Fintech on Friday: Digitisation the only choice for wealth managers

“What we fear most is ‘boiling frog’ syndrome, in which the unsuspecting creature delights in the comforts of the warming water,” said a senior executive of a private bank participating in a new global survey carried out by Create-Research and Dassault Systèmes, covering 458 asset and wealth managers in 37 countries. The survey traces the promise and perils of digitisation in today’s wealth and asset management. 

Between the peak in October 2007 and the trough in November 2008, global stockmarket losses totaled $21,000 for every individual in the developed world and three times as much for every wealthy investor. 

Unsurprisingly, they have become ultra-demanding, pursuing a multiplicity of goals, like uncorrelated absolute returns, capital conservation and inflation protection. Before then, high returns in themselves were the overarching goal, in the belief that they could accommodate other goals. But this is no longer possible, as central banks’ ultra-loose monetary policies have borrowed against future returns by artificially inflating asset values. 

But that is not all. As most active managers have struggled to beat their benchmarks, wealthy investors have been just as demanding about fees and charges, with clear separation of alpha and beta. Latterly, around 65 per cent of them expect to manage their wealth digitally, according to proprietary polls carried out by some private banks. 

Hence,  digital innovations are being adopted by wealth managers more widely. Not only that, wealth managers are ahead of asset managers in the three-stage adoption cycle in virtually all eight digital innovations covered in Figure 1, according to our survey. 

Currently, the central thrust of wealth managers’ digitisation strategy is based on the old dictum: investment performance attracts assets, service quality retains it. That means segmenting clients by their goals and risk tolerances and designing a service proposition that is aligned to them. 

The implied customisation is achieved by adopting a wide range of standards that accommodate a variety of client needs. Customisation is also creating a new spectrum of human-machine interfaces. 

Some clients are becoming increasingly self-directed in making investment decisions. They are seeking better online service and greater choice via multichannels. For them, robo-adviser platforms are offering low fees, attractive self-assessment tools, rapid enrolment and widespread facility for portfolio rebalancing. 

The majority of clients, however, will continue to prefer a bricks and mortar presence, offering a human touch. Robo-advisers are set to democratise wealth management, but it will remain a gradual process. 

Over the next five years, wealth managers will offer hybrid services that pair computerised investment advice with human help. They want to give this option to prospective clients who want more hand-holding as well as to existing clients whose needs become more complex as they age and prosper. 

For their part, wealth managers have to ensure that human advisers offer a clear value-add over machine advice to justify higher fees. Robo-advisers will be unquestionably raising the bar for their human counterparts. 

Client experience 

“Far and away, the biggest change in the wealth management value chain is likely to centre on a significant client experience,” says Guillaume Dufour, VP Financial and Business Services at Dassault Systèmes. “This has to be customised, natural, seamless, intuitive and user friendly – based on interactive tools and mobile performance capabilities,” he continues. 

All these will be deployed in a client-friendly manner to deliver portfolio management as well as transactional banking, account integration, investment insights and client-to-client social media connectivity. 

A number of private banks are shifting up a gear and moving towards this model, often termed ‘Buyer 2.0’, where clients are hungry for insights, yet still able to cover many of their investment needs in their own time without any need for human help. 

Over time, such a model will incorporate cognitive computing and big data to give an edge by virtue of being able to go beyond top-down and bottom-up analysis to weigh up various risk factors, their probability and ‘what if’ scenarios in ways that might not occur to a seasoned portfolio manager. A new dawn beckons. 

The aim will be to obtain more accurate predictions, better decisions and more sophisticated machine insights, thereby sounding another death knell to the traditional ‘HIPPO’ principle – relying on the highest-paid person’s opinion rather than on rigorous forward-looking data analysis – which has long underpinned the star culture prevailing in many wealth managers. 

Speeding up metabolism

“BlackRock chooses wires over wizards to pick stocks,” ran a headline in The New York Times back in March 2017. On the same day, Bloomberg reported the legendary John Paulson, who made billions from the sub-prime crisis, was slashing bonuses at his hedge fund after a dismal 2016. 

Such headlines are commonplace. They underline the new reality: money management is at an inflection point where the future will be different from the past.  Business models need to adapt. 

Hitherto, three factors have served to slowdown the adoption of digital innovations, according to our survey: legacy IT systems (cited by 80 per cent of survey respondents), the innovator’s dilemma (57 per cent) and regulatory issues (57 per cent). 

The prevailing IT infrastructure remains ill-suited to new innovations in many cases. While margins remain healthy, there is not much incentive to upgrade it.  Indeed, high margins also lie at the heart of the innovator’s dilemma: if it ain’t broke, why fix it. Wealth management is among the most profitable industries in the world. Why disrupt your current business model while your bottom line is so healthy? 

The implied organisational inertia has begun to crumble as active management has had a torrid time. The winds of change are evident. 

When asked to identify the factors that will accelerate the pace of implementation of digital innovations, survey respondents identified eight factors (Figure 2). They fall into three interconnected clusters. 

The first relates to financial pressures emanating from three sources: growing cost pressures driving the need for automation (cited by 66 per cent of the respondents); fees and charges becoming a major differentiator (42 per cent); and the rise of passive funds (22 per cent). 

The  relentless rise of passives has been driving down fees, a phenomenon historically associated with bear markets. “New talent of different kinds are needed to first leverage technologies to decrease the cost of regulatory overdrive and second to justify the fees by providing a new experience, which is perceived as a meaningful and valuable asset by end-clients,” adds Mr Dufour.

Indeed, the second cluster relates to changing customer needs, arising from three sources: end-investors becoming more demanding about investment returns and client experience (60 per cent); the growing social acceptance of digital innovations (57 per cent); and end-investors becoming more self-directed (40 per cent). 

The internet and mobile phones have been consistently singled out as two of the top five innovations since the Second World War. They have altered the way people learn, work, manage, invest and behave in the developed world in general and the key fund jurisdictions in particular. Businesses that are unable to adapt to this new reality risk a gradual death.  

The third and final cluster relates to competitive dynamics, influenced by two developments: market entry of fintechs and internet giants (30 per cent),  and consolidation in wealth management (11 per cent). 

Scenarios of disruption  

The survey also shows that, as market competition and cost pressures have intensified, consolidation has continued apace, giving rise to three plausible scenarios (Figure 3): 

• Barbarians at the gate: this envisages that the external disrupters will take the fight to the incumbents by penetrating the commoditised end of the market especially amenable to DIY digital tools. 

• The empire strikes back: this envisages wealth managers adopting digitisation for a large part of their business, in much the same way as most flag carriers have emulated the low-cost airlines by segmenting their client base. 

• Peaceful co-existence: this envisages that, as the money management pie continues to grow worldwide, diversity will characterise the prevailing business models. Within that diversity, competition and co-operation will prevail. ‘If you can’t beat them, join them’ will be the main theme. 

The first scenario has least support. Investors will be wary of trusting their money to an organisation that lacks investment DNA and the associated brand. Investing is a bet on an unknown future. Its success requires a deep understanding of risk and its dynamic nature.

Similarly, the second scenario is more likely in wealth management than asset management, where the time-honoured innovator’s dilemma is felt more widely. The problem is compounded by legacy systems that also nurture legacy thinking. 

In contrast, the third scenario is more likely in asset management than wealth management. It allows each side to bring unique capabilities to the table. Money managers will bring better risk instincts, while the newcomers will bring technology knowhow. 

However, whatever the ultimate outcome, one thing is for sure: like all other industries, wealth management faces disruption (Figure 4): 31 per cent expect it to be ‘full disruption’ and a further 46 per cent expect ‘partial disruption’.  The corresponding figures for asset managers are: 19 per cent and 61 per cent, respectively. 

The key driver will be changing client behaviours under which, wealth management will increasingly evolve from being supply led to demand led over time.  That does not detract from the fact that early adopters are reporting numerous benefits.    

Benefits so far

Among the early adopters, digitisation is delivering operating leverage through the so-called network effect. “When a product or service is perceived to be more valuable as ever more people use it. This concept, in conjunction with the setup of scalable business platforms, underpins the phenomenal success of today’s online titans,” concludes Mr Dufour.  

The economics of the business is being transformed. First, by providing end-clients access to other fund buyers or comparison websites, on top of DIY tools and educational support. Second, by creating new capabilities for alpha generation and cost savings. Third, by strengthening the market position among client segments not covered by the existing distribution channels. Fourth, by offering better client experience that improves the prospects for up-selling and cross-selling. 

Finally, by having a faster time-to-market by improving the product development process and the governance around product suitability.   

To conclude, therefore, wealth management is at the dawn of a new transformation, more far reaching than anything experienced before. For it, digitisation is not the first choice or the last choice – it is the only choice. The future belongs to those with a clear vision for their business in the digital age.