Imitation is the sincerest form of flattery, but robo-advisor firms like Wealthfront and Betterment might not feel so flattered.
According to new research from global analytics firm Cerulli Associates, the entrance of Charles Schwab and Vanguard into the robo space will make it difficult for existing robo firms to compete.
“For [robo-advisors], imitation is a serious threat to their continued existence. These firms have rolled out innovative ideas, but the existing financial services industry has ample resources available to replicate the robo-advisor business model,” said Frederick Pickering, research analyst at Cerulli, in a statement. “Previously, many robo-advisors banked on the idea that financial firms were unwilling to duplicate their model for fear of upending their revenue. Wealth management firms responded to the innovator’s dilemma by building their own eRIA-inspired services.”
Not only are the business models of robo-advisors, which Cerulli refers to as “eRIAs” in its research, relatively easy to duplicate, but firms like Schwab and Vanguard have the resources to offer more services at a lower cost.
“Firms such as Vanguard, Charles Schwab and Fidelity possess the resources and talent available to create tax-efficient ETF portfolios, but more importantly, they are able to gather the fee on the underlying ETF,” according to the report. “This helps these firms scale the automated investment model and lower the cost of service to the end client.”
Schwab is replicating the Wealthfront and Betterment model by rolling out low-cost exchange-traded fund portfolios, called Schwab Intelligent Portfolios. (It took hits from Wealthfront and fellow robo-advisors when it launched.)
SIP charges no advisory fees, but clients pay the underlying expenses of the ETFs and are required to hold a percentage of assets in cash.
“The firms that will be successful in this landscape will be those large enough to realize the economies of scale necessary to turn a 25-basis-point fee into a profitable business model,” according to Cerulli. (Wealthfront charges 25 basis points a year on assets over $10,000.)
Before Schwab made its announcement, Vanguard had already announced its robo-style platform, Vanguard Personal Advisor Services, which quickly grew to $4.2 billion in assets as of the third quarter of 2014 from $755 million at the end of 2013.
Vanguard will offer this program for 30 basis points and allow clients to talk with their advisor via Apple’s FaceTime video platform.
“This feature is a major competitive advantage compared with the online-only model in which investors can save five basis points, but at the cost of being able to talk to a human,” the Cerulli report says. The report also points out an obstacle for robo-advisors that use Vanguard ETFs in their portfolios.
“Many eRIA firms find themselves in a tight spot; they often use low-cost Vanguard ETFs to construct their portfolios and will now have to explain how their service is superior to Vanguard’s,” according to Cerulli.
Cerulli’s research suggests that robo-advisors, like Wealthfront and Betterment, will need to adapt and change their business models to remain competitive.
“With increased fee compression and expanded services from the direct space,” Cerulli says, “eRIAs may be forced to change their business models to become technology providers to advisors.”
While many of the eRIAs pitch themselves as a “revolutionary Web-based advisory model,” Cerulli notes that their model may not be that revolutionary.
For example, Wealthfront established relationships with Google and the San Francisco 49ers, which helped its average account size grow to approximately $80,000. As Cerulli notes, this is higher than its main rival, Betterment, whose average account size is close to $17,700. And, to make sure the model is scalable, key account managers need to manage the relationship between the robo-advisor and its business-to-business clients.
“By partnering with businesses, eRIAs are not a radical departure from the existing financial advisory model,” according to Cerulli.
There are some robo firms that already have unique business models that don’t pose a threat to the existing advice model. Cerulli points to firms such as Covestor or Motif Investing.
“Covestor essentially acts as a model separate account supermarket, in which asset managers submit their models to Covestor and the firm executes the models on behalf of the client,” the report states. “While they do offer portfolios based upon different risk profiles, they are primarily a supermarket. Such firms can present an opportunity for asset managers that offer model distribution.”
Meanwhile, Motif lets clients create their own investment ideas or “motifs.” Motif does not offer advice, but the firm is attempting to create a community of users who present their investment ideas for implementation by Motif.
“[T]his model does not compete with wealth managers because active do-it-yourself investors dominate the client base,” Cerulli states.
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