Fractional stock ownership and robo-advice 3.0
Fractional stock ownership and robo-advice 3.0
I believe that we are on the verge of an entirely new generation of wealth management solutions, that build on the shoulders of robo-advice, but they won't come without risk.
The robo-advice 'movement' set out to democratise the old world of traditional wealth management - and they've achieved this through providing simple and cost-effective wealth-building solutions to a large population, that was previously unserviced (or under-serviced) by traditional wealth management firms. The experience is entirely digital and frictionless for investors and more compellingly, it's transparent and engaging.
Having said all this, the big question for me is: Is robo-advice experiencing a race to the bottom?
My first concern is around differentiation. Robo-advice is first and foremost about low cost, which is why providers have gravitated towards using low-cost ETFs as the building blocks for portfolios. But how many 'Modern Portfolio Theory' ETF portfolios can be constructed... and if all portfolios are equal (ie. use the same or similar methodologies and so have the same or similar performance) - can you differentiate on the user experience alone?
My second concern is around the future of the revenue model. Don't get me wrong - I'm a huge robo-advice fan and think there is a need for this kind of service, but I think the space will become crowded. It's reasonable to assume that a number of traditional wealth managers (particularly bank-owned wealth managers) will launch some flavour of robo-advice within the next three years.
I would go even further and say that bank-owned wealth managers will have to offer these services at low or even no cost - in order to win wallet-share, while seeking to make the client relationship profitable through other elements of the relationship (eg. transaction accounts, mortgages and credit cards). And although it's highly likely that the majority of these will be white-labels or partnerships with incumbent robo-advisers; it still takes a another client off the street and that impacts revenue.
Schwab's entry into the space recognises (and even propagates) the race to the bottom - by offering robo-advice portfolios for free! Unlike Betterment and Wealthfront, Schwab make their money through the underlying ETFs, which they own and use to build their portfolios.
I personally think we will see more ETF product manufacturers come upstream and either offer vertically integrated propositions like Schwab or Vanguard, or partner with traditional wealth managers (and banks) to bundle services.
If you accept my observations as probable scenarios, then what does the future landscape for robo-advice look like?
The future of robo-advice
The reality is the landscape is already evolving. Swanest for example, offer a kind of hybrid between robo-advice and self-directed investing. They do this by providing a model portfolio (similar to Betterment or Wealthfront), while also allowing clients to incorporate individual stocks (or sectors/themes). They then use their own proprietary algorithm - a kind of 'efficient frontier analysis' - to determine the optimal allocation of these additional holdings into the model. And we're seeing a number of providers entering the thematic investing space: Motif for example are making some great ground here, as are the team at Macrovue. Each of these take the core robo-advice proposition (low-cost, algorithmically-generated model portfolios and digital distribution) and incorporate their own spin on it.
I like to think of the pioneers in the robo-advice space as version 1.0 players and these variations on the core proposition as version 2.0. And while these variants are all healthy and progress the core robo- advice proposition, I believe there is another, less talked-about attribute of robo-advice, that could be the basis for robo-advice 3.0: fractional stock ownership.
Fractional stock ownership
Fractional stock ownership is an approach used by most robo-advisers to enable them to build heavily diversified portfolios from very low investment amounts (it effectually allows multiple investors to own a 'fraction' of the same stock). Previously investors had no option but to own a whole unit of stock, which meant they needed some serious dollars to build a reasonably diversified portfolio.
Is there an opportunity to leverage fractional stock ownership, to replicate indices more cost effectively than owning the ETF and paying MER?
Better still, could fractional stock ownership remove the dependency on ETFs altogether and enable robo-advisers to create more alpha-generating portfolios, for a fraction of the cost of traditional methods? And if this is possible, does it create a launchpad for a more superior product at an even lower cost? If any of these assumptions held true, it would surely create both a source of differentiation and sustain a more compelling revenue model.
I fully expect that these kinds of products are already in development. But the key takeaway here is that robo-advice has brought affordable, transparent financial advice to a market that couldn't be reached by traditional wealth managers and in doing so, has shown us a new digital engagement model and service delivery platform that has the potential to evolve way beyond what we see today.
I personally believe we are on the cusp of a new wave of wealth management solutions for an entirely new market, that will build on the shoulders of robo-advice and drive up competition and quality. What excites me most about this, is that the winners will be the clients - the investors. More options, better options, better outcomes... and at a lower cost!
Corey Thompson is the head of banking and wealth management product at Citi
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