The WealthTech sector is going through a rapid development phase, triggered by changing market conditions, new regulations and customer demands.

WealthTech is redefining the way people invest their money. The year 2017 was tough for robo-advisors, as the race to lower fees continued. However, changing business models, competition against mutual funds and the implications of RegTech have made the business quite unusual.

The Attraction for High-Net-Worth Individuals

It is a myth that only millennials or low-net-worth individuals (LNWIs) are interested in robo-advisors. Robos primarily targeted millennials back in 2008, but things have changed since then. Today, financial firms are recognizing the demand among high-net-worth individuals (HNWIs) and baby boomers.

Typical robo-advisors offer core investment, but HNWIs seek more than just passive ETF offerings; they need to secure and diversify their portfolios through active management and hedging. SAMT AG (a Swiss wealth management company), for example, has developed robo-advisors that provide “sophisticated hedging” with a core–satellite method, employing various managed futures strategies in addition to the ETF core.

At the end of 2017, wealthy investors were shifting their interest towards a mix of active and passive investment. The market was filled to the brim with passive investments; as soon as it corrects, profits will be very difficult to earn with solely passive investment.

Collaboration with the Wealth Management Industry

According to a report by PricewaterhouseCoopers LLP, about 50% of financial services firms around the world plan to acquire FinTech start-ups in the next three to five years.¹ Within the first four months of 2017, several FinTech M&A deals had already occurred.

For instance, Takealot (an African online retail company) was acquired by Naspers (a multinational internet and media group) for €65 million.² Similarly, ANT Financials (an Alibaba Group affiliate) acquired MoneyGram (a US-based money transfer company) for €826 million,³ and for €3.5 billion Cisco acquired AppDynamics (a US-based app performance management company).⁴ Notable mentions from previous years include Goldman Sachs acquiring Honest Dollar (investment advisory),⁵ BlackRock acquiring FutureAdvisor (digital investment manager)⁶ and UBS's partnership with SigFig (robo-advisor).⁷ According to a survey, banks all over the world view FinTech start-ups as possible collaborators or to acquire as valuable technology.⁸

This tendency for buying by the big financial service firms is less of a trading approach (as the robo-advisor is not truly a revolutionary concept) and more of a direct distribution approach, as the robos sell direct over the internet to customers. The big finance firms sell “cheaper” solutions through the robo distribution channel than when you enter their brick-and-mortar branches.

The HNWIs who get their financial advice from an ad-hoc advisory relationship are more likely to opt for robo-advice.⁹ This signifies a market opportunity for WealthTech collaboration: offer automated services to these individuals by collaborating with WealthTech start-ups. A synergistic approach where FinTech/WealthTech are not viewed as “disruptors” would be more practical.

Looming Danger of Becoming Obsolete

There is an inherent danger that many robo-advisors will become obsolete due to lack of profits. The low fee of robo-advisors sounds lucrative for the client but for a company – Betterment is an example – to generate profits while charging 0.25% including tax, they need a huge asset base to successfully run their operations. Even a single service contact like a phone call from a customer can eat away the US$10 contribution they get from the average customer.

The big financial firms generate multiple income streams from their clients, which include the ETF expense fees. It makes sense for them to not rely on their digital services for lucrative profits. They would prefer to offer these digital services as a bonus to their clients.

Fidelity and Charles Schwab are prime examples of companies that provide digital services at almost no cost, because these facilities are in addition to their core business. The problem is that for the FinTech start-ups, they are solely relying on their digital services for profitability. Currently, the majority of robo-advisors are investor-money-funded, with unusually high burn rates of up to US$1 million a month.

The race to zero contribution is underway, and some sites like https://www.ways2wealth.com/ are already providing unbiased free advice. People expect robo-advisors to provide free services: after all, it's the digital age, and the internet gives free information. The problem with this thinking is that it will not be able to generate profits for robo-advisor companies. Either they will recommend/advertise securities from their affiliates for a commission, or merge with a bank/insurance company.

Competing Against Mutual Funds

Looking at the bigger picture, robo-advisors are breaking the monopoly of mutual funds. The majority of robo-advisors invest primarily in ETFs, and compared with mutual funds they are more flexible. Currently, most robos run between 5 and 20 different risk levels, and manage segregate accounts for each customer, which reduces cost and work (i.e. each account is handled individually). They could run 5 to 20 ETF funds which replicate the risk level in the segregate accounts, and dramatically reduce costs by simply moving the customer's money to an ETF with a corresponding portfolio risk level. This might be the next step in cost saving.

The greater probability is that both robo-advisors and mutual funds will try to get each other's market share by developing hybrid solutions between a segregated and a pooled account, with robos aiming to provide services to people with more expensive portfolios, while mutual funds will lower their costs to compete against the robos. Robos with billions under management could easily get a banking licence and do all the conventional banking operations such as cheque accounts. Perhaps you'll be able to wire money through Facebook using your robo account!

Test of Survival for FinTech Companies

As the competition in the WealthTech industry stiffens at the cost of profitability, many start-ups will not be able to weather the storm. In my opinion, the majority of robo-advisors will have to hold clients for about 10 years just to break even. Many of these companies are only accumulating liabilities if their algorithms fail or the market takes a nose dive. If the market crashes and these companies are 10–20% underwater, they would rethink their robo investments and look for more sophisticated solutions or return to mutual funds.

These are serious profitability pressures for any business, and the way robo-advisors have tried to tackle this is by selling affiliate products. So, when robo-advisors claim to give free advice, it is not really free, as they receive affiliate commissions from their broker-dealers, clearing firms and custodians.

If FinTech and WealthTech start-ups are to survive, they need to formulate a strategy that goes beyond “free digital services”. Features such as research and development, innovation, improved software and location are all attractive to clients, but the most crucial reason clients invest with a firm is trust. The threat of unprofitability is real for many FinTech firms. However, if they can build trust with their clients and investors, they can transition from survival mode to a growth phase very quickly, and financial regulations help establish just that.

RegTech Becoming Stricter

RegTech is a major player shaping the future of WealthTech. As there are concerns about the financial legitimacy, privacy of data and credibility of investment solutions of WealthTech products, RegTech will impose stricter regulations. The Dodd–Frank Act (Basel III) contains reforms already in place that are shaping the operations of financial firms, even helping whistleblowers.¹⁰ In Switzerland, the Swiss Federal Council has lowered the regulatory barriers by introducing features such as the FinTech licence.¹¹

This brings additional competition into the market for the independent advisor. As more WealthTech firms enter the market, financial advisors will lower their fees as they partner with ETFs. Advisors need to give clients an incentive to choose them over WealthTech companies, and fee compression is the most likely choice.

Conclusion

WealthTech trends might seem unusual, but innovation usually is. The target clientele of robo-advisory companies is expanding, from millennials to high-net-worth individuals. Banks and financial institutes that consider FinTech firms as a threat will need to shift their perspective, because a synergistic approach can provide better services to clients. The strategy of lowering fees is a constant threat to the survival of many FinTech start-ups. These start-ups would want to acquire mutual fund customers, as ETFs (at minimal management fee) sound more lucrative. RegTech has so far helped FinTech companies achieve this goal by lowering the barriers to entry.