Credit: Shutterstock photoIt wasn't long ago that complex advances in investing, such as automated asset allocation, portfolio management and tax-loss harvesting, were considered high-minded concepts reserved only for the elite.
Enter the robo-advisor, an automated version of the financial consultant, born in the wake of the last financial crisis. It quickly became the new norm, delivering these same services to ordinary investors for very low costs and putting them on the path to modern investing in minutes instead of days. It was another in an endless series of examples where technology leveled the playing field.
As it made services more accessible, digital advice also threatened to put the squeeze on traditional financial services firms. These new robo-players gave their regards to Main Street on their way to infiltrating Wall Street, armed with algorithm-driven, web-based platforms that undercut big names such as Vanguard and BlackRock ( BLK ).
But established players in the investment industry are striking back, flexing their own muscles in a variety of ways. Their methods are familiar -- one popular choice is buyouts, often a quick fix -- yet their arsenal is vast, ranging from white-labeling robo-advice services to building partnerships. In some cases, they're creating their own proprietary platforms.
Ultimately, the robo-advisor industry is headed for a shakeout that could mean fewer upstarts and more power to established players. For investors, that means financial advisors will be more attentive to them right now as the established names vie with upstarts for accounts, but that could change after the shakeout is over and choices dwindle.
"Investment industry incumbents are finally taking the digital advice threat seriously," analysts at research firm Corporate Insight wrote in a recent report.
After years of waiting and watching, several financial heavyweights elbowed their way into the digital advice space since the beginning of 2015. Among them:
- Charles Schwab ( SCHW ) launched Schwab Intelligent Portfolios.
- Vanguard debuted Vanguard Personal Advisor Services.
- Northwestern Mutual took over LearnVest.
- Interactive Brokers ( IBKR ) purchased Covestor.
- Manulife Financial's ( MFC ) John Hancock bought Guide Financial.
- Bank of America ( BAC ) announced it would build its own proprietary robo-advice platform.
- Invesco (IVZ) acquired JemStep.
- BlackRock acquired FutureAdvisor.
BlackRock shares fell 7% Friday as the market sold off on Britain's planned exit from the EU. Schwab's stock sank 12%, Interactive 6%, Bank of America 7% and Invesco 14%.
The moves into automated advice are opening up possibilities for these companies.
The BlackRock-FutureAdvisor deal was particularly striking in that it expanded the reach of the robo-advisor, says influential financial blogger Michael Kitces . The world's largest investment manager announced that the acquired FutureAdvisor unit would meet the needs of banks, broker-dealers, insurers, other advisory firms and even 401(k) plans.
In other words, the classic direct-to-consumer robo model pivots toward a more business-to-business model, with automated advisors integrated into a partner's web portal in some cases.
According to BlackRock, the B2B approach will allow a much larger and broader segment of clients to benefit from digital advice. Industry watchers point out that it may benefit BlackRock too. See sidebar on how robo-advisors will fare in the next market meltdown.
"The robo-advisor is now a distribution channel," Kitces wrote after the FutureAdvisor deal was announced. Asset managers are trying to pick up robo platforms to distribute their exchange traded funds, Kitces told IBD. He noted that Schwab's robo channel "is filled primarily with Schwab ETFs," and its success prompted similar moves from BlackRock for its iShares ETFs, and Invesco for its PowerShares ETFs.
Fourteen of the 54 ETFs on Schwab Intelligent Portfolios are Schwab ETFs. The average portfolio in the service has about 60% of assets allocated in Schwab ETFs, based on objective selection criteria including low costs, according to Charles Schwab.
Disruptive Innovators
Recent research highlights both the successes of, and pressures on, robo-advisors.
Corporate Insight has found that as of July 2015 -- the latest period for which data are available -- the 11 leading digital advice providers had $8 billion in managed account assets, a 208% jump from $2.6 billion in April 2014. Betterment, the largest independent robo-advisor, reports its assets under management have vaulted more than 300% to a current $4.8 billion since the start of 2015.
However, Morningstar (MORN) estimates that robo-advisors need between $16 million and $40 billion in assets under management just to break even. The fees-per-customer robos generate far outstrip their average costs to acquire a client.
Investors are increasingly comfortable in giving control of their assets to a digital portfolio manager, according to Corporate Insight.
"Spearheaded by such firms as Betterment and Wealthfront that offer low-cost, online managed accounts and have significant venture capital backing, these innovative startups are creating a growing market for digital advice," the firm recently reported.
The first robo-advisors emerged on the investing scene around 2008, in the wake of the financial crisis. They succeeded by identifying key consumer demands, especially among millennials -- the use of technology to deliver financial advice and cheap, index-based exchange traded funds to lower the costs of investing.
That growing market for low-cost, online managed accounts caught the attention of traditional firms, Corporate Insight's report said.
It added: "The wealth management industry's existing clients, baby boomers, are nearing retirement. Incumbents seem aware that the next generation of young investors will have different expectations than boomers, particularly when it comes to technology and cost."
Hybrid Financial Advice
According to Vanguard Group, its new Personal Advisor Services (PAS) was a response not to a vague robo-advisor threat, but to specific client demand. The product went into testing stage three years ago and was in development even before that, a Vanguard spokesperson said.
Like a robo-advisor, PAS generates client portfolios using software programs, based on responses to online questionnaires about risk tolerance, time horizon, current income and other matters.
PAS, however, caters mainly to baby boomers nearing retirement rather than to millennials, and it offers an ongoing client-advisor relationship, Vanguard's Katie Hirt told IBD. The spectrum of advice spans everything from financial behavior coaching to cash flow analysis. The client and Vanguard advisor chat between two and six times a year on average.
For this hybrid service, Vanguard charges a 0.30% annual fee, or $150 on the minimum portfolio balance of $50,000 -- not far removed from Betterment's annual advisory fee of 0.25% for an account of the same size.
"A robo offer that's targeting a younger investor may be well suited for someone who's looking for a purely online experience and not looking to work with an advisor," Hirt said.
At PAS, investors' assets are allocated in portfolios comprised of Vanguard mutual funds and Vanguard ETFs. Assets under management have more than doubled since PAS debuted -- from $17 billion in May 2015 to $36 billion as of March 2016.
To put that achievement in context, here's a simple fact:
Total assets of the 11 leading robo-advisors were $21 billion in July 2015, including both online managed accounts and paid investment advice, according to Corporate Insight.
Outroboing The Robos
Robo-advisors initially outmaneuvered the investment industry's old guard, but their future is anything but assured, a recent Tabb Group report said.
"The value of their much-needed innovation is not in question," wrote Marlon Weems and Alexander Tabb, analysts with the international research firm. "The rising concern (is) that the sleeping giants they have awakened, i.e. traditional firms, have superior economies of scale and resources that will allow them to respond quickly and at a lower price."
Robo-advisors aggressively and successfully targeted millennials, whose needs will become more complex as they age, Weems and Tabb said. That raised this question: Can robo-advisors make those young investors stick as long-term clients?
Weems and Tabb point out that traditional wealth managers are able to charge fees on the underlying ETFs in their portfolios. That gives these firms an edge over smaller, upstart robo-advisors. Another key issue is that millennials simply don't have much in the way of assets, at least as of now.
In fact, financial blogger Kitces observes that some robos are struggling to keep growing as they face increasing competition, get buried by client acquisition costs and struggle to grow their average account size. That's why FutureAdvisor and others are agreeing to be bought out, he says.
Classic robos like Betterment and Wealthfront earn a flat advisory fee regardless of which portfolio or fund a client is invested in. Kitces has argued that Schwab and BlackRock's use of proprietary products in their new robo channels, coupled with their discretion over clients' investments, could be problematic.
Other industry watchers wonder if even industry leaders like Betterment and Wealthfront can remain independent in the long run.
In an interview with IBD, Daniel Egan, Betterment's director of investing, said it is not the target of any big investment manager. Nor is it rattled by the ETF and mutual fund firms rushing into the digital advice business. As a fiduciary advisor, Betterment is aligned with a client's best interests, he said.
"I couldn't be happier," Egan said. "I love when, effectively, existing players validate our business model."
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
