The fledgling robo-advice platforms in North America have a couple of strikes against them in their quest to establish sustainable businesses, according to Nicholas VanDerSchie, head of advisor solutions, North America, at Chicago-based Morningstar Inc.
The first issue facing these firms is the expense of acquiring clients, VanDerSchie told the 2015 Distinguished Advisor Conference in Puerto Vallarta on Wednesday.
The average cost incurred by a U.S. robo-advisor to acquire a client is roughly US$350, VanDerSchie said, which covers such items as digital advertising and mass mail notifications. Given that the average fee in the robo space is about 25 basis points, and the average account balance is US$35,000, “it basically takes them four years to just recoup their acquisition costs, and we’re not even talking about additional operational overhead expenses on top of that.”
The second issue facing robos — especially in Canada — is the size of the marketplace and the number of traditional advisors who are available to serve it. In Canada, VanDerSchie said, industry data on the growth of household wealth and on number of advisors in the marketplace shows that there is not a large market that is currently underserved by traditional advisors. This suggests that it will be difficult for robos to carve out a profitable niche here.
Canadian robo-advisors “are going to struggle given the fact that the advisor population from a supply perspective is very much aligned with the demands of the marketplace,” said VanDerSchie.
However, the situation in the U.S. is a bit more positive for robo-advisors. There is a larger share of the market that is now underserved, which could spell opportunity for digital advice platforms. Much of the underserved market is composed of millenials, VanDerSchie said, because advisors tend to focus on older, more profitable clients.
He suggested that robo-advisor’s success in capturing assets has benefited greatly from the bull market of the past few years. “But [robo-advisors] are going to need scale up at a much higher rates in order to continue to remain profitable.”
He added: “I think you will see a lot of these folks dipping out of the market when the next long-term bear market occurs. I also believe that we’re going to see a lot of industry consolidation over time.”
He also noted that fees charged to clients by Canadian robo-advisors — which have collectively gathered about $300 million in asset under management — are a shade higher than those charged by their U.S. counterparts and minimum investments required by Canadian firms are also a little higher.
“Given the uphill battle [Canadian robo-advisors] have, I think both their minimum investment and their [fees] will have to come down,” VanDerSchie said.
One development that could bode well for digital advisors is the recent appearance in the U.S. market of robo-advisors that augment the digital experience with a flesh-and-blood advisor. Firms following this business model assign an advisory team to each client with assets greater than a specific benchmark.
In this relationship, the client does not meet face to face with the advisor, but has the opportunity to call in to a call centre and talk to an advisor about basic financial planning needs.
What is particularly interesting about this business model is that firms are able to command average account balances that are 10 times greater than what the regular robo- advisor holds, said VanDerSchie: “This speaks to how powerful the digital solution can be in conjunction with a human solution.”