Automated Investing 1.0

Will Trout

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Dec 6th, 2014

My recent report, Disrupting the Disruptors: RIAs, Online Brokers, and the Challenge to the Automated Investment Advisors, looks at the accelerating cycle of disruption that characterizes wealth management today, in which traditional, advisor-centric providers are coming under pressure from technology-based market entrants, which in turn prove vulnerable to disintermediation themselves.

Evolution of this sort used to take place over decades; today, disruption is measured in years. Technology has been the driver of change, lowering barriers to entry and expanding the price and servicing options available to investors. These investors include the mass affluent segment and the equally underserved Millennial Generation, whose behavioral characteristics and privileged position as inheritors and generators of assets make them the future of wealth management.

The shift toward a technology-driven means of investing has undercut the role of the advisor and exposed inherent weaknesses in the high-cost model of brokerage houses and registered investment advisors. Looking ahead, however, automated investment advisors will face a more rugged environment defined by tighter margins and competition from online brokerages (in many respects the natural competitors of the automated investment advisors) and institutional players such as Vanguard and Charles Schwab, which have built-in client bases and are better positioned to withstand an eventual market downturn.

Consolidation lies ahead, whether the result of a price war or a weaker outlook for equities. The real question is whether this consolidation marks the beginning of the end or the end of the beginning for the automated investment advisors. My bet is squarely on the latter.

Buy side insight for Fixed Income platforms

Nov 20th, 2014

Time keeps becoming scarcer and we all become more selective on what conference we will attend or speak at. But yesterday, as I was by chance in Paris, I dropped by one of the potentially nth conference on fixed income, and was presently surprised by the value of its content. Congrats to Trading Screen for pulling it off.

Let me share with you a few takeaways, mainly from a great buy side panel:

1) One of the buy sides (whom we all know are the ones calling the shots nowadays) summarized his selection process for choosing a new trading platform as follows:

i) Who owns the platform? A bank (negative points) or a vendor (positive points if strong balance sheet). I would add exchanges (they are neutral) and interdealer brokers (for whom it is one of the only options to remain in business) to that list, but the latter will have a challenge at connecting all the buy side.

I have an open question here: why wouldn’t the big buy side invest together in a platform they believe in with Equity so that they can reap the benefits of the success they will bring to it as the banks did with Tradeweb?Aren’t they in the business of investing?

ii) Buy side is not an option: if the buy side doesn’t all connect together in an automated way, the success rate of the platform will be low. (c.f. who’s calling the shots).

iii) The need for an independent clearing agent from ownership and/or for the functionality to choose one’s own clearing agent.

Here I actually pushed the question further as a big custodian is currently rumored to be the clearing agent of a MD2C platform’s new product: should custodians be involved, should they become agent brokers since they have the assets of the AMs (and a clean balance sheet, may I add?), or be a platform? Some people in the audience laughed at that one, pretty sad considering what some of the big global custodians have in pipe, let’s assume these were brokers who have never taken the time to understand what happens “post” trade… thankfully at least two of the big buy sides in the panel actually got my point: there could be room for some innovative matching engine to team up with custodians (Algomi?). See last year’s Celent report: Innovation in Focus: The Analytics Powering Fixed Income Matching for a comparison of the functionalities of the new matching vendors.

iv) Flexibility of interactivity: the buy side has to be able to choose to interact only with each other, to exclude toxic flow, to include some banks, etc. Everyday potentially in different ways. So just a switch functionality for the other side of the trade.

Some new platforms thankfully already have that in their rule book/functionalities such as Bondcube or TradeCross (Trading Screen’s 2.0 version of Galaxy).

In our report we actually had mentioned the “selective multicast” capability of Baymarkets for banks to select what prices to send to what client in cascades; this is an interesting adaptation for the buy side to select who to send what interest or order or request for quote to whom in cascade or not.

2) Another point that was made was that there is no first mover advantage, this is taking time to pick up as AMs are adapting to change and regulations on transparency is not final: I could not agree more as we have been having these discussions for the past 3-4 years non-stop, and the number of professionals buy and sell side interested keeps increasing. Still, at some point the big AMs will have to jump on one ship as the cost of illiquidity is becoming too expensive for their funds’ performance (nice presentation on that from an AM quant).

3) Last but not least is the cost of connectivity to all of these platforms‎, apart from the time spent to connect to them (and to convince senior management to connect to them?). This has to be corroborated also by the lack of screen space available for new entrants, the need to come in via other or incumbent screens maybe? Or via a web browser?

4) Last interesting point which is an idea we have been pushing out at Celent for a while: the buy-side could go directly to the issuers: yes, and they already do actually, for big infrastructure projects or issues whereby they already have a relationship with the issue. A platform with both and no brokers, banks to build the book and syndicate and sustain the price? CSDs and iCSDs have a role to play here: such a platform could work with Dutch auctions or even normal auction process, but it would work more in the interest of the smaller buy side than the big ones obviously, creating a level playing field… hence hard to make it pick up… SMEs and small institutions could meet on P2P lending platforms through aggregators of interest such as Orchard though. More in an upcoming report on these…

As for TradeCross‎, I still need to get a demo but we already know that it will be All-to-All (but in the flexible way mentioned above, not our old definition with CLOB and level playing field), anonymous, an MTF, trading with all-in price (commission), interest and orders, multiple trading models (did they mean protocols?), spread or price or yield trading and with a web browser if need be. No go live date as of yet.

Growing importance of Historical Market data

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Nov 19th, 2014

The market data industry has been a hub of activity in the last few years. A number of leading global exchange groups have used their proprietary market data to create a steady revenue stream for themselves. Various other firms are also trying to utilize their market data processing capabilities and create a niche in the market. Against this larger backdrop, Celent has been conducting some research of late on the historical market data space. The spurt of regulation in the last few years means that firms have to test their current capabilities against upcoming regulatory requirements. This is something that all capital market participants regardless of size would have to do much more of. The only difference is whether this testing happens in-house or using a market data vendor capable of providing such analysis. Generally, the tendency for larger, traditional buyside firms has been to use third party vendors, while most hedge funds prefer to undertake their own analysis. The latter are also major players for back-testing related to low latency trading strategies. This is the other important area where historical data is used and understandably has become a high growth segment for market data providers. Overall, the significance of these growing uses for historical market data is that data providers are now beginning to see it as a standalone business segment. Instead of providing such data at a low cost, or almost free, to their existing users and even new users, these vendors are now realizing that it is possible for them to price it in a fashion similar to real-time data, the main difference being the more one-off nature of the historical data market. This development has been concurrent with the rising use of market data analytics. Firms today realize that they have a wealth of data at their disposal which they can gain insights from. Industry incumbents see analytics as one of the main growth areas in market data, as the rest of the market becomes more commoditized. Another response to the high level of competition is the focus on historical data for OTC derivatives. Unlike exchange-traded data, data for OTC derivatives and exotic products is more difficult to procure and hence a more attractive segment for providers that serve these products. All in all, there is a lot of activity in this market data segment, not to mention the fact that it is also the focus of an upcoming Celent report.


Price Pressure Weighs on Automated Investment Advisors

Will Trout

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Nov 18th, 2014

Signs of a price war are troubling for an industry known for its door-buster fees. Charles Schwab’s forthcoming launch of its zero cost Intelligent Portfolios platform is another round in what quickly could become a life or death battle for many of today’s automated investment start-ups.

As I discuss in a previous post, Schwab’s decision to share details on its direct to consumer platform (to be launched in early 2015) followed the announcement of a Fidelity-Betterment partnership by a week. Schwab had originally revealed its intention to roll out such a platform in July, a few months after asset management rival Vanguard launched its low-cost Personal Advisory Service managed portfolio service.

Now the time between salvos is shortening. A few days after Schwab’s announcement, TradeKing Advisors slashed charges on its Core portfolio offer to 25 bps, while matching Schwab’s $5000 entry minimum. It also eliminated first-year fees entirely. The clear but unstated message: investors don’t need to wait until some indeterminate point in 2015 to try fee-free automated investing.

It is tough to top free (one automated competitor described Schwab’s move as an attempt to “freeze the market”) but give TradeKing Advisors credit for trying. Pressure will be on other automated advisors to respond in kind. While downward pressure on prices is good for investors, the implications are less sanguine for automated investment managers, particularly for those lacking a strongly differentiated value proposition.

When does healthy competition become a race to the bottom? It seems we are nearing that kind of inflection point.

Automated Investments Platforms: Build or Buy?

Will Trout

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Oct 29th, 2014

I recently wrote about the entrance of broker custodian Charles Schwab into the automated investments business. Here I examine Schwab’s decision to build a platform on its own, rather than buy a start-up (or partner with one, as Fidelity has done with Betterment). In case you hadn’t seen the news, Schwab has named its zero-cost platform “Schwab Intelligent Investor” and has put up a placeholder site to announce it.

I am also adding here to my commentary on this blog and in Investment News by addressing more broadly the implications of the “build vs. buy” question for online brokerage firms. Price pressure from shrinking trading commissions plus the quest for differentiation in an increasingly commoditized business is encouraging these firms to consider rolling out their own advice platforms. Indeed, one firm, TradeKing, has already done so, and other firms are quietly working on their own.

For online brokerage firms, the “build” option now is clearly more in vogue than the “buy”. It is tempting to link this trend to the sky high valuations (which are frighteningly reminiscent of the boom) held by the current batch of automated investment advisors. Yet the decision process around “build vs buy” (or partner) is more complex and to some degree rests with one’s vision of the future. Given the downward pressure on fees (from platforms like Schwab’s) and low barriers to entry, it may not be very long before some of today’s gilded start-ups are on the auction block.

At the end of the day, a firm like Schwab may decide to build for a number of reasons. First of all, implementing solutions “in house” versus buying (or even using a vendor, which can be expensive and confining) may simply be part of its DNA. Schwab also may feel that building in house will allow it to move faster to market, and retain the ability (i.e. the code) to innovate or build out the platform at a later date. Acquisition or even partnering (including via a white label solution) can pose some sticky integration problems.

On the other hand, the purchase of a B2C start-up would seem to be an obvious way to do an end-run against the limitations that have held back other online brokerages and custodians so far. These limitations center on legacy technology (systems dating back to the early 2000s that are in dire need of updates), and culture (the automated investment managers are mostly software engineers, while the discount brokerages are a mix of techies and investments folk). One might ask if a large custodian based outside the Bay area might even be able to attract enough talented software engineers to do a build-out quickly and right.

Schwab, which is based in San Francisco and presumably has ample budget for hiring, may still be challenged in constructing what should be a massive platform offering potentially dozens of portfolio models (compare this to the TradeKing Advisory platform, which offers 10). Already more than six months of concentrated effort has gone into building it. Time will tell if the Schwab approach will be a winning strategy. Certainly Schwab CEO Walt Bettinger’s brash predictions for the success of his platform have raised (at least in terms of expectations) the proverbial bar—not to mention the hackles of his many start-up competitors.

The Custodians Enter the Automated Advice Wars

Will Trout

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Oct 28th, 2014

Broker-custodian Charles Schwab’s eagerness to share details on its zero cost automated investments platform reflects the fact that it has essentially been trumped by arch rival Fidelity, which announced last week it was partnering with Betterment to distribute automated investments advice to clients via its RIA network. Unlike the Fidelity offer, the Schwab platform will be offered direct to consumers, with a white label version to be offered later to Schwab’s network of advisors. The Schwab announcement follows what has essentially been radio silence since Schwab CEO Walt Bettinger revealed plans to launch an automated platform last summer.

Some thoughts:

  • The automated investments business is fundamentally a software play (if you can write the code, you can start up an automated advisor) with low barriers to entry, and Schwab’s decision to offer algorithm-driven portfolio management services for free is a troubling sign for an industry already offering door buster fees. We may be seeing the acceleration of a race to the bottom in terms of pricing. The end result: curtains or at least consolidation for many of today’s crop of automated advisors.
  • Schwab’s decision to offer its platform to consumers for free is unlikely to go over well with its captive network of advisors (i.e. those who use Schwab for custody purposes), who will feel undercut by their custodian. The advisors will be even less happy if they have to pay fees (for example, for the branding of their web sites) for a platform that their customers can access for free. The most important thing to note, however, is that the Schwab move puts downward pressure on the RIAs’ high fees, even if the RIAs claim they are offering a better, more personalized service than the automated advisors.

From a strategic standpoint, Fidelity’s ability to get a leg up on arch-rival broker-custodian Schwab speaks to the challenges custodians and online brokers face once they decide to launch an automated advice platform. Should they build their own, as Schwab is seeking to do, buy a startup automated advisor, or partner a la Fidelity?

I’ll share some of the thinking around these considerations in a subsequent blog post.

Beyond Budgeting: The New Generation of Personal Finance Tools

Oct 27th, 2014

Beyond Budgeting: The New Generation of Personal Finance Tools is the second of a series of reports focusing on the delivery of online financial advice. This study focuses on the North American market and examines a range of firms. Celent’s research on the PFM space includes, but is not limited to, the following vendors:

  • BillGuard
  • Finovera
  • Geezeo
  • HelloWallet
  • Level Money
  • Mint
  • MX (formerly MoneyDesktop)
  • Moneytree
  • Prism (formerly Mobilligy)
  • Yodlee

This list is by no means exhaustive, but it does portray an array of relevant wealth management players. A broader overview of PFM players is provided in an earlier Celent report, Personal Financial Management: The Devil Is in the Details. The goal is to focus on those adding value from a broader wealth management perspective.

Celent defines PFM as a platform of online money management tools offered at a low cost that aim to allow the retail investor to control his or her financial future through account tracking and budgeting features. The core features of a PFM solution include: consolidation of accounts, bill payment reminders, credit score checks, and short-term cash flow management. In more complex PFM solutions, an even more holistic view is offered through investment tracking, data visualization, social capabilities, financial goal planning, and advanced analytical capabilities. In short, PFM solutions provide the retail investor with a relatively independent, transparent, and holistic view of his or her financial position at any given point in time, thereby facilitating the financial management process.

Celent focuses more on the segment’s position within the advice continuum, which extends from PFM to investment management to financial planning, and less on the functional aspects of PFM, which are closely aligned with online banking.

“This macro-level approach is designed to highlight the utility of PFM as a starting point for the delivery of advice generally, and financial planning advice in particular,” says William Trout, a senior analyst with Celent’s Securities & Investments practice and coauthor of the report.

Over the past several years, PFM providers have worked to alter their images and perceptions from a simple budgeting tool to a forward-looking, actionable financial planning tool. Celent considers modern PFM solutions as a steppingstone to financial planning, particularly given its transformation from a reactive, backwards-looking tool to a predictive instrument capable of providing cash flow projections and actionable recommendations around spending and saving. Celent explores drivers for PFM tools, charts the evolution of their functionality, and examines the challenges and opportunities these firms pose to the traditional wealth management industry.

“There has been a surge in the number online financial advice providers to the US retail investor market,” says Ashley Globerman, an analyst with Celent’s Wealth Management practice and coauthor of the report. “The target client is tech-savvy, cost-sensitive, skeptical of financial institutions, and willing to use nontraditional wealth management services that speak to their digital lifestyles.”


Towards a Technology Based Delivery Model for Investing

Will Trout

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Oct 27th, 2014

The commoditization of the portfolio construction process has created fertile ground for the emergence of automated advisers providing investment management services at very low cost. But how real are these virtual advisors and what do their technology based delivery models mean for the traditional advisor?

These were some of the questions put forth at a recent Celent Executive Roundtable in London. Senior strategy, technology, and innovation leaders from UK and European financial institutions joined several market “disruptors’ for the discussion, which sought to capture emerging trends and highlight innovation within both wealth and asset management.

The topic of automated advice served as a starting point for a discussion of the broader transformation of the investment management ecosystem. As traditional advisors with their high cost service models move upmarket to defend their profit margins, automated providers are filling the gap. To date, algorithm driven portfolios have appealed largely to younger and NextGen investors, but as one Roundtable participant noted, these investors will not stay young and cash-poor forever.

Indeed, the aspirations and behavioral characteristics of the large NextGen population offer a window into the future of wealth management, as London based analyst Ashley Globerman suggested. Goal focused, idealistic and entrepreneurial, NextGen investors want low fees and control of their financial lives. They value the transparency, personalization and tax management offered by the automated investment advisors.

For these advisors, the ability to deliver both customization and scale is not just a strategic advantage; it represents something a holy grail. Certainly, it meets the Celent criteria for disruption in that it breaks existing trade-offs. But as Celent Senior Analyst Jay Wolstenholme noted, innovation must also be judged by the results it delivers. The automated investment managers have not yet been faced with a major financial crisis, nor have they suffered a data breach that might call their model into question. Traditional advisors meanwhile have recognized the threat to their model and have started to respond. To borrow a British expression, it’s still early days.

Utility Model in Capital Markets

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Oct 24th, 2014

In the aftermath of the financial crisis, the regulatory environment has undergone rapid changes and is still evolving, creating additional obligations for financial institutions, particularly in the areas of risk management, reporting and regulatory compliance. Since many of financial institutions have to make same, or similar, changes to their processes and systems due to new regulations, many of them are looking to “mutualize” the costs – an arrangement where an independent third party provides the technology and services that banks can in turn use on pay per usage basis. This is giving rise to a new utility type of offering that is a step in the outsourcing value chain.
As a consequence of these changes we have observed in last 6-12 months the emergence of shared service-utility mode of offering which is a highly standardized type of offering built by a third party provider and offered to financial institutions on a pay-per use basis. Often these solutions were conceived in direct response to the user communities’ expressed needs for them. Not surprisingly therefore some of the ones being launched in the market are by bank owned or bank backed institutions and have had active involvement of many banks in their design and development processes.
One area that has seen a number of solutions emerge under the utility-shared service model is the know-your-customer (KYC), client on-boarding space. The current practices in managing KYC, on boarding operations are complex and redundant requiring every customer to exchange information with every financial institution they deal with. The utility model on the other hand envisages gathering all customer information at a single space that can in turn be shared with financial institutions.
A recent Celent report discusses the drivers behind the emergence of the utility model and studies four solutions in the KYC, on-boarding space that have been or will soon be launched under the shared service-utility model, including SWIFT KYC Registry, Thomson Reuters Accelus Org ID, Clarient Entity Hub (by DTCC and 6 co-founding banks), and Markit | Genpact KYC Services.

Fintech and the Democratization of Investments

Will Trout

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Sep 29th, 2014

One of the most remarkable characteristics of this September’s FinovateFall 2014 conference in New York was the number of presenters focused on wealth management. Typically only a handful of WM firms dot the PFM and payments landscape, but this year nine of the 70 seven-minute demos concentrated directly on investments and financial planning. Presenters included established WM vendors (eMoney Advisor, which rolled out its EMX platform for advisors), well known disruptors such as Kapitall, and a few companies that seem to have just come out of the woodwork.

The diversity of wealth management platforms and providers speaks to a trend at Finovate that has been gaining traction in the broader market: the democratization of investments. Democratizing firms posit that best-in-class ideas, managers and investments should be accessible to all investors, and not just to the rich alone. Firms such as HedgeCoVest and iBillionaire (platforms that allow investors to mirror the trades of hedge funds and billionaires, respectively) and Loyal3, which offers no fee access to IPOs, embody this line of thinking. So do the strategies of UK based firms like Algomi (bonds) and True Potential (micro payments), which undo trading obstacles for investors, while lowering the bar for entrance.

The democratization of wealth management is also noteworthy in the traditionally advisor-driven financial planning space. While B2B vendors like eMoney Advisor seek to enhance advisor interaction with clients, iQuantifi offers financial planning services directly to individual investors, as does FlexScore, which throws in the added element of gamification or gaming.

The idea here is that planning and investing should be fun. No firm at Finovate represented this quintessentially Millennial ideal more than Kapitall, an online brokerage firm that bills itself as a fusion of investing and gaming.

Indeed, efforts to incorporate gaming into the historically sober wealth management business represent only one of the ways that fintech startups are seeking to capture underserved populations (i.e. democratization), target market inefficiencies (i.e. build a better mousetrap), or in the case of firms like Blooom, do both. The Kansas-based firm won a Best of Show award for its tools-based platform enabling entry level investors to better manage their 401k plans.

Tellingly, while these firms tend to target opportunities created by local market inefficiencies, their ideas may have resonance in other markets as well. Investors in Australia, for example, have just as much a need for advice on their retirement savings as do Americans. The universal appeal of the ideas put forth by the fintech startups, combined with the inherent efficiency and scalability of their business models, suggests that real disruption in WM may have barely gotten started.