Thursday, 11 August 2016

The unstoppable rise of robo-advisors

The Financial Times estimates that the market for funds advised by hybrid robo-human services will grow to $16.3 trillion worldwide in the next nine years. According to Swiss financial research company, Myprivatebanking.com, pure robo-advice has jumped from $19 billion in 2015 to $43 billion in 2016. The rise of the robo-advisor appears to be unstoppable and is key to the opening up of wealth management to the mass market. There are a number of reasons why this is happening and why now.
·         Low interest rates
With interest rates at record lows, virtually zero or negative in many parts of the world, savers are looking for places where they can get a return on their money as an alternative to putting it under their mattresses and seeing rising inflation eat away at the value of it faster than the moths.
With cheap funding available from the central banks the high street banks, who have traditionally used savings accounts to fund their lending activities, are no longer interested in competing for consumer savings. The days when the likes of ING Direct were fighting for savings at attractive rates have gone.
·         The disappearance of affordable investment advice
Governments have introduced legislation such as the UK’s Retail Distribution Review that was designed to raise the quality of the advice that customers received from their financial advisors and to make the charges paid to advisors far clearer. This well intentioned regulation has resulted in the disappearance of affordable wealth advice for the mass market from the high street. The banks, many insurance companies and Independent Financial Advisors (IFAs) deciding that the cost involved in training the staff to meet the new standards for the significant reduction in the revenue from selling investment products (as both upfront and trailing commission, largely invisible to customers, was banned and replaced with explicit upfront fees) was simply not worth it.
·         The demise of the star active fund manager
In a rising market it is relatively easy to appear to be a successful fund manager, particularly when your low risk investment strategy is largely to shadow the indices in the markets you are focused on. Even the star performers who have been hugely successful in the past have been seen to be human – the challenges that Antony Bolton had with his Fidelity China Special Situations trust and Neil Woodford has with his Patient Capital Trust illustrate how difficult it is for active funds to consistently perform. Increasingly and particularly during periods of economic uncertainty and turbulence in the markets it has become evident that the majority of active fund managers fail to outperform passive index trackers, even more so when the charges for these funds are taken into account.
·         The emergence of Exchange Traded Funds
In 1993 the first Exchange Traded Fund was launched and there are now several thousand of them. An ETF is a marketable security that tracks an index, a commodity, bonds or a basket of securities like an index fund and because it is traded on a market is priced throughout the day unlike mutual funds. Amongst the reasons that the emergence of ETFs is influencing the rise of robo-advisors is that they generally have very low costs, they have a low entry price (buying one share is possible) and because they operate like an index it is very easy to automate the management of the fund.
All robo-advisors have been built around ETFs as the core funds in the portfolios that they recommend to their customers.
·         Increasing trust in computer generated recommendations
With consumers increasingly trusting personalised recommendations from the likes of Netflix, Spotify and Amazon there is far more acceptance that artificial intelligence can be relied upon. This is further boosted by the considerable loss of trust by consumers in the people within the Financial Services industry following scandals such as the mis-selling of Payment Protection Insurance (PPI), fixing of the LIBOR and FX markets and the 2008 market crash.
·         The low cost and availability of supercomputing and the cloud
Without the dramatic drop in the cost of supercomputing and the ability to deliver it over the cloud the sort of services that robo-advisors can offer would not be possible. The Independent Financial Advisor used to have the advantage of having information superiority and exclusive access to financial models – this has been taken away by the pervasiveness of information and the ability to deliver supercomputing to mobile devices. Algorithms that used to require a Cray to process can now be delivered via the cloud to an iPhone, tablet or android device. This allows the ordinary person through their robo-advisor to take advantage of sophisticated tools such as algorithmic trading.
·         The ability to process structured and unstructured data in real time
With high volatility in the markets and with 24x7 newsfeeds then the ability to process both structured and unstructured data, including sentiment analysis, all in real time reduces the risk involved in investing in the market. This provides the robo-advisor firms using AI to flex the recommendations and portfolios in real time.
Who are the key players?
The market was started in the US with the likes of Vanguard, Betterment www.betterment.com/, BlackRock’s FutureAdvisor www.futureadvisor.com, Charles Schwab’s Intelligent Portfolio https://intelligent.schwab.com/ and Wealthfront www.wealthfront.com/
In Europe the key players are currently MoneyFarm www.moneyfarm.com, Nutmeg www.nutmeg.com, Swanest www.swanest.com (still in Beta) and Yomoni www.yomoni.fr
With the potential size of the market it is likely that not only will the large US players bring their offerings to Europe but others from within Europe will enter the market. This will be thorough a combination of three ways:
·         Banks and asset managers building their own robo-advisors using platforms that can manage structured and unstructured data in real time such as SAP’s HANA, advanced analytics tools, AI and cognitive computing
·         Partnering with an established robo-advisor platform provider. This could either be on a white labelled basis or leveraging the robo-advisor brand. Fidelity originally did this with Betterment until it decided to build its own solution. In the USA BBVA and RBC are both partnering with Backrock’s FutureAdvisor.
·         Fintechs entering the market in a similar way to Moneyfarm or just like Solarisbank www.solarisbank.de has done for banks offer robo-advise as a service to business both within and outside financial services e.g. retailers
 
A significant threat to the relationship with mass affluent and wealth management customers
The low cost to consumers of buying a funds portfolio using robo-advisor technology is significantly increasing the market size for what has traditionally been seen as wealth management. With many banks and insurance companies abandoning the provision of financial advice to the      mass affluent it is also providing a significant opportunity for new technology enabled players to enter the market. This is a significant competitive threat to established players who persist in only using traditional channels. It also threatens the relationship banks have with mass affluent customers and risks relegating banks to simply providing low margin transactional services.
Now is the time to act.

Friday, 5 August 2016

Digital Transformation in Banking is not happening

There is a lot of talk about digital transformation by banks but the reality is that despite what they say they are not doing it. What the vast majority of banks are actually doing is digital enablement. They are simply using digital technologies to do what they are doing today only slightly better. There is nothing transformational about what they are doing.
Fundamentally the products and the services that banks are offering are no different than those they have been offering for the last fifty years, if not longer. They may be offered through different channels like the mobile, tablet and over webchat but they are still fundamentally the same as those offered to your parents when they were your age.
It is not only the big banks that are guilty of digital enablement but also the majority of the so-called challenger banks. For most of them the term ‘challenger’ is not even appropriate. What is challenging about providing free dog biscuits in branches! Their impact on the market share of the big banks is negligible and not growing at a sufficient rate to be a significant threat anywhere in the short term.
The reality is that the majority of the challenger banks are simply competitors offering a subset of the products and services that the big banks provide. However the emergence of a large number of competitors into the market is to be welcomed as the choice for individuals and small businesses as to where they get their bank services from has, and continues, to expand.
When you take the UK market as an example the competitors break down into a number of categories:
Existing Competitors
These are the likes of Co-op Bank, Nationwide Building Society, Clydesdale and Yorkshire banks who have been around for many years with a fairly consistent market share. They are all in different ways and at different speeds enabling their businesses with digital technology. Some are being more ambitious about growing market share of current accounts than others.
The Clones
These banks are the ones that have been spawned from previously existing organisations, been re-sprayed with a new or revived brand and trade on the fact that they are not one of the big four banks. The main players in this category are Santander (Abbey National), Virgin Money (Northern Rock), TSB (Lloyds Banking Group) and Halifax (Lloyds Banking Group). Of course the latter is still owned by one of the big four, but is positioned as their ‘challenger’ brand.
The Clones offerings differ from each other. Santander has expanded the range of products that Abbey National offered with a push into current accounts and SME banking. While the Santander 123 account has shown some innovation it is still fundamentally a vanilla current account. Virgin Money has expanded the Northern Rock offering into balance transfer credit cards, but despite previous announcements is holding back from entering either the current account or SME banking markets for the moment.
None of the clones are leading in their application of digital technologies and, at best, are enabling some of their processes with digital.
The New Traditionals
Into this group fall the likes of Metro Bank, Shawbrook, Aldermore, Oaknorth, Handelsbanken and OneSavings Bank. New banks that are offering an alternative to the Big 4 banks but all of which have a small market share and whilst growing quickly will take years on their current trajectory to be of serious concern to the large banks. Like The Clones they position themselves as not being one of the big four and differentiate themselves on offering superior, personalised service. They have not invested heavily in digital - Metro Bank has only just (August 2016) launched its customer website. In the cases of Metro Bank, Handelsbanken and Aldermore have made their branches and face-to-face service a key point of their differentiation.
The Mobile banks
These are the banks that are being designed with mobile in mind for the Millennials the likes of Mondo, Atom, Tandem, Starling and Monese. While a number of these have been granted their banking licences and a number are in beta testing these banks have not really been launched yet. We have some indication of how they will operate however until they move to full launch it is difficult to judge how transformational in terms of their digital offering they will be.
So if today’s banks are only undertaking digital enablement what is it that they would need to do to be undertaking digital transformation?
Re-imagining the business models for banking
Transformation is about fundamental change – something that the banking industry has not seen since the Medicis created the first bank. This is about changing the business models for banking to reflect what customers want and also how the way industries boundaries are blurring.
Banks that are truly undertaking digital transformation are reimagining the business models for banking
Customers do not want to do business with banks. Customers do not fundamentally want a mortgage they want a home. Customers do not want a loan they want a car. Banks for customers are a means to an end. Banks who get this are recognising that they need to be offering services beyond the banking product. For example some banks are forming agreements with online estate agents so that when a customer is looking at a property online the banks knows this and can tell the customer whether they can afford it and whether the bank is prepared in principle to offer them a mortgage.
Banks have lots of SME customers many who will have offers that are of interest to other SMEs or individuals. The banks know how well those SME businesses are performing so banks are in an ideal position to create a SME marketplace where their customers can do business with other bank customers knowing that the supplier is backed by the bank. Equally the supplier will know that the customer is backed by the bank. In this model the bank operates as the introducer adding value to both the business and the customer.
For those banks that have invested in building a modern banking IT infrastructure they recognise that this is a highly valuable asset and there are opportunities to offer banking as a service to either businesses outside the banking industry such as retailers who want to offer banking services to their customers or to banks in other countries. Two good examples of organisations that already do this, both German, are SolarisBank https://www.solarisbank.de/ and Wirecard www.wirecard.com
The three examples of different business models above are just illustrative of what banks and other organisations are doing to use digital as an enabler to fundamentally change the banking industry.
This is true digital transformation and for those organisations that embrace it the future is positive and full of hope; for those who don’t the future is a slow decline into obscurity.