The financial services industry is undergoing rapid technological change. Who will the winners and the losers be, 10 years from now? The winners probably exist today, but may not be the obvious candidates. Rather than focusing on specific companies, it can be helpful to consider the fundamental forces at work, their impact on the ecosystem, and what they mean for fund managers.
What are the forces at work?
The macro trends are well known: faster than average growth of emerging markets, shift from accumulation to decumulation in many geographies, growing share of passive investments … In this short review, we focus on the impact of digital technologies.
1. Pressure on margins
While most people focus on the tremendous profitability of Google and Facebook, the reality is that technology usually squeezes margins, due to more intense competition, escalating customer acquisition costs, and lower marginal operating costs of new entrants. A recent McKinsey estimate found that digital technology shrinks EBIT growth by 1 percent a year across industries.
2. After the disruption, consolidation
Consolidation is a consequence of margin squeeze. While today’s leaders may not be tomorrow’s, ultimately customer acquisition costs escalate to a point where only a few dominant marketplaces control critical choke points in the value chain.
While distributed ledger technologies (blockchain) offer the promise of decentralized platforms, it is likely that a few players will capture the bulk of the financial value (today, those are the large exchanges and miners like Coinbase).
3. Self-directed clients
Not all clients are likely to be fully self-directed, but most clients are going to become more self-directed, thanks to easier access to information and due to the decreasing profitability of non-HNWI clients.
Product curation by informed advisors will not die, but it is increasingly a niche proposition. In e-commerce, the retailer with the largest assortment usually wins (Amazon, Taobao, Lazada). In the wealth management industry, investors are less and less convinced by the value-added of advisors, in a world where ETFs and online trading platforms are easily and cheaply accessible.
4. Online acquisition of end customers
Most consumers engage in online research prior to buying financial services. In the case of credit cards, personal loans and mortgages, these online searches often lead directly to product purchases.
One US robo-advisor is currently spending $2000+ to acquire each active user. This value is captured today by Google and other ad platforms, whereas it will take 10 years for the robo-advisor to break-even on that customer.
These economics explain why Google and Facebook continue to focus on ad revenue (pay for click) as opposed to trying to become e-commerce leaders, travel agencies, or financial services providers (except for payments, that grease the wheels of the core ad business). In fact, Amazon, with a commission-based model, is more likely to become a provider of financial products.
5. Continued regulatory fragmentation of digital financial services
Regulators are the main ally of established financial players. While regulators are working on regional fund passports and open APIs to enhance competition, they are also heavily driven by the imperative to promote a safe wealth management ecosystem for consumers. Regulatory fragmentation is likely to continue when it comes to online customer account opening standards or distributed ledger technologies (blockchain).
6. Rapid test and learn
Digital technologies allow tech-savvy industry players to rapidly test new products, fail, and try again. While some players will take 3 months to test a new idea, others will take 6, 12, or 24 months. In a digital world, the slowest players will consistently fail.
What does it mean for the wealth and asset management ecosystem?
Digital ad platforms, social networks and financial “app stores” are poised to become a major channel for end-customer acquisition. Across industries, digital ad spend represents 38% of total spend globally, overtaking TV, the majority through mobile devices.
Ad platforms will favor the biggest brands, who are able to generate higher conversion rates, and have the financial means to invest in customer-friendly, seamless interfaces with many payment integrations.
Traditional intermediaries: slow AuM shifts, but rapid operational transformation
Existing wealth management models will not disappear overnight. At the top end of the market, financial advisors and relationship managers provide several unique services such as integrated asset/liability management, access to illiquid opportunities and mediation of family relations. At the bottom and middle end of the individual market, shifts in distribution channels tend to take a long time. Besides, in many countries, individual savings will remain partly captive due to national pension ecosystems and tax incentive schemes.
Consider direct car insurance, a commodity service that was introduced more than 20 years ago. It represents around 20% of premiums in the most advanced markets and only 5-10% in others. The main barrier to greater penetration is the high customer acquisition cost and low profitability of a significant percentage of users.
In Greater China, the world’s most digitally advanced wealth management market, Alibaba and Lufax represent around 20% of total mainland AuM (or 10% including Hong Kong).
However, financial institutions should not feel safe. Margin squeeze is likely to occur much faster than currently anticipated. Wealth managers will experience tremendous pressure as they have to pay more for new customers, and their revenue structure becomes more transparent and harder to justify. This trend will severely impact the profit pools available to the entire wealth and asset management industry, especially in Asia.
Margin pressure will drive intense cost reduction efforts by all market players. Straight-through-processing of transactions will become the norm. Fund managers will be forced to connect to APIs, through which distributors and customers are able to transact. Most of the protocols underlying these APIs will be defined by a few large fund distributors or aggregators. A few of these protocols, but not all, will rely on distributed ledger technologies (blockchain).
A growing number of self-directed customers will turn to electronic wealth management supermarkets, where they will be able to easily access the world’s investment opportunities at low cost. A lot of these investment flows are likely to be skewed towards ETFs and big-name brands.
In Mainland China, Alipay and Lufax are examples of this new type of providers. They may offer their own funds but will also operate an open architecture to host hundreds or thousands of third party investment options.
In the UK, there is a growing number of fund supermarkets competing in the direct-to-consumer market: Hargreaves Lansdown, TD Direct Investing, Fidelity Personal Investor, Aviva Consumer Platform, to name a few.
In the US, individual investors can trade stocks and mutual funds via online brokerage accounts at Interactive Brokers or Merrill Edge.
Admittedly, fund supermarkets have not yet attracted massive adoption outside of China. Growth will take time, and massive investments are needed to overcome market inertia. Depending on the geography, tech companies, social networks and/or wealth managers may achieve leading market positions.
One interesting characteristic of these digital fund supermarkets is that, although they are B2C players, they may prefer to aggregate client orders and perform a single fund purchase or redemption at the end of the day. Hence, the fund manager is dealing with a single institutional client (albeit one that exhibits volatile behavior and herd mentality).
The primary function of robo-advisors is to allow individual investors to determine their risk profile and automatically and cheaply allocate their holdings across 10 to 20 funds, typically passive index funds.
Robo-advisors are experiencing rapid growth, however they are not likely to become a dominant model for 2 reasons:
• Not all individuals have the psychological inclination and financial literacy to invest the majority of their savings into a robo-advisor model.
• Robo-advisors are by definition low-cost players, so they lack the marketing and sales firepower to rapidly convert large numbers of customers.
The largest robo-advisors could theoretically diversify into fund supermarkets. However, this shift would not be easy given that they communicate heavily to highlight the drawbacks of active investing.
Fund aggregators / Fund platforms
Fund aggregators are B2B platforms that connect a large number of fund managers to each wealth managers. Examples include iFast (based in Singapore) and Allfunds (based in Spain, owned by Singapore’s GIC and Hellman & Friedman).
Fund aggregators are poised to occupy an ever-growing place in the retail asset management industry.
By connecting its back-end to that of a single fund aggregator, a wealth manager or fund supermarket can instantly offer thousands of funds to its end customers. This allows wealth managers to focus on customer acquisition, customer experience, and cross-selling.
For many fund managers, especially those not in the global or local top 10, fund aggregators are likely to become the primary channel to access the non-HNWI market.
What should fund managers do now?
1. Re-engineer processes
Cost reduction is the clearest short-term imperative for fund managers. It is a mandatory response to continued pressure on margins, and will create much-needed financial room to invest in technology upgrades.
2. Intensify sales efforts
Traditional fund distribution channels continue to drive most of the flows, and they remain relevant for the time being.
Given ever growing competition, fund managers should continue to drive their sales efforts as hard as possible. In Asia, state-sponsored institutions and family offices continue to grow in importance, and should be targeted persistently.
3. Experiment with digital connectivity
Fund aggregators, fund supermarkets and other digital platforms will require fund managers to offer straight-through-processing of purchases and redemptions, and easy access to performance data.
The jury is still out as to who will be the winning players in each geography. Nevertheless, fund managers should start working with existing platforms, to familiarize themselves with the technical and operational requirements of this expanding universe.
4. Consider white labelling
While white-labelling is not a new idea, the demand for white-labelled funds is likely to grow as traditional wealth managers and new entrants struggle to differentiate in an open-architecture world.
For the fund manager, the main upside is in increased AuM, as white-labelled products typically occupy prominent positions on the distributor’s web page or mobile screen. Another benefit is the opportunity to learn from the fund distributor, by working closely with its product and marketing teams.
5. Differentiate product design and packaging
Increasingly, consumers will make product purchase decisions based on a small number of product characteristics such as:
• Investment theme / index
• Recent historical or short-term expected returns
• Minimum investment amount
This trend is emphasized by the limited amount of information displayed on a mobile device.
Fund managers need to work closely with their marketing teams in order to stay on top of market trends and determine how their offering will differentiate along these few important product characteristics.
6. Start brand building
Should all fund managers invest in building brand awareness among end customers? Can they?
Nevertheless, direct-to-consumer marketing is likely to become more important in the future.
The recent development of cryptocurrencies is interesting in this respect, since it has happened mostly outside traditional marketing channels. Instead, individual investors have been looking at a small number of well-regarded developers and key opinion leaders in order to navigate market developments.
Fund managers who operate in the retail market may ask their marketing teams to start looking beyond the traditional conferences and investment magazines, and engage with selected wealth management influencers who have substantial following on Twitter and other social media platforms.