlier quip that no one would advise a person to become a travel agent, he asked (in all seriousness): “How many people here would tell their child to be a financial adviser?”
Will Robos Fail When Markets Fall?
If there is one question that you hear over and over when it comes to robo-advisers, it is some derivation of this: Can robo-advisers deal with skittish clients when markets tumble?
Betterment suffered some backlash over the summer when the firm suspended trading for several hours on Friday, 24 June 2016, because it didn’t want clients trading blindly into extraordinary Brexit-related volatility until order and liquidity returned to the market. That the firm had not alerted clients beforehand was the most contentious aspect of the controversy.
(In a poll of CFA Institute Financial NewsBrief readers on whether financial institutions should limit the trading activities of clients in response to market events without first receiving explicit authorization from clients, the overwhelming majority — 66% — believed that advisers should never do so without permission.)
Cass said Nest Wealth views market downturns as business opportunities, not threats.
To illustrate his point, he said the firm has been through two downturns since it has gotten to scale. What was interesting, he said, was that two things he thought would happen didn’t: Log ins didn’t increase, nor did phone calls.
That said, Nest Wealth made a couple of deliberate choices. When the market’s tumbling and you have thousands of clients and you’re trying to figure out what to do next, you can do an email blast telling them not to worry, Cass explained. What’s wrong with that approach? “Blasting 95% of them an email to tell them not to worry is going to cause 95% of them who weren’t worrying to log in to their portfolio and wonder what the hell they should be worrying about,” Cass said.
Another option: You can post a message on the website explaining what is happening and why customers should stay the course. That way, the only people who see the message are those who had already expressed an interest in logging in to the system that day.
The firm can then compile a list of the people who logged in and group them into a sub-classification of customers who perhaps have greater anxiety about market fluctuations than the rest of the client base, Cass said.
“The next time there is a volatile period in the market,” he added, “you can proactively, before the market opens, reach out to them with an email saying, ‘In case you’re nervous about what’s happening in the market today, here’s what’s going on.’”
