01 Dec 2015
317
317 views


Case Study: Bionic Banking

Re: Patrick Cleary (MBA 2010); Francine Miltenberger (MBA 1983); Louis Lebbos (MBA 2010); Allegra Jordan (MBA 1995); Amy Butte (MBA 1997); Mark Chussil (MBA 1979)

Topics:
ShareBar

(Thinkstock/Getty Images)

Robo-advisors, like Betterment and Wealthfront, are built for millennials-automated asset management for those with lower account balances or an aversion to traditional financial advisors. Silicon Valley has taken notice, aggressively funding robo-advising firms with the hope of digging into Wall Street’s high profit margins. Current robo-advisors focus on passive “buy-and-hold” strategies, selecting a handful of low-cost exchange traded funds (ETFs), investing the funds according to a standard portfolio model, and facilitating tax-harvesting—a good meat-and-potatoes approach for the masses.

Investment management startup Alpha Architect, cofounded by COO Patrick Cleary (MBA 2010), is considering the launch of an affordable, active robo-advisor that would seek to outperform a passive, globally diversified market index using its proprietary ETFs. Automation isn’t new to the firm: A majority of the team are computer programmers and developers, employing sophisticated algorithms to manage more than $275 million in assets.

This active model would pit Alpha Architect against big banks, but with an advantage: The banks’ expensive overhead and expansive size result in higher consumer costs and less agility. Alpha Architect’s focus on staying lean and minimizing distribution allows it to serve an account at almost any level, no longer needing to manage $1 million accounts to be profitable.

The Question:

Alpha Architect faces a few strategic questions as it contemplates moving forward with an actively managed robo-advisor. First, Alpha Architect has an overarching concern about pricing: Current passive robo-advising fees run about 0.25 percent, and have already begun to trend downward. And yet, traditional portfolio advice and fund fees run in the 1.5 to 2 percent range. Should the price be 0.25 percent or 1 percent? Second, how would an active robo-advisor work with other market participants? Alpha could leapfrog traditional advisors and deal directly with consumers, work with traditional advisors to make their operations more efficient, or form a direct partnership with traditional advisors.

The Answers:

When I first started researching the robo-advising space two years ago, there were already 20 offerings out there. Wealthfront and Betterment have the highest visibility, but many others have built “engines” and are now finding that they need to be part of a larger, established wealth management firm.

If you go the consumer route, you will need deep marketing pockets. If you go the advisor route, you need to realize that you already have established competition. I personally would advocate the advisor route. On that path you have two choices—align yourself with a big consolidator of wealth management firms or decide to go after the 17,000-plus independent RIA firms. If you go with the independent firms, you will need to have a robust sales and support capability; most of these firms are thinly staffed.

To your pricing question: If you are selling “efficiency” you should not go with the 100 basis points (1 percent) pricing. You’ll lose your differentiation from traditional advisors, and worse, you’ll be grossly out of step with the competition.
—Francine Miltenberger (MBA 1983)

Go with 0.5 percent or lower. Whenever I see fees at 1 percent or higher, I get a really bad vibe from the fund. I think many consumers are wising up to how much fees eat into their portfolio performance over the long term, and 1 percent or more is a psychological threshold.
—Louis Lebbos (MBA 2010)

I believe that the main barrier to your sales will be your customers’ values, emotions, and cultural issues. I recommend you bring in 30-50 potential customers and test the sales proposition with them. Run those tests with an eye for emotion, culture, and values, not just efficiency. You will have better data on which to build your strategy.
—Allegra Jordan (MBA 1995)

Let’s separate the “black box” from the “client interface.” The black box seems at present to be an index fund allocation algorithm. Nothing special here—the robo-interface is essentially a web-based interface. All in all, it is an automated tool for the masses to invest in index funds. Go with the 0.25 percent pricing. Returns will lag the index, and higher pricing will cause that lag to increase dramatically.

The “secret sauce” Alpha Architect hopes to create are ETFs that “beat” the index. ETFs are a tough business with high barriers to entry. ETF-based market-beating methodologies are hard to create, and any “proprietary” advantage will be even harder to maintain. Alpha Architect’s success will be based on its secret sauce and not on the serving spoon—even if it is a robo-serving spoon.
—Amy Butte (MBA 1997)

I recommend that Alpha mock-up potential customer profiles, based on psychographics (beliefs and needs) as opposed to demographics. For what kind of customer does Alpha have the most compelling, best-differentiated pitch? Either way, I think Alpha’s biggest chore is convincing the customer—and determining for itself—that it has a good product. Customers in this field are, rightly, skeptical of performance claims. The price comes after the proof. Otherwise, it’s like asking what’s a fair price for a car before knowing what the car is.
—Mark Chussil (MBA 1979)

Got a case? To take part in a future “Case Study,” send an outline of your company’s challenge to bulletin@hbs.edu

ShareBar

Post a Comment