I was a leading provider of both data content and product design consulting into a range of companies in the dotcom boom years of the late 1990s. I was able to see first-hand how the companies operated, how differentiated their products were and how sustainable their business models were. Today, I work alongside the CEOs of their successors. Their disruptive desires are matched, but beyond that there is a lot that leaves me so much more excited this time around.
For this article I want to focus on one key and rapidly developing area – that of investment and wealth management for the mass market. I do not intend to get anywhere close to discussing the current interesting Twitter war between Betterment and Wealthfront, which feels more Wall St than FinTech 2.0 – I leave that to the history books.
Right now, out of the US comes a range of new competitive threats to both traditional wealth managers, as well as the lower-cost dotcom winners - firms like E*Trade and the like. Today, we see huge momentum swinging behind fast growing firms like Betterment, Wealthfront, Aspiration and Personal Capital. If anything, at times the hype seems to be even greater for their disruptive potential. Is it just hype?
Evolution of investment services
I find it easiest to think of the evolution having three distinct phases. At first what we had were full-service and expensive options (often too expensive for people in the mass market – with median or below incomes and assets) that were people heavy and tech light. The dotcom boom brought cheap and ubiquitous self-service options, though they required a lot of financial understanding to get them to work for you (and a lot of new retail investors seem to have been prey to unscrupulous professionals). They introduced a lot of valuable new tech for sure, but many continued to require large numbers of people to keep them running. The new options are akin to a hybrid model that blends the best of both practices, while eliminating the worst risks and costs of each. The new players offer low fees, low risks, cheap advice (through robo-advisors or access to better strategies) and a long-term focus on wealth creation. They also seem hell-bent on keeping relatively slim.
From a revenue model perspective, it seems that the one that best aligns service providers with their clients is an assets under management (AUM) one. With traditional firms the allegation was they just sat there and got paid for not doing a lot once they’d won your business. In general there was little differentiation between firms and the rates they charged, only in service and demographic segments. Well the antithesis of this became the pay per trade model of the online brokers. They needed to get you trading regularly to make money. Overtrading is a value destroyer for investors, and pits traders against their clients.
The FinTech 2.0 breed all seem to favor tying their return to the investors, but at significantly lower rates.
How big are the new breed?
Right now the world’s largest investment firm, Blackrock, has around $4.3Tr in AUM, whereas these upstarts have at most $2.5bn (Betterment, Wealthfront seemingly neck and neck), but this is still substantial. To get into Towers Watson’s annual survey of the top 500 they will need to more than double - $7bn seems to be the floor for getting on to this key barometer of performance.
It is also worth noting that these are all domestic firms right now, and while the US market is the largest domestic, it would be reasonable to assume that the new breed will be top 100 size sooner rather than later.
Is it safe to say “this time it’s different?”
There is a clear difference in the offerings of the new breed, and they offer investors a very different product proposition. So there was with E*Trade and its peers, though. So why will this disruption be better?
First of all, there is recognition of the inherent risks involved with sending retail investors out to trade with professionals as we see with low fee brokers. It is always going to be an unfair fight, and there is no reason for the professionals to go easy on retail – they have to make a living too. The new breed all have a major focus on creating structures to avoid sending the sheep among the wolves.
Secondly, there is a lot of work being done to build and operate more effective and relevant financial products for each firm’s investors. In both institutional and retail investing, shaky investment managers with lackluster performance and unkempt promises have prompted once bitten, twice shy investors to be more scrutinising of their asset managers and demanding for more personalised and innovative products, for a lot less outlay.
Thirdly, there is a lot more differentiation in target markets – goals, incomes and other demographics between the new breed. Even Betterment and Wealthfront - who have similar AUM – get there through different routes. Betterment has 120,000 active accounts, Wealthfront around 36,000. This indicates that they are successfully targeting different segments. This never felt the case in times past with the many E*Trade wannabees who came and went – they all had similar levers, models and target markets – low price trading aimed at middle income investors who were too small for a personal wealth manager, and the winners (E*Trade, TD Ameritrade etc) won more due to deeper pockets (for marketing spend, promotions and better technology) in a long war of attrition.
How are they operating differently?
The majority of the dotcom FinTech firms I observed failed, generally quickly, and often pretty spectacularly. Numerous investments were made, and many huge sums were burnt through very quickly. A lot of this came down to the state of technology at the time. Looking back it was very basic compared to where we are now.
Each firm was building each and every aspect of their businesses technology stack from scratch. There were no real shared services, no cloud server farms. Each tech team was starting from ground zero. A good analogy was the birth of the automobile, versus how cars are built today. A lot of traditional, manual work was needed behind the scenes too – only now are automated protocols in place to reduce this – know your customer, trade confirmations, etc.
I recall in graphic detail walking into many start up online brokers and marveling at just how many people it took to launch a service. Even when they started trading, the cash burn was often crippling. Reality rarely matched the hype in the valuations on the potential for what were really quite limited benefits, and service take up and activity failed to meet expectations.
I’ve been lucky enough again to have been on the floor with some of the new breed and it is amazing how different their make-up is. The new breed, even in their current monetisation and hyper growth states continue to value their slim sizes – I do not believe any to have over 200 employees. They’ve taken advantage of external services and inexpensive infrastructure over building everything from scratch, worked diligently to build models with minimum human involvement, and the current environment has been extremely favorable to tech led companies in these respects.
Areas for focus
The rise of the new breed brokers undeniably puts choice back in the hands of investors, especially middle market ones, who’ve had Hobson’s choice for some time – pay too much in fees, or do it yourself and be victim to someone who has a loaded deck.
But a few areas do concern me with the new breed. The low cost approach at times seems to have gone too far. While the theory of self service is great, you need a plan B for when things don’t work. At this time they all have limitations in terms of their customer support hours for instance.
In the new paradigm, and now that we can in theory manage our finances at our chosen time of the week, it seems contrary to continue with old-world customer care hours. It really is in this one area that they all fail to fully commit to being an addition to the 24x7 pleasure of dealing with Uber or Amazon.
Client facing services are growth opportunities in themselves and cutting back in the wrong spots could backfire for the new breed.
It is also a concern that it will take a long time at current growth rates to really break into the big time. It has been suggested that the current Wealthfront and Betterment Twitter war came about because growth may be slowing for Wealthfront and that there are only so many Silicon Valley CEOs to bank. While organic growth is an inevitable challenge for fully primed, mature markets such as traditional wealth management, the new breed need to keenly sense, spot and act upon auxiliary growth opportunities through innovations in product, personalisation and marketing.
What is not a concern is that the traditional firms are going to be able to quickly - if at all - update their business models to compete on service, cost and quality. I’d suggest that of their client base, the ones most likely to jump on these new models are likely to be their most profitable ones, and that is probably a radical transformation too far.
I am sure traditional firms will hope that some cracks open up in the armor of the new wave before the world they have gotten familiar with is altered forever. If there is one thing that’s certain, a surge of new FinTech players will continue to reinvent and break the rules of traditional investment management models. I’m sure Charles Darwin would like to watch the next phase of the evolution.
By Ian Jackson, Managing Partner, Enshored and bobsguide Contributing Editor