The FinTech revolution has changed the face of Finance. It has also brought us a number of other tech-based buzzwords. While it can be a bit confusing, these are useful to better define the various areas of financial services that FinTech has transformed. Nonetheless, it’s important to understand what these terms stand for, so in this series we try to explain the different sectors, how they have changed thanks to innovation and what the future might hold, starting with WealthTech.
It’s an obvious one, isn’t it? Wealth + Tech = WealthTech! Wealth comes in this context from Wealth Management. It combines all or parts of the various professional services to manage a person’s (or sometimes entire families) financial life from financial planning, investment advice, the management of assets or an investment portfolio, and other services, which we get to later. It was traditionally something reserved for the wealthy (as you may have guessed) like high-net worth individuals (“HNWI”), or families that own a certain amount of assets. Getting into the bracket of HNWI is no small task though; the Capgemini World Wealth Report defines HNWIs as those having investable assets of US$1million or more, excluding primary residence, collectibles, consumables, and consumer durables. Wealth Management aims to provide a holistic service that covers several aspects for the client, combining the various services through internal and external providers, so that the client works with a single person or entity instead of different institutions. Obviously, this comes at a price and that’s one of the reasons why the service is usually available to people with deep pockets.
And this is where tech enters the ring: thanks to innovation, many of these services are made available to the more average person. This is done through the use of automation, big data and artificial intelligence (AI), via micro-investment platforms or trading based on social networks. While there’s an overlap of technologies and business models across the different sub-sectors, let’s get into the details to understand how #wealthtech disrupts financial services.
Robo-Advisory
Possibly the most prominent representative of the wealthtech disruption is robo-advisory. Basically, a robo-advisor employs automated portfolio management, which is based on algorithms. Since it is an online service, it needs less staff, in particular the figure of the human financial advisor, driving down the costs of operation. In many cases, robo-advisors employ similar software like their human counterparts, but because of automation they can offer their services at a fraction of the costs. That’s why it can be made available to average investors as it’s important to bear in mind that traditional financial advisors generally work with minimum investment amounts. Lowering these thresholds opens the service up to a wider audience. However, robo-advisors have not only introduced a whole new group of investors to wealth management. More and more, they have managed to get a piece of the pie of the traditional institutions as their wealthy clients have been moving to new providers as well or demanded the use of robo-advisors to reduce fees.
Largely, it has attracted younger generations though since they are simply more open to using online services as opposed to brick-and-mortar institutions. The sector has however already seen some form of transformation as traditional institutions are starting to use the same technology to equally reduce costs and subsequently fees.
The advantage of robo-advisory is not limited to reducing costs though. The profiling of investors can be improved, for example, through the use of gamification so to mitigate some well-known biases identified by behavioural finance and prospect theory to avoid making inconsistent decisions. Gamification means the use of engaging gaming mechanisms to modify the behaviour of individuals. As a result, this helps to better educate investors about the perils and biases related to financial investments. Robo-advisors can often offer sophisticated risk management through the use of self-learning AI that adapts the algorithms that drive the investment activities. The algos then more efficiently shift through asset classes when changing market conditions and individual investment needs make it necessary. The technology also makes it possible to either propose or automatically rebalance portfolios when required, i.e. when the weightings of the different assets in a portfolio to its original asset allocation if the change of value of some assets has generated a discrepancy.
Representing the disruptors two familiar names are Wealthfront and Betterment, two of the biggest player in the field. With more than $7.5 billion in assets under management, Wealthfront builds a personalized, diverse portfolio for the client based on the answers to a risk questionnaire. With minimum investment amounts starting at $500, the service is rather affordable, but it’s also a good example for the business model of robo-advisors. While there are no management fees for accounts valued at less than $10,000, fees are 0.25% of AUM for sums above this threshold. Wealthfront also offers additional services, for instance, the periodical rebalancing of a portfolio, which is available to investor with more than $100k in their portfolio. The company offers a wide range of offerings with accounts depending on whether you plan for a home buyers, retirement or the college for your kids and so on. Betterment even tops Wealthfront with $10bn in assets under management. Betterment has no minimum investment amount for its basic digital plan that gives investors personalised financial advice, automatic rebalancing, strategies to increase after tax returns, and access to a diversified portfolio. These are only two of a number of FinTechs offering robo-advisory, but they outline the basic model pretty well. If you’re looking for more information and names in the field as you can read in the disruption of Wealth Management.
On the other hand, traditional players have added services based on robo-advisory like Charles Schwab with its Schwab Intelligent Portfolios, or the largest provider in the world of mutual funds, the Vanguard Group with its online offering, Vanguard Personal Advisor Services. Both offerings have a relatively high minimum investment amount though ($25k and $50k respectively), but they add a human element with a hybrid model, which combines the use of computer algorithms with human advisors. Other traditional financial institutions have followed suit by launching their own robo-advisory services. Bank of America-Merrill Lynch launched its robo-advisory platform Merrill Edge Guided Investing in early 2017 and Morgan Stanley Wealth Management in December 2017 announced the launch of Morgan Stanley Access Investing. Both services sit somewhere in between the offerings described above with an investment minimum of $5k and an advisory fee of 0,45% and 0.35%. Again, just two examples, but others either already offer similar services, i.e. Blackrock or TD Securities, and others like Goldman and JPMorgan are in the process of developing their own robo-advisory.
It is estimated that at the end of 2017 robo-advisors had almost $400billion in assets under management. Forecasts see a rapid growth of these numbers over the coming years with the number of assets under management surpassing $1trillion by 2020.
While we are already looking ahead, it seems likely that we are to see further consolidation in addition to the recent trends in the industry. The focus on costs alone leads to an unsustainable race to the bottom, so the way forward appears to be the hybrid model as well as using digital offerings as an entry model in order to bring customers into an existing ecosystem, where the profit is made with premium accounts. Spiros Margaris even goes so far as to predict that the sector will see a consolidation to the point where the only robo-advisor survivors will be the big ETF players like Vanguard, BlackRock and some established fintech startups like Betterment or Wealthfront.
Robo-retirement
Robo-retirement is similar to the robo-advisors described above and in effect many firms active in the former section, also provide specific retirement related financial planning. Again, it is through algorithms without human interaction that the financial planning is done, i.e creating a retirement portfolio based on the needs and risk-appetite of a customer. The computer allocates and manages assets automatically. The machine also proposes different strategies and recommends based on the input given by the future retiree plans to achieve the goals of the client.
It is a bit of a more simplified service and at the same time more automated as it doesn’t envisage too much of intervention from the customer as retirement planning is naturally even more long-term than other forms of financial planning. Eventually, you’re planning on building that house you’re saving in your 60s or 70s, right?
Robo-retirement focuses even more on reducing costs as the key selling factor. With traditional institutions taking up to 2% cut for planning and managing, the newcomers don’t charge more than 0.5% and often less than that. Another aspect is that some incumbents require customers to have a set minimum value of assets on average of $500k, which represents a rather significant obstacle especially for younger clients.
Bloom and Feex are two of the companies offering automated retirement advisory to help individual investors manage their savings plans.
Lastly, it should also be said that while most of the above cases focus on the relation between business and customer, but some FinTechs focus at varying degrees on the B2B approach by developing the platforms used by others to provide robo-advisory services or white-label their own technology for use by third parties as well. Two examples are RobustWealth and NextCapital: while the former offers the entire range of robo-advisory, the latter offers a retirement savings platform for individual investors and is an open-architecture platform that can be configured to meet investment advisory firms’ needs.
End of Part 1: Read on in the second part of our overview of the WealthTech industry or check out our dedicated section to learn more about FinTech.