The Indie Robo-Advisor: A Doomed Business Model?

Bigger competitors and growth-hungry venture capitalists are bearing down, but there may be a way out, Cerulli says

Pivoting to a B-to-B model may be robos' only hope, Cerulli says. Pivoting to a B-to-B model may be robos' only hope, Cerulli says.

In the changing world of financial advisory services, it’s not just the traditional advisors who have to adjust but also the robo-advisors that have been leading the disruption.

According to the latest Cerulli Edge report, software-only eRIAs – electronic registered investment advisors, Cerulli’s term for robo-advisors — are operating in a business threatened with commoditization, which will depress fees that are already under pressure from the entrée of Schwab and Vanguard, soon to be joined by BlackRock (BLK). (BlackRock’s acquisition of FutureAdvisor, a robo-advisor, is expected to close in the fourth quarter.)

"eRIAs will need to grow approximately 50%-60% per year for the next six years and gather approximately $35 billion in AUM to remain a standalone direct channel for consumer business," says Federick Pickering, research analyst at Cerulli.

“Ultimately the eRIA services need to prove themselves as a business model and not a technology offering,” the Cerulli report states. The business, which is expected to more than triple in size this year, is under pressure on many fronts, according to Cerulli:

  • Robo-advisors lack an economic “moat,” or barrier to competition
  • They are unable to charge higher premiums in an increasingly competitive market where major institutions have started their own robo-advisory service or and big independent robo-advisors like Betterment and Wealthfront are cutting fees or minimums, or both
  • They don’t have the deep pockets needed for massive marketing campaigns
  • Their venture capitalists, which initially financed their operations, want to see high double-digit growth, which will become increasingly difficult as assets grow and especially difficult if markets weaken

Given all these pressures, Cerulli suggests that robo-advisors consider “pivoting to a business-to-business model.” 

Betterment, for example, has been moving in that direction with its partnership with Fidelity Institutional Wealth and its recent announcement of a 401(k) offering, Betterment for Business, beginning next year.

Cerulli suggests that eRIAs partner with banks, especially smaller regional banks; smaller RIA firms; and independent broker-dealers who haven’t built their own robo-advisory service, becoming a third-party vendor (TPV).

“The traditional retail bank and RIA channel are a natural fit for many of the eRIAs,” according to the report, which notes that Bank of America (BAC) and Ameritrade (AMTD) already have such offerings.

Such collaborations will allow eRIAs “to engage with established distribution channel, lower their distributions costs and attain the aggressive growth rates necessary to meet the projected expectations of the venture capital partners,” according to the report.

“Banks already have a roster of existing clients,” say Pickering, and they are looking to expand their services to include more financial advisory services. “The last time I went to my bank they asked if I want a financial checkup,” Pickering added.

And small RIA firms and independent broker-dealers “more and more want to build relationships with their clients’ children,” says Pickering. “This is an area, if you can scale your platform to take on new clients, that would enable advisory practices to service a larger number of lower net worth clients.”

In the meantime it’s important to remember that digital advisors — whether they’re independent or part of large financial institutions like Vanguard or Schwab (SCHW) — are still a fraction of the broader $19 trillion wealth advisory market. Total digital advisory assets are expected to reach $54 billion this year – more than three times the sum at the end of 2014 — but independent robo-advisors are projected to be a little more than one-fifth of that market, at $12 billion, according to Aite Group, a research and consulting firm focused on wealth management.

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