While contemplating the rise of robo advisors, traditional wealth managers would do well to remember the railroad industry, warned one finance professor.
In the late 19th century, railroad companies represented 50% of the market cap of all firms on the New York Stock Exchange; by the 1970s, they represented just 2%, according to Leonid Kogan of MIT's Sloan School of Management.
"It's fair to say that every time you observe a new technology in development, it does present some kind of risk for the incumbents that the way of doing business may change due to the new entrants that are going to compete," he said.
"We have seen that replay over and over again across different industries."
Kogan spoke on Friday at the Frontiers of Finance forum in New York sponsored by MIT, where he examined his scholarship into the connection between innovative patents and stock market fluctuations. In an interview afterwards, he addressed disruption in wealth management.
Establishment firms need to adapt to automated advice competitors because of the rise of tech-savvy consumers, Kogan said.
"I would say we are living in an interesting time period, this generation is more tech savvy than the one before," Kogan said. "This new generation, as they enter a saving period, they are going to be different from baby boomers. They are more self-reliant. They like transparency. They like to emphasize control over their investments and less willing to delegate to advisors."
Though digital wealth management still represents just a sliver of assets under management of the industry at large, it is a fast-growing segment. Aite Group estimates digital wealth management AUM will rise from a reported $16 billion at the end of 2014 to $50 billion by the end of this year, as established firms like Vanguard enter the space too.
In its report on the digital wealth management space, Deloitte noted that "established firms are trying to decide whether it is worth their time, money, and effort to better understand these emerging businesses," but in the consulting firm's opinion, "The answer is clear. Wealth management is an industry ripe for disruption, and wealth management startups are a leading indicator of what is anticipated to come."
Adam Schneider, principal with Deloitte, said he is concerned about wealth management firms who resist a digital strategy.
“If firms [do] that, they will miss a giant digital revolution,” said Schneider, comparing it to the transformation of the travel agency industry. There used to be 150,000 travel agencies but with the advent of online ticketing services, there are just 60,000 remaining, he said.
While it is difficult to predict the outcome of how technology will change the industry, the human touch is still needed in the foreseeable future because advisors can approach complex situations with customized solutions drawn from professional insight, Kogan said.
"I think that's an opportunity for the traditional financial management industry to really embrace the new technology and use it as a way of leveraging the systems they do have," he said. "They need to adapt. They need to retool to be able to leverage technology as opposed to just competing with the new entrants."
Attending Kogan's lecture was Bernard R. Horn, Jr., president of Boston-based Polaris Capital Management. Horn said the simplifying aspect of digital wealth management posed the greatest threat to advisors and some products.
"A lot of this stuff can be automated to some degree," Horn said. "It also is a big threat to the investment vehicles that people can invest in. You can mechanically screen [for] the best fund managers, the best funds. It would be interesting to see how these robo advisory businesses direct investments."
There are some immediate benefits of offering a robo service for a firm, Kogan added, in that they can help streamline necessary support functions, such as form filings.
"I think of this (robo advisors) as more of a force multiplier. It's possible to use technology to increase efficiency and the quality of the traditional financial advisor. I don't think it's mutually exclusive, you either provide investment advice using technology or use traditional human methods," Kogan said.
As a reminder of the disruptive nature of technological change, though, Kogan ended his talk with another warning. “Innovation: If it can make your job easier, it can probably make it irrelevant.”
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