As robo-advisors take over, how do the incumbents respond?

Yesterday I said something better change, and it is.

This blog has covered extensively how things are changing in payments, retail and commercial banking, but I haven’t covered investment banking or asset management as much.

So here's an insight sourced from yesterday's Financial Times.  According to a poll of 400 senior executives by State Street, the custodian bank, four-fifths of senior asset management staff expect the fund market to be disrupted by an outside participant in the same way Apple upended the music industry with the introduction of iTunes.  79% fear they will face direct competition from a non-traditional entrant to asset management.

No wonder as Alibaba and Tencent are distributing asset management products in China, and have launched banks MyBank and WeBank respectively.  Alibaba, China’s leading ecommerce company, started distributing a money-market fund, Yu’E Bao, last year and raised $65 billion within its first 12 months to $93 billion in less than two years. Cash transfers from bank accounts to Yu’E Bao take just one click.

Meanwhile Google commissioned research last year on how it could enter the asset management industry, as has Facebook.

Some great insights on this market:

“Google and Amazon entering the market is a real possibility. The trouble is, we as an industry always seem to be behind the curve on these things, but it is good that people are worried, as it will sharpen up our act.”  Helena Morrissey, Chief Executive of Newton Investment Management

“I am the CEO and am paid to be paranoid, and I am paranoid about this. The big danger for companies like ours is we become complacent and believe our business is safe forever. It’s not.  Having said that, it costs us £500 million a year to run our business and that is a big commitment, even for Google. I do not see them manufacturing funds but I can see them coming in and distributing funds.”  Martin Gilbert, Chief Executive and Co-Founder of Aberdeen Asset Management

“The next generation of investors will be totally different to the ones we have now. It is not the behaviour of Google we need to worry about but the behaviour of our clients.”  Alexander Schindler, Member of the Executive Board at Union Asset Management and President of the European Fund and Asset Management Association

I did note a while ago that the investment management industry is broken, and now see more and more proof that this industry is more challenged perhaps than the retail and commercial banking markets. 

Maybe this is why we are seeing the rise of Betterment, Wealthfront, Motif Investing, FutureAdvisor, Personal Capital, Hedgeable (USA); Nutmeg, Wealth Horizon, Rockfox, Swanest (UK); MoneyFarm (Italy); Vaamo, OwlHub (Germany); Moneyvane.com (Switzerland); InvestYourWay (Europe) …

… but don’t assume that these robo-advisors will wipe out the traditional industry that fast.  For example, by the end of 2014, the US asset management start-ups had raised just over $420 million in funding (Wealthfront had raised $130 million, Motif Investing $126 million, Personal Capital $104 million, Betterment $45 million and FutureAdvisor $22 million).

The two industry giants are Blackrock and Charles Schwab.  BlackRock spends $400 million a year, or 4% of its net revenues, just on marketing.  Charles Schwab spends $300 million a year, just 5 percent of its net revenue.   Both are doing well, and growing.

Techcrunch notes: “Wealthfront has now passed the $1.5 billion assets under management milestone. They point out that it took them just two-and-half years to get to $1 billion of assets but it took Schwab six years. $1.5 billion may be chump change compared to the $2 trillion that Schwab manages today, but the threat has been noted.”

So when I ask how will the incumbents respond? perhaps the best example is what Charles Schwab and others are now doing: offering asset management for free.  You pay nothing for the robo-advisor but make money through cross-pollinating the portfolio with other services, generating advertorial income and more.  It's a different game but if you're not playing it, you're not in the game.