This article first appeared in Private Banker International, March 2021 edition
The pace of digitalization is accelerating in wealth management, which puts private banks and other investment managers under pressure to speed up their technology investments.
However, the goal of these investments should be to create optionality – to allow your business to respond to changing needs – rather than to invest in new technology per se. But a lot of times, technology drives business decisions, not vice versa. This must change if firms are to realize the promises, and avoid the pitfalls, of the digital transition.
The speed of digitization is accelerating. In many financial markets this is happening because of regulation, such as open banking, which is facilitating data sharing across the financial services ecosystem.
In wealth management, however, digitization is speeding up because of other factors, especially demographic trends. For example, according to Wealth-X, over $15 trillion of wealth will be passed down from Baby Boomers to their children and grandchildren by 2030 (with PwC estimating that $1 trillion will be passed down in the Middle East alone). These younger generations have markedly different preferences in terms of investment choices (such as a preference for sustainable investments), investment styles (opting to be more actively involved in investment decisions), as well as servicing, preferring mobile apps over branches.
Consequently, changing demographics create demand for new services and, in doing so, generate openings for new entrants. The strategic consultancy, aperture, estimates within their recent Digital Age Wealth Management Report, that there have been over 400 new technology-driven wealth management firms (WealthTechs) launched since 2016, many in particular focused within the areas of robo-advisory and digital brokerage. These new entrants aim to cater for these changing client preferences which are producing significant churn – according to EY, 23% of clients in the Middle East are likely to switch wealth management providers within the next three years.
Digitalization is about new business models, not new technology
The challenge we see indicated that a lot of firms, WealthTechs included, are putting the cart before the horse. By that we mean that they start by thinking about how technology can be used to create a new client proposition, without starting with client needs or, even better, business model requirements.
There is enormous potential for technology to transform the wealth management industry, but it’s unlikely to materialize without business model change.
Technology is an enabler. Deploying systems in the cloud can theoretically lower the cost of wealth management. Capitalizing on machine learning should allow for better portfolio selection and optimization.
But technology alone doesn’t change industries. It wasn’t the smartphone that changed the taxi industry or the internet that changed the music industry, but business model changes based on these new technologies, such as allowing people to stream all the music they want for a flat fee.
So, in wealth management, it won’t be any single technology that changes the industry, but new business models. Therefore, incumbents and new entrants should look at how they change distribution, sourcing and operating models to deliver something that can transform client experiences and then invest in the technologies to make that happen.
It must be noted though that financial institutions may not buy a platform for a single specific use case. Their needs will evolve over time, adding new use cases based on client demands, perhaps building up from a simple digital offering. And changing market conditions may demand that product and service offerings are adapted, for instance according to the stock market cycle. For example, extending services to enlarge their revenue pools such as a Lombard loan facility.
Adapting to compulsory regulatory changes can also significantly affect what can be offered, for example there may be a need to change the client journey as a result of consumer protection clauses. Add to this the need to adapt to changing client demands and new opportunities which make new products attractive in the market eg. new tax regime allows tax savings with special products like life insurance policies, and the need for a flexible platform is more than evident – it’s essential.
Of the 400 plus new WealthTech entrants into the wealth management market that aperture’s report highlighted, very few have enjoyed any mass adoption, but there have been a few exceptions. Those exceptions, including eToro or Vanguard, have introduced new business models. In the case of eToro, it turned its registered users into co-creators, allowing them to copy each other’s portfolios and exchange ideas, while Vanguard started selling its asset management services directly to the consumer, significantly reducing the fees. Both business models were enabled internet technologies, but neither came about just because of technology investment.
Taking a unit cost approach to wealth management
One approach to test the soundness of your existing or new business model is to look at it through the lens of unit economics. Very few incumbents do this because they continue to think in terms of overall profitability or cost/income. A lot of new entrants, buttressed by venture capitalize (VC) money, tend to think that unit economics will turn around once a critical mass of clients is achieved. But both would do well to focus more closely on unit costs.
Take self-service robo-advisors, for instance. Notwithstanding the draw of a simple, low fee service, there is still a significant cost of client acquisition in reaching attention-poor consumers and getting them to invest for the first time (or change their investment behavior). The cost of client acquisition through robo-advisory channels is significantly lower than for a traditional investment manager. Historically, traditional personal advice client acquisition costs can often amount to $10,000 per client within private banking, but through self-service robo-advice this cost is typically around $600. However, of course the amounts invested are usually significantly lower.
Therefore, the lifetime value of the client is also much lower than for a typical investment manager. Furthermore, while there is little formal data available on this yet, we would estimate that there is significant churn for two reasons. The first is that the service is commoditized, meaning that the client will easily switch for a lower price. The second is that, as the client’s wealth grows, they are likely to want a more personalized experience from an institution in which they place more trust. So robo-advisors suffer simultaneously from high cost of client acquisition, low lifetime value and high churn. Therefore, most continue to be loss-making.
But at the other end of the spectrum, the highly tailored net worth individual market, the unit economics problem persists. The cost of client acquisition is even higher because this demographic is harder to reach and harder to persuade. While the lifetime value is dramatically higher than in the mass affluent market, so too is the cost to serve given the high level of personal touch. Moreover, the risk of churn is not insignificant – especially as demographic changes kick in, such as the aforementioned intergenerational wealth transfer or the growing importance of women investors, who also have noticeably different preferences and display a higher propensity to change providers.
Optionality is the name of the game
Bringing this all together, the solution lies not only in carefully considering your business model but in retaining the flexibility to vary the approach according to different demographics – and as those demographics change.
The weakness of so many models is that they are rigid. Many traditional wealth managers are seeing the possibility of digitalization as offering the same services, and just opening them up to digital channels. This will not suffice as younger demographics become more important. It fails to grasp the potential to change sourcing models to distribute a wider range of services quicker than before to meet different and changing client needs. But it also fails to offer up the level of digital engagement that clients expect. Our recent study with Hubbis which looked at client preferences in the Middle East found that 67% of wealth management clients want digital investment offerings that are out of the reach of many incumbent organizations, such as access to sophisticated trading and simulations.
But newer WealthTech vendors are also falling short. In the same additiv/Hubbis study, only 15% of respondents favored discretionary portfolios, with most (73%) favoring advisory mandates and a minority (12%) wanting execution-only.
Hybrid distribution with aggregation
For the foreseeable future, the smartest distribution model remains hybrid wealth management, which we define as a mix of self-service and advisor-assisted channels. If you’re currently serving the mass affluent with a self-service only model, you face a risk of attrition as your clients’ wealth grows and they want more assistance. If you’re only offering advisor-led channels, then you face attrition as younger clients become more important.
It is also prudent to start to offer more service aggregation. The most important characteristic of the digital age is that supply becomes more abundant, while demand becomes more constrained. Once your business has invested in acquiring your clients, the best way to raise lifetime value and lower churn is to use the pull of that client base to aggregate the third-party services – banking and non-banking (often through partners) – that this client base would want to access. Not only will you save your clients time and increase your value add, but you also trigger the network effects that make your service increasingly valuable over time.
In future, everything may change, which is why optionality remains so key. As my colleague Eric Andersson writes in this same edition when he reviews ‘7 use cases for wealth management as a service’, wealth management, like other banking services, is likely to become more embedded in other services over time. This again calls for wealth managers to consider the viability of their existing business models. However, a significant change may not always be required, it may be enough for a bank to just extend their offering to other products and instruments to meet the needs of their clients in different stock market cycles. For example, a new live insurance product, a special tax saving product, a theme product, a new currency product etc. And this also calls again for optionality, to respond to change as it happens. This should caution firms against technology investment for technology’s sake.
The best thing to do is to ensure technology can enable new business models – in this case, by separating client channels from the engagement and intelligence that underpin great experiences, so these experiences can be delivered across any channel, bank proprietary or third party.
Digitisation is accelerating. There is pressure to act, to initiate technology innovation. But no industry was ever transformed by technology alone. It took business model innovation, enabled by technology. Wealth management is no different. The best technology choice, then, is to build the optionality to adapt business models, now and in the future.