Resistance wasn’t futile: the first wave of disruptive robo-advisers has failed to breach the status quo, a recent Morningstar analysis has confirmed.
The Morningstar report found established financial services firms have usurped the robo-revolution leaving start-ups either on the back-foot or in the back-pocket of the enemy.
According to the study, Morningstar’s 2015 “dire assessment of the original robo-advisor business models has proved correct”.
“They have failed to disrupt investment services incumbents and are still unprofitable. Many have sold themselves to established firms after realizing they can’t count on investors giving them money,” Morningstar says.
Since 2014 the most high-profile US stand-alone robo-advice firms – Betterment and Wealthfront – have been rapidly overtaken by name-brand financial services operators, notably Charles Schwab and Vanguard. For example, Vanguard has accumulated about US$100 billion via its robo-advice offering – roughly 10-times the best of the independent robots in less than half the time.
Myles Allan, founder of Auckland-based consultancy firm Mosaic Financial Services Infrastructure, said the Morningstar research “aligns with what we’re seeing in the market”.
Allan said the Morningstar findings also reaffirmed the conclusions of the 2017 Mosaic ‘Bot or not?’ report on how robo-advice would play out in NZ.
“Institutions that are well-resourced, agile and trusted can likely turn a well thought-out [digital advice] strategy into a winning business model,” the 2017 Mosaic report says.
To date, three firms – all well-known financial brands – have been granted leave by the regulator to offer robo-advice services in NZ: Kiwi Wealth; Nikko Asset Management; and, Cigna Life Insurance (which only joined the party last week).
Until robo-advice is formally legalised in NZ – expected next year – providers can only offer a limited version of the service after approval by the Financial Markets Authority.
Allan said if stand-alone robo-advice firms were failing in the US it did not bode well as a viable model for NZ. He said the Morningstar research indicated robo-only advice firms need huge scale to reach profitability.
Morningstar estimates the cost of customer acquisition combined with relatively high operating costs and low-fee models (typically about 25 basis points) would require huge scale for stand-alone operators to simply break-even.
“With their low fee rate, robo-advisors need near industry-leading expense efficiency and substantially more scale to be profitable,” the paper says. “Using a range of comparable companies, we estimated that the break-even client asset level for robo-advisors is $16 billion-$40 billion.”
The report notes free-range robo-advice firms would typically have an advertising spend of about “$300 per gross new account and $1,000 per net new account”.
“At their presumably low operating margin after they become profitable, the payback period on advertising costs can be more than a decade,” the study says.
Betterment and Wealthfront would’ve chewed through between US100 million-$200 million each to reach US$10 billion under management, Morningstar says. Both firms also raised capital recently with indicative lower valuations.
And from 2015 most of the ‘disruptor’ robos have put up the white flag – either selling to incumbents or cutting deals, the report says.
“Multiple robo-advisors that had been offering their services directly to retail end clients (a business-to-consumer orientation) have completely pivoted to or have complemented their B2C offering with services that will be provided in partnership with asset managers, banks, or wealth management firms,” Morningstar says.
Robo-advisers built to service low-end clients would need scale and efficient ‘hybrid’ models to allow access to human advice, the study says: most likely human advisers would be salaried rather than earning asset-based fees.
Allan said the 2017 Mosaic study tipped the hybrid model as the most likely to endure with traditional financial institutions expected to partner with “agile” third-party technology firms to develop robust solutions.
“Partnerships will be symbiotic for tech firms and institutions,” he said. Start-ups robo-advisers would never reach escape velocity by themselves – especially in NZ – Allan said. Likewise, traditional financial services firms need to partner with tech businesses that can offer the “proven functionality, speed and innovation” necessary to thrive in the “agile” world, he said.
Morningstar, meanwhile, says stand-alone robo-advice firms “have three life-or-death choices”:
- grow slowly while continually losing money and hope that new capital can be raised to plug the hole;
- work with established firms via a distribution partnership or merger; or,
- grow quickly by spending on advertising to reach a profitable scale.
“At the moment, we see most robo-advisors electing the first choice as really just choosing death,” the report says. “… Our best prediction of what will happen is that either they’ll go bankrupt, de facto sell themselves to venture capitalists that demand increasing ownership of the firm with each additional capital raise, or decide on choice 2: selling themselves or partnering to survive.”
Nonetheless, Morningstar says robo-advice models in the US are adapting via partnerships as well as new pricing and service propositions.