The Digital Investment Space –
more and more independent from their product advisors in banks or advisory firms.
Spanning from Social Trading
to Digital Private Banking –
A FinTech Sector Made for
Disruption?
By Michael Mellinghoff  of this, and continue to drive the change in the FinTech sector, which is complex by
Managing Director, TechFluence
In the mid-1990s the mutual fund industry introduced distribution fees to reward
their distribution partners for promoting their own mutual funds to private investors.
The reduction in margin for mutual fund providers was immense. A fund which at
that time charged a management fee of 1% suddenly had to pay on a recurring
basis half of the management fee to the distributor, who sold the fund to the client.
This decreased the margin of the product provider by at least half. This marked the
starting point of a negative market development for product manufacturers, and
especially investors in these products, in favour of product distributors. Clients over
time paid the bill via higher management fees, as product manufacturers increased
their management fees, and thus charged even higher distribution fees, since the
fee level very often was expressed as a percentage of the management fee of the
investment fund: a vicious circle decreasing the yield of the investor and increasing
the profit of the industry.
These high profit margins are one of the reasons why digital competitors entered
the field of wealth and asset management and why they have a chance to capture
enough market share to survive even fierce future competition between the
traditional and the digital world, which will most likely lead to an overall reduction
of fees. Moreover, decades of underperformance by active mutual funds have led
to a massive outflow from the category to the benefit of low‐cost passive and ETF
options as well as alternative asset classes and instruments. At the same time,
client demand changes rapidly as the very low interest rates across the globe foster
the need of savers and investors to act more proactively than in the past, i.e. take
higher risks and invest more than previously or start investing in risk‐bearing asset
classes.
The FinTech Book: The Financial Technology Handbook for Investors, Entrepreneurs and Visionaries Edited by Susanne Chishti and Janos Barberis
© 2016 Susanne Chishti and Janos Barberis
Furthermore, technology in the past few years has enabled retail clients to become
Clients simply start applying their digital behaviour from the e‐commerce sector
to their financial needs and thus are open to digital financial offers. These digital
behaviours changed more quickly than banks could adapt their services offer,
especially because post financial crisis they had to focus on saving the industry by
adapting to a new regulatory regime rather than keeping up to date regarding their
digital offerings. Digital challengers have jumped onto the opportunity and the early
movers among the FinTech start‐ups have attracted substantial attention because
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definition, as the regulatory environment is more demanding than in other sectors.
Extrapolating these trends, it is fair to assume that available assets are going
to increase for digital challengers and thus increase the margin pressure for
traditional players that will be forced to cut costs and re‐focus their business
models. The first digital challengers to traditional players in the field of digital
investment were social trading companies and companies offering automated
investment advisory services (“robo advisors”) both focusing on retail investors.
The first market entrants in the robo advisory field innovated by business model
and did not compete over price. As robo advisory enables all market participants
to compete for the private client, many players in the financial universe will tap the
market of automated investment advice: banks, online brokers, asset managers
etc. will start offering robo advisory services for free. The US market unsurprisingly
started to move first into this direction as Charles Schwab counters Wealthfront’s
successful market entry by offering robo advice for free. Similar developments are
now being witnessed in other markets, for example in Germany where ebase, a
subsidiary of Commerzbank, entered into the robo advisory business in July 2015.
A question mark for the moment remains, whether non‐financial players will enter
the automated advisory space, as they did successfully in other areas, for example
the supermarket banks in the UK like Tesco Bank, M&S Bank, or Harrods’ Bank.
These developments are likely to result in reduced margins in the retail space and
traditional players will focus their activities on more complex areas of the market (for
example, private banking), which will foster competition here and lead to a market
concentration in this part of the market over time, too.
The more robo advisory models mushroom – white‐label versions are already
available for example from start‐ups in Germany – the more different algorithms
 will be competing in future and will align over time. The independent robo advisory
providers are forced to continue striving for innovation and will over time offer more
connected services like a concept that can be labelled as the “talking portfolio”.
The Internet of Things will create completely new business models and markets in
all aspects of our current lifestyle. Money matters are not excluded from this. For
example, self‐driving cars, plus the Internet of Things, plus insurance will in the
future allow a bunch of tailored solutions in the InsuranceTech space.
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The Internet of Things will also have an impact on our savings and investment
Capital and Investment
culture. The investment world will see similar developments as the insurance world:
why should only petrol stations and hotels be shown on Google Maps? Why not
the next available (human) investment advisor? Why should a navigation system
in a rental car not offer the option to choose a portfolio‐optimized route? Such
a service would provide information on companies that are directly or indirectly
linked to the current portfolio holdings of the investor: only Royal Dutch Shell gas
stations, no other fast food locations than Starbucks would be displayed, and of
course respective vouchers would be given to shareholders first, etc. As self‐driving
cars are connected to fridges and other household appliances, the “driver” has
time to consider decisions about whether today he would like to optimize his daily
household spending on optimization of his short‐term trading portfolio, or instead
the long‐term investment portfolio. Based on the global real time and projected
drive thru waiting times at McDonald’s, the portfolio itself will issue buy or sell
recommendations on McDonald’s stock. Also the connected fridge or freezer will
have a button to order portfolio‐optimized food only, telling you every morning that if
you and all other users of this service use this service, the joint financial gain will be
“x” % p.a. on invested capital. The portfolio holdings and its expected return will be
automatically readjusted based on the aggregate buying activity of all connected
smart fridges. Such a trend could result in the formation of special interest groups/
communities based around investment styles. Analysis of investors’ private and
business lifestyle through smart appliances will certainly result in buy or sell
recommendations for certain asset classes or securities.
While these developments seem like fiction today, we currently see only the
beginning of robo advisory structures that enable start‐up companies to enter
a high margin business. In the US robo advisors are mushrooming already.
Techfluence assumes the number of automated advisory services to at least rise
tenfold globally in the next few years. Advisory services become a commodity. More
sophisticated tools, which allow investors for example to exclude certain product
providers from the portfolio or single asset classes or even single stocks, will be
able to offer this as a fee‐generating premium service, which can be paid in fiat
currency or social currency, i.e. personal data sharing models.
The traditional competition among portfolio managers on the best (risk‐adjusted)
performance will at least partially be replaced by competition of the best algorithms
of the automated analysis providers. The technological developments thus impact
all parts of the value chain of wealth management. Successful sophisticated
investment algorithms will also be offered through B2B channels as robo advisory
with a human touch. UBS is already using smart data verified by client advisors
to optimize portfolio returns. As more social trading platforms emerge and grow
more user profiles, advisory services – online and human – will be added to the
platforms, helping investors to select the best user mix in their social trading
portfolio.
As robo advisory services entered the market only recently, especially in the next
few years, there is going to be direct competition between automated advisory and
human advisory services, be they branch‐based or online. Over time, this will lead
to hybrid models as it is fair to assume that the growing complexity of algorithms will
lead to the need for human support, thus creating new job opportunities, too. The
investment advisor of the future does not pick stocks or asset classes on behalf of
the client but consults on algorithms or even helps tailor them.
In summary, the FinTech industry is set to disrupt the digital investment area as
a whole, starting with B2C business models, with B2B to follow soon. The whole
value chain of wealth management will be under tremendous pressure to change
and adapt. The new competitors have the ability and agility to offer products and
services digitally and the successful players will continue to innovate. The Internet
of Things and wearables will boost this development. Traditional players should use
their grace period as they still earn high recurring fees from the past by investing
these wisely and try to compete with the new FinTech players and actively seek
collaboration with tech companies.