Sunday, June 12, 2016

Robot Wealth Management: Wall Street's Missed Opportunity?

Until a few years ago individual investors had two primary options for wealth management services: hire a financial advisor or do it yourself. The former usually required a high minimum account balance and involved management fees that cut into returns. That latter took time and some level of investment savvy.

Enter robo-advisors, which in just two years have defined a new segment in wealth management by automating the sophisticated investment advice of full-service brokerage at the low-cost, low-minimum entry point of DIY investing. Investors of nearly any age or portfolio size now have access to statistical models Wall Street has used for years to build portfolios, but at a fraction of the cost.

Many robo-advising companies use Modern Portfolio Theory to build algorithms that automate portfolio creation, maximize returns and minimize risk. Unlike mutual funds, which typically diversify along industry or asset style and track indexes – and offer low minimum investments and fees - robo-advisors attempt to create a broadly diversified portfolio you’d only get by purchasing securities individually yourself or through model portfolios offered by your FA.

When robo-advisors first came on the scene, full-service brokerages like Bank of America, Morgan Stanley and Wells Fargo looked the other way. Robo-advisors target the low end of the market – those with small amounts to invest and little tolerance for high management fees. There fees tend to be 50-75% less than those at full-service brokerages.

These are the very customers Wall Street has been turning away for years because the ROI isn’t attractive.

Understanding this positioning, this excerpt from Christensen’s Innovator’s Dilemma sounds ominous: “There are times at which it is right not to listen to customers, right to invest in developing lower-performance products that promise lower margins, and right to aggressively pursue small, rather than substantial, markets.”

Firms like Charles Schwab saw the growing threat of robo-advising and did respond aggressively. Schwab introduced its Schwab Intelligent Portfolios robo-advisor service in 2014 and has 75,000 clients using it today. It’s got $6.6bn under management – compared to the $2.5 trillion it has under management in its traditional businesses - and is now leading the space, ahead of start-ups like Betterment at $4bn and Wealthfront at $3bn. There is a great article on Fast Company describing how Schwab did it.


Bank of America, Morgan Stanley and Wells Fargo are now paying attention. All have said they plan to develop or buy a robo-advisor of their own. As Wells Fargo CFO John Shrewsberry put it in this Bloomberg article, “That is a real threat to our business, because we are disproportionately full-service, high-value-added, person-to-person activity, which isn’t for everybody.”

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