When the “tipping point” for robo-advisors hits the market, it won’t be with a loud crash, but more likely with a quiet thud, where big firms acquire smaller robo-tech startups and consolidate the high-cost, low-margin business. So predicts John Ndege, CEO of Pocket Risk, which provides risk tolerance questionnaires for financial advisors. But don’t expect this technology to go away, he said, as it will continued to be used by big firms to augment client business.
Robo-advisors still are in a hot market with the likes of JPMorgan, Goldman Sachs and BlackRock either buying or building the technology, but the growth of these products’ assets under management has leveled off dramatically, said Ndege. In fact, according to a 2016 report by Michael Kitces, growth rates of AUM, which were estimated to be around $20 billion at purely digital robo-advisors, have fallen to just one-third of what they were a year prior. And as the report states, this drop happened “in a bull market,” and at big firms, such as Betterment.
Ndege believes a tipping point for robo-advisor growth will be reached in a couple of years. That’s about the time robo-advisor firms will run out of venture capital and their valuations will fall. Another potential problem is if there is a 20% market drop — how will robo-advisors perform in those markets?
Yet the main challenge is not the robo-technology, which Ndege believes is “great for consumers; it makes the process of deciding how to allocate their investments a lot easier,” but how to leverage a business with low margins, a lot of competition and the need for large amounts of capital to get started. “Robo-advisors may be good for consumers, but for shareholders of robo-advisor businesses, it’s a challenging position to be in,” he said.
Math Doesn’t Add Up
Client acquisition always has been the largest expense and most difficult aspect of financial advisory, Ndege said. In fact, the Kitces.com paper showed that gross revenue on a single client might be $50 a year for robo-advisors. Even over a lifetime, this is less than the cost of client acquisition, which a Morningstar study estimated to be as high as $1,000 per client. As the report says, “Robo-advisors appear to be spending more to get clients than they can ever earn by serving them.”
Further, the Kitces.com report notes, “Like bringing a knife to a gun fight, the robo-advisors brought an operational cost efficiency solution to what is fundamentally a marketing and client acquisition cost problem. Robo-advisor fintech is failing because they tried to solve the wrong cost problem.”
Ndege concurs. “Acquiring customers has always been a challenge in the financial services industry because you’re handing over money, and that takes trust, and trust takes time to build,” he said. Further, robo-advisors don’t replicate what financial planners do, such as designing comprehensive plans, discussing insurance needs or doing tax or estate planning. “It’s comparing apples to oranges.”