“Financial products are sold, not bought.” This fundamental belief is widespread within the financial industry. Many surveys support this fact. They show that the average customer, if asked on the street, neither knows the performance nor the costs of his investments. Do we believe that new digital applications (so-called robo-advisors), low-cost financial products (such as exchange-traded funds (ETFs)) and upcoming regulatory requirements will change the way we invest? If so, how will these applications look and how will this change the market structure of the asset management industry? We will explore these questions with seven theses.

Speaking on stage three years ago, we often received one question: “How many robo-advisors (by banks or start-ups) will enter the market?” We often wondered about the surprise of the audience as we answered: “We believe everyone who sells financial products offline, might offer them online. It’s like websites in the 1990s.” Today, many announcements indicate that most banks will provide a robo-advisor soon. For the sake of simplicity, we will use the term robo-advisor for any digital application that supports the customer in their investment journey – no matter if provided by a start-up or a bank, and disregarding whether it matches the regulatory term “investment advice”. Furthermore, when we speak of banks, the same might apply for insurers, asset managers or advisors.

Robo-Advice Goes “Hybrid”

How will robo-advice affect offline advice? In “offline advice”, it’s hard to tell what’s being said behind the glass door. A standard protocol is the only, often poorly read, evidence of the advice. After buying a fund, the average customer can only see her current investment value in paper reports or online banking. Important information on performance, costs or risks are rarely provided. This differs in an online process. The customer answers public questions and receives an asset allocation and a selection of investment products based on their profile. Everything that has been “said” can be traced via the internet.

How will these two approaches coexist? As we began our journey together with banks, online advice was often considered a “side experiment”. This changed in 2017, driven by regulations such as the Markets in Financial Instruments Directive 2 (MiFID2). Differing from the offline world, robo-advisors can adopt new regulatory requirements without intense training of the workforce or replacement of material. They can implement requirements like suitability checks or product governance before the regulation is in place (or even 100% defined). By doing so, robo-advisors collect early feedback on managing the intersection of conversions and compliance.

We expect these learnings to shape “the general concept of advice” within banks. Today, many want to take the best of both worlds. This means combining the anytime, anywhere, simple and fast digital processes (online) with the social interaction and contextual information (offline) in so-called “hybrid advice”.

The Third Generation of Robo-Advice Gets Smarter

So far, we have seen two generations of robo-advisors: the first generation were simple onboarding tools. Deriving a risk score from 5–10 questions, one out of up to 10 model portfolios got suggested. The second generation offered discretionary portfolio management, covering regular rebalancings and dashboards to monitor the portfolio.

In 2017, we see a third generation coming. Applications that take all kinds of values of customers into account. This might look as follows: within their online dialogue, the customer connects their cash and portfolio accounts from all their banks automatically. In the background, application programming interface (API) calls to all their banks are triggered to request this information. Manually, the customer adds up their real estate, pensions, insurances, etc. The application matches this information with financial market data (such as the performance of investment products, real estate prices) to provide a solid base for the online financial advice.

How will this technology impact the market? Banks can offer portfolio checks that help the customer detect bad performance, insufficient diversification, high risks and costs within their portfolio. Very simplified, Bank A says: “Look, your Bank B sold you overpriced products with a cost rate of X, its performance was worse than our product Y and is not diversified enough for your risk profile. I can offer you something better. Interested?” The accessibility of accounts empowers the customer to get “a second opinion” without much effort. This might impact the market. As it’s no longer important which bank holds the customers’ accounts, market barriers are shrinking.

Robo-Advice Moves All-Finance

Analogous to the evolution in the offline world, we expect robo-advice to go “all-finance”.

In the first step, we already see robo-advisors that offer access to alternative investments. Those are, for example, asset classes created by other FinTech companies, which can be executed online – such as investments in loan portfolios from peer-to-peer credit platforms, financing of real-estate projects or loans for trade finance. In the second step, we see robo advisors increasing that focus on products with an asset management component, such as life insurances or corporate pensions. In the third step, robo-advisors might move cross-product. Rebundling is expected to gain relevance in robo-advice. Imagine you connect all your assets and accounts to one application. As the underlying data is there and financial questions are interconnected, the same application can advise you on your asset allocation while also suggesting the right mix for financing your real-estate venture.

Specialized Robo-Advisors Will Rise

At the beginning, most robo-advisors targeted young digital natives. We soon learned two lessons. First: we almost always underestimated the average customer age by more than 10 years. Second: it’s hard to get the young digital native “excited for finance”. Today, robo-advisors first target the wealthy and/or senior customers.

We expect to see more specialized applications for professions or life stages soon. Take retirement planning for example. While the 25-year-old wants to see the effects of his savings or a pension forecast, a 60-year-old who owns a variety of assets – like houses, insurance policies and pensions – might pose different questions, like: How long will my wealth carry me? Should we sell our house and move to a nicer place? How much can I leave for inheritance? Those questions are still underserved.

Another underserved group are institutional investors. Here, robo-advice is more complex. Institutional investors want to understand whether the offered asset management strategy suits their complex portfolio. They have additional requirements on regulatory reporting, sustainability scores or features such as blacklisting sectors by fundamentals, stocks or regions.

Financial Education is Increasing

We once made a joke at a fund conference. With help from our design team, we took a screenshot from Google Shopping. We “googled” a specific shoe. Google showed us some pictures with prices and a link to a shop. Our design team replaced the search field with the name of a prominent mutual fund and the shoe picture with an efficiency curve showing risk and returns. We replaced the price by cost ratios (like operating cash flow (OCF) or total expense ratio (TER)). Then, we showed on the right-hand side: “Other people purchased instead”, featuring a list of funds with better positioning on the efficiency curve plus lower costs. We immediately lost the attention of the audience. Most directly grabbed their phones and searched. Why? Because, from a user experience, it could work exactly like this.

We have already seen that the popularity of ETFs was fuelled by the internet. Simple ideas, such as “no one can beat the market” or “Warren Buffet recommends Index funds” spread fast. Financial portals grew, educating on products and strategies. Financial education gets more present, and “googling” for something we do not know becomes a habit.

Being Compliant Will Make or Break Robo-Advisor

Regulation plays a central role in robo-advice. On the one hand, regulation builds a barrier to entry. Executives of robo-advisors need to know what requirements will meet their business model, no matter whether it is self-execution or discretionary portfolio management. By the nature of online business, failing to comply immediately receives public attention. Thus, knowing if suitability checks match MiFID2 criteria, or requirements on product governance, and documentation – but also data protection documentation – requirements as well as data protection are met, is crucial. For those that do, regulation offers a chance. Some regulation opens up possibilities to build new services (such as Access to Account (XS2A) within PSD2). Whoever complies early might have a head start.

Mass Retail Asset Management Strives for Zero Marginal Costs

Today’s asset management industry is complex. The value chain covers research, product manufacture, several steps of bundling and distribution, which itself contains multiple players such as brokers, advisors, insurers and banks. This complexity has its cost, which the customer needs to carry.

Last decade, futurists like Jeremy Rifkin formed the idea of zero marginal cost societies, stating that value creation processes without scarce resources might become fully automated. Robo-advice, often combined with passive ETFs, is following this idea. They lower the marginal costs for the customer’s benefit. Still, one cost block remains challenging: customer acquisition costs (CAC). The average robo-advisor pays between $100 and $400 to win one client. This creates a fear that companies with low CACs will enter the market, such as Google, Amazon, Facebook and Apple, or strong product brands like Vanguard.

A company with low CACs plus enough customer touchpoints might outperform large offline salesforces in terms of reach and conversion, without having to carry the fixed costs. It comes down to reach and scale to drive retail asset management towards zero marginal costs, leading to a shift that “financial products might be bought, not mainly sold”.

To sum it up: We believe we have only completed 1% of a digital evolution. The best way to “predict the future” is to create it.