Kitces: Why broker-dealer robo advisors miss the fintech point
Over the past two years, there's been a growing trend of broker-dealers announcing prospective launches of their own robo advisor solutions. From LPL developing a platform with BlackRock's FutureAdvisor to Voya planning to launch a robo advisor, and Kestra Financial announcing it is working on a robo platform on the back of its acquisition of H. Beck, there's been no shortage of announcements.
Yet while I’m very upbeat on the potential for advisor technology to improve our businesses, I think broker-dealers in particular are entirely missing the point of the robo phenomenon and particularly when it comes to advisors.
Launching a robo advisor does hold appeal among broker-dealers. Many of their reps are asking for it, either because it’s an easier way to handle smaller clients, or just to have a robo advisor option for millennial clients. Who wouldn’t want a button for the advisor’s website that young people can click to open up small accounts that will grow with time? And from the broker-dealer’s perspective, ideally, this helps them address the coming generational shift of assets from baby boomers down to millennials.
For the individual advisor, however, the significance of this trend — the great rotation of assets from baby boomers to their millennial children — is grossly overstated.
The reality is that the average financial advisor is in his mid-50s, which means the average advisor will retire long before their average baby boomer client starts bequeathing assets to millennial children. Also, in 10 years the average advisor may see some client roster attrition due to the occasional death and ongoing withdrawals, and maybe lose 3% to 5% a year in assets and revenue because of it, but that won't hurt them much financially, as most retirees never even substantively draw down their portfolios. And to the extent there are outflows, advisors can make it up with new clients given 10,000 baby boomers are turning 62 every day. Simply put, the advisor can cruise it out with limited impact until he/she retires.
But for a broker-dealer that in the aggregate is losing 3% to 5% a year in asset outflows a decade from now, it’s a crisis, because a broker-dealer still has a multi-decade open-ended timeframe as an ongoing business entity. This is why we see broker-dealers, as well as RIA custodians, so obsessively beating the drum about advisors needing to focus more on younger clients. It’s not actually because advisors desperately need younger clients for our businesses to survive. It’s because they, the broker-dealers and RIA custodians, need us to get younger clients for them so their businesses survive and so they have younger clients after we’re gone and retired!
And so from the broker-dealer’s perspective, if millennials are pursuing robo advisor solutions, then the broker-dealer wants to roll out a robo advisor to get those younger clients and solve its own long-term generational issue. But here’s the problem with the strategy: robo advisors live and die by their ability to get clients online, and that’s not easy for anyone, especially a large base of independent registered representatives.
DOOMED TO FAIL
Betterment is just over $10 billion in total assets after six years. Wealthfront is just over $7 billion AUM in that same duration. Schwab made news for $15 billion dollars of assets, but has actually noted only a third of that total was new assets. Vanguard is now over $80 billion, but remember they had much of their assets already as well. Vanguard is direct-to-consumer through the Internet already; those in Vanguard’s Personal Advisor Services were predominantly existing Vanguard investors, simply upsold to human advice. Even Edelman online, which launched in early 2013, has accumulated barely 1,000 clients and just $62M of AUM after four years (and their average robo client is actually a baby boomer anyway.)
So even the leading robo advisors, priced at a phenomenally low 25 basis points, are struggling to attract millennials, and are getting maybe $1 or $2 billion a year in net new assets. Which at that price point is just a couple million dollars a year of gross revenue, before the cost to build and service and support the robo technology for the broker-dealer itself. Which means even for a mid-sized broker-dealer, the robo advisor opportunity is really small potatoes.
Furthermore, the leading robo advisors (and digital advice solutions like Vanguard) are focused on building robo solutions with centralized marketing that is highly conducive to economies of scale. But that’s not how it works in a broker-dealer environment. There are hundreds or thousands of reps, each of them with their own marketing plans. Which means that while robo advisors constantly iterate in their marketing and are running dozens of A/B tests on their websites every day, every individual registered rep has to get every digital initiative and every little change on their website pre-approved approved by compliance. Which is not exactly conducive to innovative scalable marketing!
In addition, the average advisor at a broker-dealer focuses on retirees. Their website probably shows pictures of couples walking on the beach toward a lighthouse, or sitting on some Adirondack chairs overlooking the ocean. What exactly is this advisor supposed to do with a robo solution from the broker-dealer for millennial clients? Put a button on their website right between the lighthouse and the Adirondack chairs that says, "Millennials click here?"
The problem is robo advisors don’t actually help advisors get millennial clients. Robo-advisors help advisors open millennial accounts after they successfully market to get millennial clients in the first place. And so until and unless broker-dealers figure out how to help their advisors get much, much savvier about digital marketing and how to actually attract and get millennial clients in the first place, and then use the robo tools to onboard and open the accounts, these broker-dealer robo initiatives are all doomed to fail.
VALUE IN EFFICIENCY
In other words, the real blocking point of robo advisors is the client acquisition cost — what it takes to market and get a young investor to invest on your platform. As the founding companies learned the hard way, this is not an “If you build it, they will come,” kind of asset-gathering opportunity. Instead, robos at best have been struggling to solve those client acquisition costs in the face of slowing growth rates, and many have been getting outright buried by those costs. That's why robo advisor growth rates continue to slow down. Most of them have already sold, and most of the ones that are left aren’t even really focusing on a pure robo strategy anymore.
In the meantime, Vanguard is hiring hundreds of CFPs. So is Personal Capital. Schwab pivoted from a pure robo solution to intelligent advisory which offers humans. Even Betterment pivoted from a robo solution to offering human advisors this year. Which means no one who’s actually succeeding at robo advice is doing it with a robo solution. They’re bringing in humans, while broker-dealers are trying to roll out robo advisors. This is not going to end well for the broker-dealers.
Notably, though, just because a robo advisor solution at a broker-dealer is doomed to fail at gathering millennial assets, doesn’t actually mean the technology itself is worthless. To the contrary, there are tremendous operational efficiencies to be gained in a lot of robo technology.
The firm's digital advice service, to be piloted in early 2017, is a bid to give RIAs unprecedented scale.October 18
That's because robos do two things incredibly well. First, the technology makes client onboarding easier and faster. That’s part of why Betterment’s technology in particular was so shocking when it launched a couple of years ago. In 2012, advisors were still mostly opening new accounts by faxing physical paperwork, and then Betterment launches and allowed prospects to e-sign the account opening, transfer funds, and fully invest the account in about half an hour from a smartphone!
Secondly, robo advisors make it much easier to manage model portfolios — with the caveat that from the portfolio management end they are really not much more than the model management tools we have today, which in the industry we call rebalancing software.
The key point is simply that the value of robo technology is operational efficiency. It makes the advisor’s back office staff leaner and more efficient. It speeds up transferring and managing assets. It cuts down on paperwork errors and NIGOs. It reduces trade errors. It keeps clients from slipping off model, or the advisor forgetting to have new cash invested. But it’s not a business development tool. The business development is still up to the advisor. The robo tools are just what you use to onboard the client and invest after the business development process.
Usually, once the average broker understands this, they don’t even want a robo anymore. Some may even feel threatened.
Because when a broker-dealer announces, "Hey, brokers, we’re working on a robo advisor solution to help you," it can feel a bit like telling a factor worker, "Hey, great news! We’re working on new automated machinery to help your job in the factory next year." Only the following year, the worker finds out they've been fired because they installed the technology that eliminated their job.
Fortunately, that's not going to come to pass, because what robo advisors do is fundamentally different than what we do as human advisors. Also, it's not like robo advisors are actually winning much business from human advisors now. Yet nonetheless, the mere announcement of a broker-dealer rolling out a robo advisor solution still stokes fear in at least some of its registered reps, and certainly makes them not want to adopt it.
That is why it’s absurd for broker-dealers to tell their reps they’re rolling out robo advisor tools. At best, it’s going to grossly underdeliver on its promise of bringing in new young clients without needing to do any work, because it’s not a marketing solution for millennials. It’s an operational solution after you market to millennials, which advisors still don’t do well in the first place. But at worst, brokers just won’t adopt the tools and technology at all because they don’t see the value of the technology and because it feels like they’re supposed to use something that threatens them.
Instead, what broker-dealers should really be doing is telling their reps they are upgrading their technology to make them more operationally efficient in the opening and managing of investment accounts. That they are providing them with better onboarding tools and better portfolio management tools. Because that’s what robo technology can deliver, and that’s the outcome that matters!