We will delve into financial services, specifically wealth management. A choice that may seem surprising, because the sector may be perceived as arid, it is precisely because of its opacity or lack of accessibility (not everyone has money to invest beyond savings accounts) that this industry deserves to be analyzed. As we shall see, this very situation entails a recurring process of democratization.
This industry is interesting for two other reasons. On the one hand, the previous technological (r)evolutions of the second 20th century had significant effects on it, forming a reference frame to consider the consequences of the AI in turn. On the other hand, its size is substantial: in 2016, this industry had no less than $ 160 trillion of assets under management.
Mechanics of wealth management
The ultimate goal of wealth management products and services is very simple: to increase savings by investing in shares of companies or debt securities of companies or governments – bonds. Here therefore, we are talking about financial savings, in hard cash, and not about physical assets (the main category being real estate).
If the principle is simple, implementation is much more complex. There are 3 ways to bridge the gap between the investor and the financial investment, stock or bond:
- Acquiring assets directly – for instance, buying shares as part of a savings plan – through a stockbroker, though.
- Trusting a “wholesaler”, an asset manager who selects assets through a fund with a given investment strategy, then resells shares of its fund to individual investors.
- Going through “distributors” who offer a portfolio of funds chosen from among “wholesalers” – for instance, life insurance contracts often offer a few funds drawn from a handful of asset managers.
In short, intermediaries aggregate demand to purchase bundles, often pile up from the individual investor’s point of view, and most of the time the latter does not directly manage the financial assets in which he invests in fine – someone else does it for her.
In terms of business model, the various players of the industry collect transaction fees (e.g., fees for buying or selling a share through a stockbroker) or management fees (e.g., 1% of the amount managed per year in a random action fund).
In the end, in this vast galaxy of financial products and intermediaries, it is the wealthiest people who get the better deal. On two levels, ultimately linked to economies of scale:
- Accessibility: to access certain products or services (for instance, custom management of one’s stock portfolio), a (really high) minimum level of investment must be met.
- Fee level: management or transactions fees are mostly declining depending on the amount of entrusted money. In addition, the wealthiest are generally less intermediated, so the commissions of the different intermediaries stack much less.
To illustrate this point, let us take the example of participation in a venture capital fund (investment in startups) in the United States. Investing directly is possible only for institutional investors, or millionaires. A middle-income employee may invest herself, but very indirectly (and generally without choosing it by the way) via her pension fund, which also levies a management fee.
New technologies and democratization
Far from being static, this situation triggers a permanent movement of the wealth management sector by a phenomenon of democratization: technological changes frequently make it possible to open the doors of previously high-end services to the masses, and to reduce their cost.
The rise of computers, for example, enabled in the 1970s the creation of index funds, which mechanically replicate the movements of an index such as the S&P 500, rather than trying to best the index through the personal selection of a fund manager. The exponentially decreasing cost of computing power has made it possible to quickly the many securities that make up an index. The effect on prices has been significant: when Vanguard Group, one of the pioneers in the field, launched its first index fund in 1976, its annual management fee was 0.5%, compared with an average of 2% at the time for all investment funds.
The IBM 7090, a computer that was used to create the first index funds
The arrival of the Web in many homes during the 1990s triggered the creation of online brokers far cheaper than incumbents. While access to electronic information on the stock markets was previously restricted to institutional investors, many individuals could easily buy and sell stocks. Between the mid-1980s and the mid-1990s, the share of Americans investing directly in stocks rose from 5% to 20%.
E*Trade was a pioneer of online trading – its website launched in 1996
A major feature of this democratization phenomenon is that it benefits not only consumers but also firms, as the attrition of value (decline in revenue per million dollars managed) is more than offset by the expansion of volume (the total assets under management).
Between 2012 and 2015, for example, the industry’s margin rate fell from 0.8% of assets under management to 0.7% – a significant change. This did not prevent the overall revenue of the industry from rising by 14%.
When AI meets wealth management: 3 new experiences
In the rapidly expanding landscape of fintechs, 3 new types of services have emerged in recent years to democratize access to new wealth management services.
1/ Investment in ideas and values. Startups like Motif allow individuals to invest in themes in line with their aspirations or interests such as “fighting cancer” or “connected cars”, with a strong emphasis on social and environmental responsibility criteria. Behind, the platforms are responsible for automating the creation of hundreds of portfolios of securities or fund shares that match the themes of interest. These products are widely available; a handful of dollars is enough to start investing (so you can own a fraction of a share, which is no small feat when the price of the Alphabet share exceeds $ 1,000).
2/ Robo-advisors. This category is probably the best known, with successes like Wealthfront or Betterment in the United States. The goal is to offer an interface with the least possible interactions for the user – “set it, forget it”. The investor fills an initial survey that allows the service to define a finely customized risk profile (rather than linking it to a few canonical profiles, “moderate”, “dynamic and others). Then the appropriate financial portfolio is created, and the service switches to automatic control. Examples of this are portfolio rebalancing (periodically returning the portfolio to its initial allocation) and tax-loss harvesting (optimizing the purchase and sale of securities so as to minimize taxes paid on capital gains). These services are very accessible and inexpensive: $ 500 minimum and annual fees of 0.25% for Wealthfront. In 2016, robo-advisors managed nearly $ 100 billion. It might not be very impressive given the size of the whole sector, but it is quite significant given the less than 10 years of age of this product category.
3/ Smart savers. Services like Acorns offer to put money aside automatically. Users simply have to connect the application to their account, so that the service analyzes their spending habits and creates additional savings by rounding up their purchases. This saving is managed with a few portfolios suited to the user’s risk profile, without that being said there being a wide range similar to the mass customization allowed by the previous two categories.
This range of new services can be pictured as follows:
Let us note in passing the importance of not considering AI in silo, as a technological wave cut off from other trends. Perhaps will you have noticed the technological revolutions combine perfectly here, and it is the hybridization between smartphone (its ubiquity and proximity) and AI that leads to the renewal of offers.
The impact of AI on the sector
These 3 innovations in the wealth management user experience redefine the internal and external limits of the industry:
- Robo-advisors allow individuals to reduce the number of intermediaries they face.
- Investment in ideas and values could attract a wider and less wealthy public to financial investments by simplifying them, thanks to their emphasis not on the technical details (product point of view) but on their personal aspirations (user point of view) – a kind of “consumerization” of wealth management.
- Smart savers widen the market by redirecting towards financial investments money that otherwise would have been used for consumption or left idle on current accounts.
In line with the new technologies from previous periods, AI will bring about a new democratization phase in wealth management, and widen the market through looser access criteria and lower fees.
The dual trend derived from democratization, that is the concurrent attrition of value and expansion of volume, has its counterpart in employment. Productivity gains (the need for fewer employees to manage a given savings envelope) generated by technology are more than offset by the expansion of the market.
Where could the resources freed by the progress of AI be redirected? Here are 3 possibilities of new jobs:
- Valuators: if investors increasingly intend to align their investments with their values, then much more time will have to be spent assessing the societal performance, or even the moral values, of companies. A role that requires dialogue with all stakeholders and to move on the ground – tasks that are far from automated.
- Life goal coaches: AI takes over the time-consuming technical finance aspects, and enables individuals investors to think more deeply about the purpose(s) of their investments. Hence beyond maximizing returns alone, wealth management specialists could focus on helping their clients achieve their goals. For instance, making sure that an investor could work part-time without financial difficulties, in order to have more time to devote to her passions.
- Creators of new asset classes: the industry as a whole has every interest in seeking new product creation, new financial assets that involve higher margins and are at the start dedicated to the wealthiest clients. This, as a treadmill, lays the first steps towards a new democratization dynamic that would take place a few years or decades later. For instance, newly created startups offer the possibility to invest in trials or in funds aggregating art pieces.
Last ripple effect to consider: what could be the impact of AI and the new experiences it made possible on the industry leaderboard? Its influence will probably be limited because of a competitive aspect of wealth management: it is much more difficult for a consumer to switch financial manager than it is for her to pick a new furniture brand. For many reasons: managing their savings is not the main concern of clients, transferring assets from one wealth manager to another is tricky, there may be a loss of tax benefits etc.
As a result, the battle in winning new customers is played out very little on the stock of savings; the new flows are the ones to be captured, and they represent only a few % each year in relation to the stock. Leading incumbents thus have plenty of time to adopt technologies and to adapt their offers, in particular by acquiring new entrants, so as to offer new products to their sizable “captive” clientele. For sure, the transformation of the industry will occur, but we believe that it will be more a conversion of incumbents rather than a replacement by new firms.
Thus, today the “old” actor Vanguard can be found as the No. 1 robo-advisor, even if startups were the ones which invented this type of service.
That said, each previous technological wave (the beginnings of computing and the advent of the Internet) made way for a few innovative firms to reach the top of the industry leaderboard. We can wager that this time as well will be no different. And that in 2025 AI will have allowed a new entrant to join the top 10 asset managers in the world.
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