A race to the bottom: Can roboadvisors build real businesses?

  • A new study finds it takes 11 years for a robo account to turn a profit.
  • UK robo spends an est. £2,794 over the life of an account.

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A race to the bottom: Can roboadvisors build real businesses?

Sometimes, when you win, you lose. Venture investors are betting that this generation of software-driven investment firms will be the future. That may be, but the future is going to be very expensive for roboadvisors. In a race to acquire assets, robos may be setting themselves up for a harsh reality.

Wealthfront and Betterment are the two leading upstart roboadvisors in the US when viewed by levels of AUM. Collectively, these two firms have less than $10 billion in AUM. They’ve built very slick platforms that have resonated well with millennials, who would rather automate their portfolio management than have to deal with a financial advisor. These platforms generally provide basic plain-vanilla portfolio managment, tax-optimizing rebalancing strategies, and are dirt cheap (fees typically start at 25 bps and go down as account sizes go up).

Not every roboadvisor is the same — some, like those offered by some of the incumbent brokers and asset managemers provide a hybrid offering that weaves in connecting with an advisor at some point. But the value proposition to customers is the same: low fees and a set-and-forget interface.

Roboadvisors have become the rally monkeys for fintech. If new software-enabled tools can change the way money is managed and suck out excess cost from the system, every part of finance can be disrupted, the thinking goes. Wealthfront and Betterment have also raised hundreds of millions of dollars of venture capital. It looks like they’ll need every penny as a recent report demonstrates just how unprofitable these firms are.

Untenable business models

The average UK robo account would have to be invested for nearly 11 years to reach break-even, according to Alan Miller, author of Fintech Folly: The Sense and Sensibilities of UK Robo Advice. Miller, a UK asset manager, drilled down into how expensive it was to acquire new accounts for these startup financial advisors. The report found that the average UK robo-adviser receives revenue of just £147.50 pa per account, but had to deal with a cost of acquisition that was at least £180 pa per account.

Those numbers may prove to be way low, too. Other online financial firms, like online brokers, marketplace lenders, and equity crowdfunding platforms, regularly pay significantly more to acquire their customers, but also see higher total lifetime value.

“We were shocked at how unviable these business models are,” he wrote Tradestreaming via email. “Even using incredibly generous assumptions regarding their costs, which are in some cases up to 18x the level we assumed, it would still take 11 years just to make a penny, by which time many of their clients will be long gone based on the average retention period of three years we discovered; as would their financial backers.”

Scale, sure, but at what cost?

As roboadvisors are software firms at their core, perhaps they scale well. Wealthfront’s CEO, Adam Nash, has always compared his firm’s growth to that of another great innovator, Charles Schwab. And in fact, at least for the first few years of its young life, Wealthfront grew faster than Schwab, reaching $1 billion in just two years, while it took Schwab 6. With a growth trajectory this steep, maybe it isn’t far-fetched to see early robo leaders getting to $100 billion or $1 trillion under management.

Wealthfront's AUM growth
Wealthfront’s AUM growth

Miller isn’t so certain. He estimates that the employee costs alone at one of the UK’s largest roboadvisers were £817 per account/year. So, all in all, between acquisition and HR costs, roboadvisors spend a total of £2,794 over the life of a client life (even excluding all the non-staff related costs). If after three years, a robo only earns £499, well, Houston, we have a problem. Miller thinks this upside-down cost structure, and potential regulatory problems, may derail the robo train.

Miller’s investment firm, SCM Direct, offers 6 different ETF portfolios, so he competes with robos. Nevertheless, he’s transparent about fees and provides a clear description of how much a customer should expect to pay working with his firm. The UK investment manager charges 1.13% per year which includes management, custodial, ETF, and trading fees.

Channel vs. standalone robos

It’s expensive to build a standalone asset manager. Incumbent firms recognize that and a few of them, like Blackrock, Invesco, TIAA, and Goldman Sachs have acquired startups in the space. They’re planning on using these firms as distribution channels for their own ETFs. Clients of these firms will have their choice of flavors to choose from.

And that’s the point. Roboadvisors aren’t a new business, per se. They’re a new way to deliver advice and product, one that’s cheaper and more automated than previous models for the investor. The other side of this coin is that the robo trend exerts downward pressure on management fees. This will kill off some of the smaller roboadvisors who don’t find a way to profitably scale or tap deep pockets of an investor willing to fund such expensive growth.

Meanwhile, the infatuation with robos continues but apart from Miller, no one seems to be asking the hard questions of roboadvisors. “We have been just as surprised by the response to the report which has only been partially covered in the trade press, especially adviser focussed titles,” he said. “There’s been no coverage in the financial pages of national media titles, given the serious issues our report raises,” he said.

Roboadvisory is here to stay, while roboadvisors may not be.

Photo credit: A Train via VisualHunt / CC BY-ND

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