Currently, digital wealth managers worldwide manage an estimated $130bn, approximately 70% of it in the USA and almost half of it by just one market participant: Vanguard. Compared with the $60trn of assets under management in the wealth management industry globally (estimates by TechFluence), this 2017 figure is incredibly small, almost negligible – so far, at least!

However, the growth picture is strong, with realized annual growth rates of +50% in some cases and an expected market size of robo-advice providers between $489bn in assets under management by end 2020 (estimate by Cerulli¹) or $2.2trn by 2020 (by A. T. Kearney²).

TechFluence expects the number of robo-advice product offerings to rise significantly to around 500 in five years’ time – in Europe alone. As of May 2017, there are 73 robo-advice providers in the market in Europe³; if you include automated product offerings from incumbents, this number exceeds 120.

What are the drivers for these market expectations and this significant change to an industry that has been going on almost without significant structural change for decades? The following reasons are all relevant and their combined impact is fuelling the change in the worldwide asset and wealth management industry:

1. Low interest rate environment. With an almost zero interest rate environment in the majority of global capital markets, the historically high management fees of mutual funds or wealth management mandates become more visible than in the past, when a government yield of 5% – realized on the bond allocation of a portfolio – easily earned the management fee on the whole portfolio. If coupons – as of spring 2017 – are close to zero, then equity performance must do the job, which is much more difficult to obtain for portfolio managers. As a result, clients tend to notice a high level of management fees more nowadays, as they are also more cost sensitive in the absence of a “risk-free” income from government bonds.
2. The internet has brought an incredible transparency into this sector. After 20+ years of internet and comparison portals, clients of all age groups use these tools for investments: comparison of fund performances or wealth management performances, or performances and ratings of client advisors on social media portals. The inherent complexity of the capital markets and investments has shielded the industry for a number of years, until now the margin compression kicks in via exchange traded funds (ETFs) and robo-advice.
3. The technical progress in general in the past 10 years is an enabler of change in the wealth management industry too. The development of cloud technology and the technologies enabling a mobile lifestyle (3G, 4G, 5G networks) is making it rather unattractive for clients to sit down in a bank branch with an investment advisor for two hours and wait until he has been told by his computer what is the “best” product to offer. On a modern smartphone, users have access to the same in-depth information as the advisor, but in an independent form.
4. Technology leads and has led to social changes. If a user has access to information from a neutral source (i.e. independent from a product provider), he will use this information to challenge institutions, their data quality, their recommendations, etc. While in the past what a banker or wealth manager said was taken for granted, it is now being questioned. The old world has lost its information headstart. In some digital tools, users can simulate backtests themselves, whereas the client advisor usually has to request this from another unit. Clients suddenly can be in control, if they want to.
5. The offers of the incumbents do not fit into the zeitgeist any more. Brick-and-mortar branches in reality always were cost factors, but were seen as revenue generators by many. This was true as long as there were no other access points for clients to their individual and general financial information. In the 1980s, people would walk into a bank branch in order to inquire about current stock prices or collect their financial statements. Now it is one click on a smartphone and if too many clicks are necessary, the user/client will avoid using it.
6. Regulation has also helped to kickstart the robo-advice movement. Nowadays an initial meeting with a client advisor is bound to be a lot longer than 10, 20 or 30 years ago due to regulatory obligations. By complying with current regulations, market participants have a long compulsory journey to reach execution. This makes any digital solution with only a few clicks or a few sentences with a chatbot – like Amazon’s Alexa – a lot more attractive.
7. Regulation is also responsible for a phenomenon coined the “advice gap”. As the time required for a regular investment advice conversation is very high, banks and asset managers have started to increase the minimum assets under management often above $100,000. This turns clients with liquid assets of $100,000 or less into an attractive target group for digital players.
8. The existence of a competitive market of ETFs was one of the key drivers of robo-advice. Only a widely accessible low-cost product alternative to mutual funds enables digital players to add their automated solutions and still be significantly lower in price than actively managed funds or mandates. As most digital wealth managers use ETFs for their solution design, they now act as a powerful distributor for ETF providers.
9. Data is the oil of the future. Wealth data by nature is of particular interest, but so far was only used by banks, etc. for cross-selling of other lucrative financial products. However, such data is also very interesting for other market participants, for example retailers, the luxury industry, car manufacturers, etc. In the past, data was not available – nowadays, it becomes available more and more due to regulation (Payment Services Directive 2 (PSD2) as a start) and changes in society: data sharing becomes the new norm and banking cannot stay behind such a powerful social trend.
10. Accessing the right kind of data for these non-financial players has been proven difficult and expensive in the past. By offering access to wealth management products, such luxury producers gain direct access to wealth data. If, for example, a luxury watch producer from Switzerland learns about a big in-flow in its robo-advisor, it might be a good time to send the client some marketing material on watches, too. So far there have been many barriers to prevent non-financial firms entering the financial advisory business, especially as the advisory process was not feasible for them. In the digital world this becomes a lot easier, as all items of the value chain are available from various providers.
11. Brands are even more important. They become more relevant in the digital than in the offline world, as the next competitor is only one browser window away. Price comparison tools are used to filter out providers by the buyers, who are price sensitive. For users who favour quality, prime brands give the highest safety net when buying online. The risk of fraud is simply too big. Once a product is physically delivered and the payment made, it can be quite bothersome and costly to return the unwanted item and ideally receive the money back. Users must then either choose a prime brand or a prime online shop in order to avoid trouble. In many cases, both.
12. Translated into the financial world – where trust is of even higher importance – this means that either the provider of the financial product (i.e. the ETF) or the cooperating bank should be a well-known firm, as this creates trust. If the sponsor of a robo-advice tool, on the other hand, is a prime brand itself (like a luxury brand or a global retail or product brand), then no-one will question the functioning and seriousness of the offer. The initiator can then even use second-tier banks and products without brand and thus offer very competitive prices, or even offer the service for free. This strategy would make sense for such non-financial players, as their main interest is access to the wealth data – and margins in their core business are likely to be higher than in digital wealth. Robo-advice becomes a cross-selling or client acquisition channel.

So, how will the market structure in the asset and wealth management industry look in 10 years’ time? TechFluence expects the following three developments: (1) Incumbents that are able to digitize their DNA quickest will continue to grow, even more dynamically than today, but with lower profit margins. (2) Those incumbents who are not able to adapt to the new digital competitors fast enough will either acquire a digital competitor relatively late in the cycle or disappear, merge, etc. The digital competitor landscape of today consists of start-ups and traditional FinTech firms, who have built tech for financial institutions in the past already. (3) The FinTech “traditionalists” have very good chances to use their competitive advantage to grow via international horizontal and vertical integration. Within the start-up category, those start-ups that acquire enough clients fast enough before incumbents manage to digitize their DNA will become mainstream players. Whether they are able to build global brands remains to be seen. In the digital world this is, generally speaking, possible (for example Uber), but more complex in a heavily regulated environment like wealth management. The pure existence of robo-advisors leads to high pressure on margins within the traditional asset and wealth management world. As this sector did not have a lot of pressure in the past to modernize its structures, the speed the digital competitors have will most likely lead to some casualties and will force traditional players to change quickly. Geographically, North America is the most developed market in robo-advice so far, while Europe and Asia are lagging behind: both regions are more fragmented, and this means growth will happen later and probably less dynamically in the European case and at lower margins in the Asian case.

However, one figure is similar globally: the percentage of equity funds underperforming their benchmark over the years is constantly very high. Analysis by Standard & Poor’s shows that in Europe, 86% of actively managed funds over the last 10 years (after costs) underperformed their benchmark,⁴ which means they should not be in the market. In the USA the situation is even worse, with 98.9% of actively managed equity funds underperforming, according to the same study. This asset pool is still vast and forms the carrot for many more digital “rabbits” that need a lot less assets under management to break even. The future of wealth management in the digital world looks bright – especially for clients, as their total expense ratios will decrease. The competitor landscape in asset and wealth management will be a lot more fragmented than now.

Maybe the new market leader in the digital wealth management space has not been founded yet. The digital world enables financial education at a high scale. Those players who are able to include tools in their offering that address financial illiteracy efficiently in developed and less developed markets will have the best chance of winning the crown in the long term.