Why Envestnet may be your next custodian
Envestnet powers the technology behind some of the biggest custodians — but it's gained enough scale as the leading turnkey asset manager that there's little to hinder it from becoming a custodian itself.
Deepening the trend of crossover within the financial industry, Envestnet’s potential path to become a custodian would flip the trend of many custodian efforts to become technology providers.
While half of the $6 trillion market is dominated by incumbents, Envestnet could potentially leverage its own technology — and its deep seated relationship with independent advisors — to become a disruptive threat to the big four, including Schwab, TD Ameritrade, Pershing and Fidelity.
In fact, adding custody could boost revenue per advisor by approximately 200%, according to a recent report by JMP Securities.
“Specifically, Envestnet could give away some or all of its technology and still end up with better net economics, which we think would be difficult to compete with,” says Devin Ryan, equity research analyst at JMP Securities, in an emailed statement. “The bottom-line takeaway is that we think the company could eventually be in a position to compete with the current oligopoly, which in turn, could be quite value enhancing to shareholders.”
Envestnet currently averages approximately 10 basis points of revenue on assets per advisor depending on how the platform is used, according to the report. Custodial revenues could potentially add another 20 basis points to its bottom line.
That’s because the number of RIAs grew to more than 12,500 at the end of the last year from less than 10,500 in 2012, according to data from the Investment Adviser Association. Assets in the RIA channel skyrocketed to more than $80 trillion from under $10 trillion in the same time period.
“Envestnet could create a custodian that integrates perfectly with its overall offering, which we think would be attractive to advisors that are already using Envestnet, and being a technology-based firm, we could imagine the company adding capabilities and an overall experience for RIAs and their clients that is differentiated,” Ryan says in an email.
An Envestnet spokesman says the firm does not currently have plans to provide custodial services. Schwab, TD Ameritrade, Pershing and Fidelity declined to comment.
To be sure, there are any number of potential scenarios that could play out in Envestnet’s future. Some have speculated about future acquisitions — including the purchases of a possible CRM provider or custodian — and even the potential to be scooped up by one of its largest investors BlackRock.
However, the world’s leading TAMP already provides technology to almost 100,000 financial advisors — which is close to one third of all advisors — and has $3.3 trillion in total assets on the platform, according to the report.
“Advisors that already have a strong relationship with Envestnet could potentially get access for a lower price point than through their existing custodial relationship, which we think could be quite compelling to the advisors,” Ryan says in an emailed statement. The additional revenue tacked on from custodial services could be used to keep the overall price of the platform down for advisors.
However, breaking into a market dominated by incumbents could be rough for Envestnet and a hard sell to shareholders. Schwab, the leading custodian in terms of overall assets, already works with 7,500 RIAs, while its closest competitor in terms of its RIA channel, TD Ameritrade, works with 6,000 independent advisors. For comparison, Envestnet services approximately 8,000 RIAs with $1.5 trillion in assets, according to the report.
“Envestnet is a beautiful mosaic with a tile or two missing,” says Will Trout, senior analyst at Celent.
The most glaring gaps include advisor-facing tools like CRM system and risk analysis tools, Trout says, as well as back-office technologies. “Taking on the custody function could also help Envestnet streamline workflow and help give it more credibility,” he adds. “It would also make existing customers more sticky, particularly if there is a built in value add such as a paperless onboarding function.”
Client onboarding has been a particularly hot topic among custodians in recent months. For example, Schwab still use 270 paper forms and are working vigorously to cut back, according to Andrew Salesky, Schwab’s head of digital advisor solutions. Recently, Schwab digitized its address change process and cut out 1,500 paper forms a week.
Another problem that Envestnet could address is the lack of efficiency between third party software providers and the custodians, says Bill Winterg, founder of advisor tech blog FPPad.com. For example, custodians have been sluggish to upgrade electronic account openings, he says, which allowed other independent robo advisor to gain a significant edge.
“Envestnet would have full control over the features and functionality of their custody platform, allowing the company to quickly address the demands of the growing independent adviser marketplace,” Winterberg says, who has provided marketing services to Envestnet in the past year.
While some analysts believe a bundled offering between advisor technology and custodial services would help Envestnet compete with the big four, it may also put Envestnet in their sights as well, Trout says.
Ryan agrees. “Clearly existing custodians where Envestnet thrives today could become territorial or aggressive back toward the firm, and as a result, we believe Envestnet would have to be deep enough and strong enough with RIAs to successfully execute, Ryan says, adding that Envestnet would likely want to assert itself even more in the RIA marketplace before putting the wheels in motion.
There would be other associated risk, as well. Namely profit margins. “Custody margins are thin and Envestnet would assume the cost of keeping up with regulatory changes,” Trout says. And investing additional time and resources to add another piece of external technology — especially in the wake of the MoneyGuidePro acquisition — could be costly. Obviously, the move into the crowded custodial marketplace would not be easy, he says.
“Because the firm is still scaling in the RIA channel and the channel itself is still developing, we think it is a bit early for Envestnet to think about a custodial rollout, particularly as the firm still has a close relationship with current custodians,” Ryan says.
Envestnet grew revenue by 12.4% year-over-year, according to data from Renaissance Capital. Over the past six months, shares of Envestnet were up 36%.
The marketplace may want to consider this custodial opportunity as a possibility, even though the real opportunities for Envestnet could be years away. For Ryan, the probability will increase over time as Envestnet continues to establish itself in the booming RIA community.
“To the extent it does add custodial capabilities, given our view that Envestnet could scale quickly, we believe the earnings and valuation implications could be quite compelling,” Ryan says.