If we assume Wealthfront in its original incarnation ushered the beginning of Robo advisory (Robo), then we are in year 7 of the Robo movement. I divide this 7 year timeframe into three phases. Phase 1 lasted from 2008 – when Wealthfront launched – til 2012 and focused on proving that individuals would trust digital platforms with their money. Robo v1 models launched during phase 1. Phase 2 lasted from 2012 til now and focused on the beginnings of platform differentiation, the start of AUM growth and the entrance of incumbents on the Robo scene. Robo v1 models morphed into more sophisticated versions of themselves – call them v1.5 – and some v1 platforms got acquired or went under. Phase 3 has just begun and will bring about more consolidation, more differentiation and accelerated growth. A few category leaders will emerge during phase 3, let’s call them Robo v2 models.
Robo v1 delivered a thin digital layer, a simple asset allocation algorithm, simple user interface and passive investment strategies.
Robo v1.5 saw more complex asset allocation algorithms, in some instances differentiated services such as tax harvesting for example. Very few Robos decided to own the investment management decision. Most still delivered passive investment strategies. None that I know wanted to expand into trade execution (broker/dealer) or custody, at least in the US.
How will Robo v2 evolve? I see three potential axes of development. First axis of development will differentiate by providing active strategies via an investment management core. Second axis of development will differentiate by providing a fuller operational stack, i.e. front end with asset allocation algos + a mix of the following => investment management + trade execution + maybe some custody. Third axis would be to execute on axis 1 and 2 simultaneously.
Depending on the research analyst and how market data is interpreted there are now over 30 Robos operating in the US managing a total of $15 to $19 billion. Recognizable Robos are Wealthfront, Betterment, SigFig to name only a few. Arguably the sub $20 billion managed in aggregate by all Robos is a rounding error compared to the +$10 trillion of retail assets managed by advisors in the US. So why, if Robos are a rounding error at this stage, are incumbents paying attention and strategically moving in the space against the early movers?
Simply put, the market is moving digital and mobile. Younger generations will not engage with financial advisors the way there parents and grand parents have. Younger generations will not suffer and tolerate the obfuscation and lack of transparency their parents and grand parents have given the lack of data they were faced with. Younger generations are empowered by technology in ways their parents and grand parents never were in the past.
To be more precise, acquisition of new customers will move towards digital channels. Customer service will move towards digital service. Retention of customers will happen at the digital level.
Do note the above also holds true for the US, Europe and Asia.
Based on these tailwinds, one would conclude Robos will experience smooth sailings in phase 3. I am not entirely convinced. Why? Because incumbents, the likes of Fidelity, Schwab, wirehouses, large independent Financial Advisors have just started to strike back. And they pack a formidable punch. Fidelity chose the partnership path by investing in Betterment. Schwab and Capital One chose the frontal approach by launching their own robo initiative. Even though it is not a pure robo, Learnvest got acquired by Northwestern Mutual. Finally several smaller US robos have already been acquired by mid size incumbents. I expect more of the same as we enter phase 3. I expect more incumbents launching their Robo platforms as well as strengthening the delivery of their existing online platforms. I expect weaker, less well funded Robos to either be acquired for their technology or to fold. I expect only a handful Robos to be successful in the long run.
There are three main reason why I make such a stark prediction – and i can of course be wildly off the mark here. The first reason is the current revenue model. Robo v1 and v1.5 for the most part deliver revenue off of a 20 to 30bps model. Is that enough to build a business that already requires large outlays of capital – after all we are talking about direct to consumer here? I doubt it. Cashflow breakeven off of 25bps is so much more difficult to achieve than off of 100bps. The second reason is the business model to date. Robo v1 and v1.5 have built an easily replicable business model architected around a digital front end and a “simple” asset allocation model. The third reason is the lack of product diversification. Providing mostly passive strategies may limit the addressable market or impair the performance Robos may deliver in a variety of market situations – think bear market for example. I do wonder what will the reaction of Robo customers be when they see a severe down market?
R66 has invested in three Robos. Two of our Robo portfolio companies are located outside of the US. Vaamo in Germany and 8 Securities in Hong Kong. Both are first movers in their geographies and are roughly where Wealthfront was 6 years ago in the US. Both are addressing a market much less mature and sophisticated than the US. 8 Securities holds a broker/dealer license in Hong Kong and Japan as well as an investment management license – hint the crucial importance of offering a wider operational stack. Vaamo is in the midst of expanding its offering.
Our third Robo portfolio company is Hedgeable out of NYC. Hedgeable already has a Robo v2 model. One built around an innovative investment strategy and innovative products tailored for the mass affluent.
The strategic question at hand is: “Will Robo v2 models be more resilient and offer more of a disruptive threat to incumbents than Robo v1 and v1.5 have to date?”.
I believe the question will be answered in the affirmative for a handful of category killers emerging out of phase 3. What say you?