Up with People (Revisited)

 

The Wall Street Journal recently outlined a trend of of increased funding for startups that provide "automated online financial guidance." The piece envisioned a clash of machines vs. humans, with new technology poised to revolutionize the industry. But as is usually the case (see our initial "Up with People" post from a couple of years ago), these battle lines are a bit too simple.

In truth, robo advisors aren't all that "robo." Nor is the technology particularly new. And the biggest opportunity to revolutionize the industry resides with a different group.

If you check the original research used by the WSJ, you'll see it refers to "automated and semi-automated services" (emphasis added). You'll also see that a significant fraction of the venture capital being invested is in businesses that feature human interaction in their value proposition. Meanwhile, traditional advisors are making plans to offer online guidance. So expect to see a variety of business models along a continuum, not just two polar opposites.

At that point, the difference between companies will stem more from how the different features are bundled and branded, and less from the quality of the features. Why? Because the underlying tools are software packages (risk assessment, asset allocation, etc.) that aren't being changed so much as made transparent. Consider similar instances of online disruption to travel agents, tax preparers and stock brokers -- industries where an unnecessarily complex system forced people to pay a premium for access. When someone came along and improved the interface, opened up the system and had people do their own data entry, most of that cost went away.

In other words, robo advisor startups gain market share in the short run precisely because <em>most people paying for financial guidance today are already using robo advisors -- they're simply also paying someone to do the data entry.

Robo advisors may have a near-term cost advantage, but cost-cutting is a hard game to win for a long period of time. Eventually meaningful company growth will require the creation of additional value for the customer. Whichever of today's startups are still standing will find themselves in conference rooms talking about deepening their customer relationships, quite likely adding humans back to the payroll and looking more like their initial adversaries.

Unfortunately, one significant source of value for customers is absent from the conversation: improved investment returns. People haven't been as focused on their rates of return in the past five years due to a steadily rising market and an industry focus on low-cost funds, but creating top-line value for customers will remain the great differentiator.

It's true that capturing alpha is hard (much harder than automating processes and cutting costs). But it isn't impossible. And in most places where it is being done, it involves people: not just at hedge funds (Bridgewater in particular comes to mind) but among every day investors. Communities like Estimize and StockTwits are evolving a concept of collaborative finance where communities of tens of thousands co-create forecasts and strategies that increase investment returns.

Interestingly, there is one group that could accelerate the expansion of collaborative finance and seize the lead in creating top-line value for customers, a group that has already scaled to millions of customers: the leading players of the previous investment revolution. Most of those surviving revolutionaries have become much less creative after their early success and have seen years of relatively flat performance (Schwab, Ameritrade, Fidelity and E*TRADE foremost among them). But I believe it is possible that one or more of them will soon head this direction and begin to help its customers help each other.

They don't lack examples to follow (thanks to eToro, Covestor and others) or a willing client base (due to changes in cultural norms). They don't lack the resources (the initial build and rollout would cost less than 1% of what they spend on advertising in a year). And if they happen to lack expertise in collaborative knowledge platforms, they can call us. The only question is whether they lack the motivation; if so, perhaps the new wave of robo advisors will provide that.