Robos Prevent Fee Compression (and don't cause it)

Until recession do us part

Before I go on, let me acknowledge as I’ve said before that roboadvisors haven’t really been tested yet. Those of us who went through 2008 appreciate this view. When the recession hits and robo clients find their portfolios crashing down by 30% and nobody to advise them to resist the urge to sell at the worst possible time, they’ll appreciate the value of human investment advice over staring at red numbers on a computer screen.

By the way, some robos aren’t straight robos anymore. We should start calling them “The Artist Formerly Known as Roboadvisor.” For a higher price, you get access to a team of CFPs available to speak once a quarter or something like that.

Right…

I have to wonder if this sounds better than it truly is. You’re telling me someone who doesn’t really have a clue who I am as an emotional being is going to render advice in 20 minutes over the phone that is going to save me and my kids from eating Alpo?

There no way to know until we go through another systematic failure of the banking system. Who’s game?

Tweet me if you’re up for going through that one more time.

Robos have yet to be tested and when the recession does come I envision consolidation. There aren’t going to be dozens of these things that survive in perpetuity –just one or two. For now, no recession in site, robos are still alive, and the industry is scapegoating them for fee compression.

Proving your value is about you, not them

Fee compression doesn’t have to become be a reality in your world. There are still shops getting their 1%.

It’s a question of value. With more options available, consumers see the differences. They aren’t necessarily throwing up their arms in resistance to paying for advice; it’s that their entire perception of the value of this advice has shifted.

It is now:

• Too expensive for clients getting marginal performance from advisors picking from a short list of ETFs and an asset allocation adjusted quarterly based upon one published by a big-name financial institution.

• Too expensive for advisors to service the millennial children of their affluent clients who haven’t a dime of their own. No fun for the advisor who has to suffer through 15 years of annual reviews until the wealth changes hands.

• Too expensive for ultra-high net worth clients to consistently neglect their estate, tax and liability planning with “comprehensive financial planning” (cliche alert) that fails to live up to its moniker for which they pay 1% fees, or more.
• Not too expensive to pay for a passive, automated solution that consumes little of their time or money but renders essentially the same results as the scenario described in bullet point #1.

The industry is going to divide

No, I don’t believe fees are going down across the board as a matter of course. But I do see the industry coming to a bifurcation where advisors will belong to one of two camps, digital advisor or private banker.

The digital advisor

You serve millennials, HENRYs, or mass affluent people. The roboplatform takes care of assets and you oversee this through platforms like Betterment for Advisors or Schwab's Institutional Intelligent Portfolios. You do this to incubate the smaller portfolios so that one day when they grow up big and strong they can join your high net worth offering.

For a flat monthly fee (plus an initial set-up charge) you:

• Offer a client-only podcast or webinar call
• Have a yearly performance review for 30 minutes
• Invite them to all client events
• Encourage them to follow you on social media
• Send them a monthly client newsletter
• Are available for phone calls or to answer emails at an additional fee which is a discount from your hourly rate
• Provide a financial plan at an additional fee which is a discount from your normal rate

This way you stay in touch just enough so that when the next recession hits, you’ll capture the clients’ respect by being their shoulder to cry on and the loyalty will build over time.

This is why roboadvisors are your best friend.

Think about what would happen if you were to sign up 20 new clients a month and oversee them with minimal effort via roboadvisor. They even take care of the tax loss harvesting for you! Not every single client is going to grow their assets, but let’s say that half of them do. You’ve essentially created a huge pipeline of high-net worth clients. This is a gift. We are talking about scaling your business on a massive level.

Don’t view the robos as your competitor – if you act strategically they are a great opportunity to free up your time to focus on prospecting or providing higher value services.

But how do you serve people who actually have money?

For high-net worth individuals, you outsource to a TAMP that charges less than 50 basis points (for example, First Ascent which charges a flat fee of $500) or roboplatform and charge planning fees on top of that. But it’s real planning that goes into depth and justifies the fee, not the pseudo planning that many advisors provide.

The private banker

Things are about to get Darwinian.

You charge 1% for services but provide truly comprehensive planning service that actually delivers sophisticated estate, tax, and liability planning. You outsource to a third-party active manager who actually outperforms.

Clients pay the higher fee but expect outperformance and that’s what they get or they leave you.

You are now more focused on sophisticated planning, the stuff having to do with people’s lives, while the technical stuff gets automated. The middle players who are unwilling to do either well are squeezed out. Fees flow to those whose performance justifies them, and players who can’t compete are eliminated.

In the meantime, here’s what’s going to happen with the rest of the industry.

What the custodians are going to do

The custodians (Fidelity, Schwab, TD Ameritrade) can’t resist the allure of earning 20+ basis points on the trillion in assets held in their custody. You mean nobody is getting rich off of $5.50 per trade?

Nein.

I used to work in the custody department of JPMorgan as my first job out of school. Custody was a commoditized business back then, so I can’t imagine what the fees are like now. Plus, the fact that the custodian can direct money to its own funds through its roboadvisor sweetens the deal. They’ll do that until everybody starts screaming about what a conflict of interest that is.

Just saying.

All of this isn’t a bad idea if the custodians are able to use these platforms as incubators for smaller clients who will eventually grow into clients of a vertically integrated business such as Schwab Managed Account Select®, much like I described in the digital advisor model.

What the independent robos are going to do

The independent robo platforms are going to align with advisors much better than the custodians. It will be too hard to compete with the penetration the custodians already have in the advisor channel. I’m originally from the greater Boston area, the birth place of Fidelity Investments, and it seems as if everyone I know either has an account with them or knows someone who works there. For the indy robos, best strategy is to partner with advisors to resist getting chewed up and spit out by their competition, the great custodians.

Other sideshows

While this transpires, watch for the following:

• Third-party investment managers will focus on serving the private bank market for the top 1%, and many will be eliminated due to underperformance.

• Companies like Amazon, Facebook, and Google will try to get into the robospace. They have way too much of a presence in our daily lives to resist. They’ll start with credit and checking and eventually move into roboadvising to reap the higher margins once they get critical mass.
• Insurance, an almost entirely paper-mongering industry, is ripe for digital transformation. This is inevitable as the investment landscape becomes increasingly digitized.

Sara’s upshot

Robos are not your enemy but an opportunity to overcome fee compression if applied strategically. Technology has arrived, whether you like it or not. Live in denial and get chewed up and spit out. Alternatively, embrace what it has to offer, learn a few new things and go deeper to provide the value that your clients will pony up the dough for.

You aren’t competing with the robos; you are competing with your own ability to provide higher value. I’ve got a podcast coming out about this topic in August; subscribe here to receive notification.

Sara Grillo, CFA, is a top financial writer with a focus on marketing and branding for investment management, financial planning, and RIA firms. Prior to launching her own firm, she was a financial advisor and worked at Lehman Brothers. Sara graduated from Harvard with a degree in English literature and has an MBA from NYU Stern in quantitative finance.

Read more articles by Sara Grillo