In recent years, Wall Street has been hit by an exodus of investors fleeing high-commission, managed funds for better performing, lower-commission index funds. In December 2016, investors pulled $23 billion out of actively managed U.S. equity funds which extended net outflows to 33 consecutive months.
The flight to index funds is a recognition that the average active fund manager does no better than the market, before fees. ?Once fees are subtracted, actively managed funds are likely to do worse, a situation confirmed in a recent Standard & Poors study. The savings can be significant. Assuming that the total outflow of $263.8B in 2016 went into index funds, experts estimate the shift saved investors over $2,000,000,000 annually in fees.
The largest active fund managers are looking at artificial intelligence to stop the hemorrhaging and win back consumers. They are relying on automated algorithms to pick stocks and manage portfolios while also lower costs. And their efforts are paying off. If new projections from consulting firm A. T. Kearny are correct, assets under management by robo advisors will increase 68% annually to about $2.2 billion in five years.
Big Banks are getting in on the AI action. Both Bank of America and Chase have launched robo advising services in the last twelve months. Large institutions depend on a team of wealth advisors and managers to oversee the assets of wealthy customers but the income potential from the great wealth transfer is prompting banks to develop newer, more cost-efficient advisory services that target a younger, less affluent clientele. These younger clients wont be less affluent for long, however. Over the next several decades, Baby Boomers, the biggest and wealthiest generation in U.S. history, will transfer roughly $30 trillion in assets to their Gen X and millennial children.
The great wealth transfer represents a big threat to mega-banks. ?When wealth passes from one generation to another, the recipient usually fires their parents advisors, thereby putting a significant part of the $30 trillion in play. While mega-banks may be scrambling to hold on to their funds, community banks are ideally positioned to grab a sizable share of the prize, for three reasons:
- Millennials are more receptive than the general population to digital banking but when it comes to making money decisions they want face-to-face advice, a specialty of community banks. Word-of-mouth and personal recommendations significantly influence the buying decisions of half of Millennials. A study conducted by Deloite discovered that 82% would like more meetings with their investment advisor. Even Betterment, the $7 billion stand-alone automated investing service which pioneered robo advising recently added access to human financial advisors.
- For a group that has largely earned its bread serving affluent clients?and avoiding smaller, unprofitable ones?this marks a major turnaround for Wall Street banks. Usually, their customers have upwards of $1 million in assets. And, clients that trust their judgment. Thats not the case with Millennials who expect a high degree of pricing transparency and prefer to collaborate with their advisors. Whether they can successfully hold on to a younger, skeptical generation using a stripped-down formula of the algorithm and limited human interaction, remains to be seen.
- Despite deep pockets, big banks will face an uphill fight. They will be hard-pressed to beat out robo advisory start-ups like Wealthfront or Betterment which founded the online advising space and excel in marketing to younger clients. Theyll also have their hands full competing against old-line players, such as Vanguard, the worlds largest mutual fund, or Charles Schwab which introduced the Schwab Intelligent Portfolios product last year. Both have more experience catering to the burgeoning DIY market.
Regardless of the cost-efficiencies of using AI to manage investment portfolios, consumers dont trust them. A recent survey of 12,000 consumers conducted by HSBC across 11 different countries found only seven percent said theyd trust a robot to manage their money. As if to pile scorn on the concept, thats half the number who would trust a robot to perform life-saving heart surgery.
Community banks dont have the will or the need to tackle robo investing. A small banks marketing advantage comes from the bonds built over the years with older, wealthy clients. A banks best bet would be to step up communication efforts with older clients and reassure them that wealth can be transferred easily and securely to the next generation. Even A2D2 cant muster the same trust that radiates from a local banker.