Since his youth, Matt has always been in investing. When he was in college, he worked on the floor of the Board of Trade, headquartered in Chicago, as a runner, taking orders and picks in the futures markets, which he feels was a pretty neat way to get started in the financial services space. He then spent a long time at Morningstar, an iconic Chicago company. Later he took an offer from Fi360. In 2017, Fi360 made it onto the Investment Analytics Tools list compiled by T3, industry’s most reputable source for market insights.
Thoughts on major trends
Matt highlights the following trends:
- On the industry level, the assets overall that are invested continue to rise. But at the same time, the absolute number of firms and advisors is actually shrinking. When you look at the impact of regulation and the cost of doing business, we are seeing fewer firms and advisors, but a larger pile of assets that are available for advisors to help investors with.
On a side note, another interesting thing is that broker dealers and advisors have never been under more scrutiny. With the Department of Labor introducing the Fiduciary Rule and redefining retirement, not only is there the traditional 401(k) or defined contribution (DC) plan, but also individual investors that are rolling money out of those plans into IRAs. That means that there is high legal and regulatory pressure in the space.
- The second trend is growth, not only in the amount of absolute assets, but also the demographics. Certainly in the United States you’ve got an aging population combined with DB (defined benefit) plans becoming rarer. More of the burden is put on individuals to make sure that they can retire in the way that they want. This puts more pressure on the individual and they have more assets at their disposal.
Back in the day, when there were only DB plans, the companies were in charge of investing. Today, even in the 401(k) space, the participant has choices to make. The growth in terms of the number of investors who are responsible for their own outcomes and the amount of money in question is significant.
- Third, a macro trend is the emerging importance of the advisor. There’s never been more need to provide guidance to the end investor than there is today. Not only do people have responsibility for taking control of their retirement savings, but we have more and more of a mobile workforce, meaning that people don’t work for one company for their entire life.
As people move, they end up with smaller amounts in their 401(k) plans that they need to do something with. At the end of the day, one of the key determinants of how successful people are in attaining the outcome they want is working with a professional advisor, whether that’s a person or more of a robo-advisor.
- The fourth trend again goes back to the fact that individuals are responsible for their own outcome; there’s definitely a greater degree of specialization within the advisor and asset-management space. Advisors have the ability to relate to customers and to add value in either a financial planning way, an investment selection way or an overall portfolio way. Thus, advisors are being asked to do more holistic planning than just selling products out to clients.
“Advisors, in order to be successful, have to be able to stand out and clearly articulate their value proposition when it comes to attracting high net worth investors.”
Think of the mobile workforce, those who are not completely committed, like they used to be, to employers for long periods of time. As they leave those firms, they’re in essence taking with them smaller amounts of retirement savings from several different employers.
They have two choices: a human advisor or a robo-advisor. The challenge or the opportunity is in figuring out how these best complement each other, because the challenges in life for somebody who’s 22, who has just graduated from college and doesn’t have any investable assets and most likely a lot of student debt, are a lot different compared to for somebody who’s in their 60s and thinking about retirement very close in time.
“[For older people,] trying to figure out how they’re going to not outlive their money is a much different situation than somebody with no or low assets but a lot of potential to earn money.”
The challenge in the industry is figuring out, first, for that person right out of school how he or she can be better served by a robo-advisor over a longer term. That person doesn’t have a lot of assets, so a human advisor is not that interested in working with them at that time. However, the advisor should be able to use technology to attract that individual to their firm. As that person grows and as life happens to them, they have children or get married, or buy a house or begin accumulating some wealth, the advisor can help them build a comprehensive financial plan.
Furthermore, the impact of technology is huge. For example, millennials don’t want to make phone calls, but they would rather do everything through their phone.
“At some point there has to be some convergence and really a place for human advisors and digital advisors.”
Benefits of big data analytics and artificial intelligence (AI)
If we went back three years, when the robo space was really exploding, there were probably between 40 and 60 different robo-platforms. Fast-forward to today, and there’s a couple of big firms that have been successful in going to investors but remaining private (e.g., Wealthfront and maybe Betterment). But there are other robos as well, or firms like Vanguard and Schwab that have launched their own robos.
“In five years, there will be robos live on their own or they will be swallowed up by some of these larger asset managers or broker-dealer firms.”
Firms like Vanguard offer inherent benefits due to their size and scale, so they are able to reach out to people. The bottom line is that if they can deal directly with the end investor, it’s to their benefit. That’s one of the interesting dynamics that we have yet to see unfold.
Cooperation between financial institutions and FinTech
If you look at Invesco buying Jemstep, it’s about a build versus buy decision. There are now so many niche FinTech solutions that serve one very specific market need. On the asset-managers’ side, however, there are definitely more buying-whole-solutions scenarios.
Other firms are beginning to put together these very discrete FinTech companies to offer more of a well-rounded solution. At the end of the day, when you think about the challenge for the advisor, not only are they running a book of business, but to a certain extent they’ve got all the fee compression challenges, too. Matt feels like at the advisor level they have to make a decision about their value adds.
If their value add is going to be to work with clients and doing financial planning, or is focused on investment selection, or emphasizes something else, all these have implications on the technology that the advisor actually implements in their practice.
The challenge of using big data and analytics is two-fold.
First, there’s never been more data available but second, if you look at advisors at their practice level they have to not only handle more clients with more assets, but also figure out a way in which they can automate their workflows to be more productive.
There’s definitely a role for technology like that, that traditionally hasn’t been employed in the financial services space. If the advisor can be more efficient and can outsource some of the manual tasks, whether it’s monitoring client portfolios, making sure that the client’s investment policy statement aligns with the proper investments—anything that the advisor can do to help automate their practice and allow them to spend more time with their clients is something that they’re going to be very interested in.
“With big data and AI, we’re just at the very forefront of what the potential might be.”
Furthermore, applying this emerging technology can help us to understand what story the data is telling, and how that helps clients.
“So making the data actionable is one of the keys because [as of now], many different formats and sources are there but if you can’t make [data] actionable, then you’re going to go into data overload.”
Fiduciary Focused Toolkit and the Fi360 Fiduciary Score
Fi360 was founded in 1999, long before the Department of Labor rule or any regulatory pressures were in place. The firm was launched to bring a fiduciary standard of care to investors. The outgrowth of that was a lot of research, but Fi360 literally published the book on a prudent investment process and took case law and legal regulation and translated that into a four-step prudent investment process.
That is the basis of what Fi360 calls its designation, which is the Accredited Investment Fiduciary® (AIF®). Once that came out, advisors went through training and loved it. This helped them achieve better outcomes for the clients they served, but when they went back to their practice at the end of the day they did not have a technology solution that allowed them to implement that into their practice.
“Back in 2007, we introduced our first toolkit for advisors and advisors, who were, and still are, very happy with that solution.”
Later on, the company evolved into the Fiduciary Focused Toolkit™ because over the years it has had several requests from advisors that have wanted different functionality, including the ability to automate different tasks in their process that were very manual. So if the client has an investment policy statement, how, on a quarterly basis, can they look across their entire book of clients and understand whether there are investments that are violating the policy or underperforming from a fiduciary standard of care? So in addition to the toolkit being built on the AIF and a prudent investment process, it’s built on the proprietary Fi360 Fiduciary Score®.
The Score is really the core of not only the designation, but also the toolkit, and the reason behind its success is that it’s a very easy monitoring and scoring system that individual investors can understand, and from which they can see how certain things might impact their portfolios in the long-run.
“The focus is to enable advisors to allow investors to have successful outcomes.”
The Fi360 Fiduciary Score® scores investments from 0 to 100. It’s much like golf, in that 0 is a perfect score and 100 is the least desirable. So, based on 11 quantitative factors, Fi360 breaks investments down into quartiles, where the top quartile is the most desirable.
The quartiles are then color-coded to make it easy to have a conversation with an individual investor, so 0 to 25 is the top quartile, and 25 to 50 is the second. The third is in between, 51 to 75, and is yellow.
“So if you think about a stoplight, green is go, yellow is caution and red is stop. Those investments that fall into the third quartile, they require further analysis to make sure that they’re suitable for the investor.”
When you get to the fourth quartile (76 and higher), those are the investments that do not meet a fiduciary standard of care, so Fi360 scores those in red.
Thus, the Fiduciary Focused Toolkit™ can be used to create an investment policy statement to not only make sure that both investor and firm understand what the goals are, but to look at the portfolio through a fiduciary lens to make sure that the chosen investments meet the standard of care.
The data is sourced from two places. First, private data collection takes place. Second, Fi360 uses Morningstar investment data.
The company uses Morningstar’s categorizations as well, so there’s different risk and return and manager tenure, as well as a minimum number of assets that are invested in the strategy.
Biggest challenges and problems to focus on
One of the most pertinent topics and trends right now in the industry pertains to the whole idea of the fiduciary duty of care. The robos or other FinTech firms have been focused on many different areas, whether it’s portfolio management, CRM or onboarding—those are all pretty discrete activities, and while you could build software to automate them, it’s harder to make them work as you add more and more capabilities to make sure that everything functions seamlessly.
“The challenge of the fiduciary duty of care is going to be applied in a broader sense.”
That’s a tougher one to translate because that is not a discrete capability like CRM or financial planning, but pertains more to the spirit of the law and really how it impacts individual investors.
Beyond that, there’s a challenge for providers because they might be experts in technology, but are certainly not when it comes to fiduciary concepts.
Things like due diligence, reporting, and portfolio management, along with planning, that’s an added level of complexity. That complexity in financial services is a tough topic because if it’s complex for the financial professional and the advisor, it’s even harder for the end investor to translate.
For people who are not skilled and aren’t really focused on the nuances of the industry, it just becomes a lot of jargon that they don’t understand. Being able to take these capabilities and adhere to rules and regulations and fiduciary duties of care, while making it easy for the end advisor and the end investor to understand, is a really big challenge.
Wealth transfer and its impact on wealth management
Think about the amount of generational wealth transfer that is only just beginning to happen, especially as the baby boomers retire and then as they pass on and that money gets transferred. That not only requires innovation on the technology side, but also forces advisors to differentiate themselves and the added value that they offer.
If parents are passing along with legacy positions, which typically could be in the companies for whom they worked for 30 or 40 years, they have large proportions of that company’s equity and stock. It may not be as important to the next generation to maintain that position just because that’s where their parents worked.
This demands innovation from the industry to help those investors not only understand what that concentrated position means, but also what they should do with it. Such a need really aligns with the demand for better financial planning.
A greater need for investment analytics that are simple for the end investor to understand puts pressure on the industry and providers to make sure that there are simple solutions out there.
Companies to watch
To start with, Matt mentions Riskalyze because he really likes what Aaron Klein has done. Riskalyze have taken very complex topics of risk and portfolio optimization and translated them into great software that really gets into the nuances and makes complex things easy to understand.
With their elegant solution, Riskalyze has enabled advisors to engage in a conversation, and at the end of the day to have taken a very complex topic and made it simple for the individual to understand.
Another Chicago based firm, YCharts, helps advisors with fairly real-time data and data from many different sources. YCharts has taken a lot of that functionality and consolidated it at a price point that is affordable for advisors to be able to have as a reference on their desktop. So whether it’s in doing research or answering client calls, they’ve also taken very complex data and made it simple.
A few macro trends will have a dramatic impact on technology, and FinTech providers specifically.
At the macro level, the absolute amount of money that’s investible will continue to grow, especially in the US where more and more people are going into 401(k) plans. In addition, the number of providers that service the industry are continuing to consolidate, whether it’s the absolute number of advisors continuing to shrink, the broker-dealers buying each other up or the asset-management branch continuing to consolidate.
At the same time, the one big trend is more and more money is going to passive investments. This puts more fee pressure on the active and traditional asset managers.
“We all know that we’re due for a market correction or a bear market.”
When that happens, will active management outperform passive? That is a question to think about.
It’s also happening to the advisor, so if you’re an advisor and your margins are starting to split based on fee compression, the one thing that you have control over is technology.
Specifically, FinTech is becoming even more important to advisors on a day-to-day basis because they have to find ways to automate tasks that they’ve traditionally done manually. If their pay based on the assets under their management is going to shrink, the only way that they can continue to generate the same amount of income is to expand their book.
“The importance of technology is not only in helping advisors automate tasks, but also in adhering to this changing regulatory and legal environment.”
If the DOL rule does go into effect next June, meaning that the DOL puts more of a fiduciary burden on everybody that’s in the financial services industry, then the business model of literally every advisor has to change.
This means that the way they deal with clients and document their decision making has to change as well. So, again, the only way that they can do that and continue to attract new assets is to begin to automate processes.
Interviewed by Vasyl Soloshchuk, CEO and co-owner at INSART, FinTech & Java engineering company. Vasyl is also author of the WealthTech Club, which conducts research into Fortune and Startup Robo-advisor and Wealth Management companies in terms of the technology ecosystem.