Ryan Caldbeck Ryan Caldbeck
Founder and CEO at CircleUp
Robo-advisors are here to stay. The question is, in what form?
Individual investors have flocked to robo-advisors, drawn to the low fees, market-indexed returns, automated tax loss harvesting, and ease of use they offer. The model is as effective, if not more effective, than those built by traditional private wealth management firms; all the while offered at a lower cost. So it’s not surprising to see some project the amount of assets invested through robo-platforms to grow more than ten-fold by 2020 and reach approximately $2 trillion worth of U.S. assets under management (AUM).
Clearly, robo-advisors are good for individual investors: just as online brokerages revolutionized stock trading for the masses 25 years ago, robo-advisors are doing the same for wealth management. But it’s not all rosy. Robo-advisors have a problem, and it’s a big one: the bedrock of their business, the algorithms that power users’ asset allocation, is a commodity.
As valuable as the algorithms are to individual investors who lack the time or know-how to build and constantly rebalance a complex portfolio, the underlying algorithms are easy to reproduce. What this means is that there is no core asset to differentiate (and protect) the business from competitors.
Increasingly, senior leaders at independent robo-advisors are awakening to the realization that their businesses have shallow moats. While they’re attracting thousands of customers and billions of assets, their scale isn’t protecting them from the next robo-advisor platform (or service) that emerges with its own flavor of algorithm. That’s why many of these robo-advisors have enlisted investment bankers to help them find viable exit strategies – namely to be acquired. BlackRock’s acquisition of five-year-old FutureAdvisor last summer was likely just the beginning.
I’ve even heard that one robo-advisor plans to white-label its product — which often foreshadows a rapid slide to lower margins in any industry.
Moreover, the dozens of robo-advisors competing to grow AUM are now facing pressure from brokerage houses and wealth advisory firms that are developing their own algorithms in-house. Already, Schwab has launched Schwab Intelligent Portfolios, and Vanguard has launched its Personal Advisor Services. There’s no reason not to expect eTrade, Fidelity, Ameritrade and others to follow suit. (At an analyst presentation last Summer Schwab CEO Walter Bettinger predicted that within a few years all financial services firms will offer proprietary versions of online investment advice.)
It’s a crowded and undifferentiated space—and the odds of long-term survival of independent robo-advisors look small.
Contrast that with an online investment marketplace. As I’ve said before, marketplaces are the best business model. In a marketplace, the core asset is defensible because as the business adds participants—both buyers and sellers—the value of the platform increases for all participants. An investor using a robo advisor gains no added value from more investors using that platform; in a marketplace, however, the network effect means that the addition of more buyers and sellers adds value for all participants. This network effect creates a wide competitive moat, and, consequently, a defensible business model.
As large, well-established investment firms enter the robo-advisor market, investors will be hard pressed to find compelling reasons to switch from say a Fidelity, Schwab or Vanguard to an independent platform given the algorithm (and value proposition) is essentially the same.
Short of selling themselves – or their algorithms, which is one in the same – robo-advisors have few options to create a sustainable business. One thing they can do, however, is differentiate by diversifying their product portfolios. The availability of private equity investments, real estate and debt products, for example, would make a robo-advisor unique in this crowded space.
One avenue worth exploring is partnering with online platforms that provide alternative assets as a long-term strategy. Without product differentiation, however, already low margins will continue to erode for the robo-advisors that manage to survive.