Written by: Scott Martin | The Trust Advisor
Hoopla around nominally free portfolio population and rebalancing tools exposes deep divide between self-directed “mass affluent” and high-net-worth advisory cultures.
Charles Schwab’s advisor-focused “robot” portfolio program only went live last week and hard industry lines are already forming between people who are convinced it’s an evolutionary leap and those who think it’s an extinction event.
On one side of the argument, every advisor needs to embrace automation in order to compete. But on the other, fears of a Terminator-style robot revolt run deep, feeding suspicion that the days of human advisors are numbered.
From everything I can see, the truth is somewhere between hype and hate. And the early numbers indicate that higher-end wealth managers may be pretty far from the “hype” position.
Yes, advisors – especially those who are already racing to the bottom – need to evolve or find themselves squeezed out of the industry.
But if you provide a value-added solution that makes extremely wealthy investors happy, you have little to fear here. This particular robot is going to have to work hard to take your place.
Giving it away for free?
The core of Schwab robo – formally known on the advisory side as “Institutional Intelligent Portfolios” – boils down to automated asset allocation and selection. Plug in the client’s initial risk profile and the tools do the rest.
In theory it’s a great way to liberate the advisor from the rote work of picking the funds, rebalancing and harvesting tax losses along the way. The advisor stays in front of clients and earns the bulk of the fees, while the “robot” does the brute lifting.
As a bonus, reasonably big Schwab affiliates get it for free. Those with under $100 million in AUM pay a minimal 10 basis points a year for the privilege.
But with the firm aggressively promoting the system to its independent RIA partners now, the assets need to add up fairly fast to demonstrate advisor buy-in.
Bringing the robot into an existing practice is free or so close that the drag is going to be minimal. On those terms, if RIAs don’t sign up, it’s because they don’t see the value or they’re worried about hidden strings attached.
Meanwhile, Schwab is clearly angling to make money on the cash component of those robot-dictated portfolios once interest rates start climbing. Low rates were a pain point in the last quarterly earnings call because assets parked in the firm’s money markets weren’t working hard enough.
With a widely reported floor of 4% allocated to cash across robo portfolios, there’s a significant corporate incentive here to help affiliates streamline their client investments along similar lines.
While a 4% cash cushion feels reasonable for a middle-class retiree like the people who make appointments with Schwab offices, it’s a lot of money when you start dealing with true multi-millionaires.
Taking that money out of the market and letting it molder in minimal-interest banking products isn’t exactly going to impress ultra-high-net-worth clients obsessed with performance. And if the platform won’t flex to accommodate those clients, the advisors who want to work with them are going to have to keep looking for other solutions.
The Schwab robot flexes up to a point. It can populate portfolios from a list of 450 ETFs that are already the destination of about 80% of affiliate advisory client allocations and more are undoubtedly on the way.
It’s a great start and already far from a cookie cutter solution. But the independent RIA principals I know are not going to give up the other 20% without a struggle.
That 20% of the portfolio is usually where advisors differentiate themselves, again in the eyes of HNW clients. It’s where you add value on the portfolio side. There’s a lot of money riding on that specialized slice of the assets.
Schwab needs to make sure advisors who work with wealthy investors aren’t getting locked into delivering a mass-affluent level of service in exchange for the automated system’s convenience.
Otherwise, to be honest, if the system is worth 10 basis points to smaller RIAs, it’s got to give bigger ones at least that much net value. That means “doing no harm” to the existing book and freeing up a lot of resources to prospect additional accounts.
Figure a hypothetical HNW advisor charges 100 basis points now to do everything because it takes up 100% of his or her time. Freeing up the equivalent of 10 of those basis points might open up 4 or 5 hours a week to prospect if the Schwab system is a good deal.
Do you spend that much time on initial asset allocation, rebalancing and tax loss harvesting now? If so, sacrificing the flexibility may turn out to be a great trade.
Not the only game in town
A lot of the hype around this program also focuses around how it’s head and shoulders better than existing “robot advisor” platforms designed for the mass affluent market.
Advisors, on the other hand, have had access to automated rebalancing and model portfolios for a long time now. Automation and outsourcing can unlock enormous growth and profitability as long as the results are a perfect fit for the existing business.
All of this technology is a known quantity for firms with the scale and the vision to reach for it, and as the industry evolves the reasons not to embrace one solution or another become less compelling as the barriers to entry fall.
Schwab affiliates probably need to bring at least one “robot” into the office. I’m just not convinced yet that the Institutional Intelligent Portfolio is that robot. So I asked around.
“Handing parts of the operational platform to any automated ‘robot’ system is probably better than nothing, but advisors who truly want to work with high-net-worth clientele probably need a little more than a cookie cutter
solution,” Cory Kendall, national sales manager at FTJ FundChoice, told me.
FTJ has built a system that provides capabilities comparable to what Schwab is offering, but when it goes live in a few days it will be a true state-of-the-art open-architecture investment platform: managed accounts as well as ETFs, elite outside managers, all bundled in a front-to-back white-label environment.
While clients will never know that you’re not doing all the heavy lifting, you’re free to intervene with the “robotic” protocols at any moment. That’s standard operating procedure in the world of high-net-worth asset management programs.
Mass-market robots are wonderful because they make it possible to deliver professional advice to the middle class on a profitable basis. FTJ and firms like it have evolved to deepen already-profitable HNW relationships, Kendall says.
“The goal here is not to race to the bottom by cutting costs through automation,” he explains. “The goal is to deliver richer, more personalized service to
In-house advisors weren’t exactly eager to promote the opportunity this spring when the program initially rolled out to Schwab’s self-directed investor clients.
The first investor-facing incarnation of the automated portfolio program amassed about $1.5 billion in its first six-week recruiting period, which looks impressive until you set that number alongside the $2.5 trillion on the Schwab broker platform.
Don’t get me wrong: an adoption rate north of $35 million a day for what amounts to a new channel is pretty amazing for just about everyone but one of the biggest brokerage firms in history.
But far from a surge of accounts embracing the robot, that $1.5 billion is practically a rounding error. And with $34 billion coming to the firm’s traditional advisory and self-directed channels across the quarter, a thousand new accounts in six weeks don’t exactly move the needle either.
All in all, only about 11% to 12% of the initial conversions came from in-house fee-based advisory accounts. That’s maybe $180 million in assets, which might represent two independent RIA partners.
Another telling detail is account size. The robot is serving big fish by Schwab standards, but the average early adopter on the platform weighed in at around $80,000 in assets.
These aren’t high-net-worth investors. Once again, we’re seeing mass affluent accounts migrate to a format that I suspect was built with them in mind.
We’ve seen Schwab have to balance its in-house “consulting” model that serves those accounts with its third-party RIA affiliates’ high-net-worth business in the past.
I’d be shocked if Schwab executives didn’t covet the RIA clientele. A few years ago, their decision to start a network of franchised advisory offices was seen as covert competition with the RIAs.
Even though the push for franchises came from the brokerage side of the company, it still raised a lot of hackles. Advisors like working with Schwab as long as the custodian refuses to cannibalize their business and the brokerage network can’t compete head to head for clients.
I’ve heard a little grousing that the robot will learn about the HNW market from the advisors it works “with,” ultimately passing that information back to the parent company as the system matures.
I think that’s a conspiracy theory, but it just shows how fragile the relationship is. Advisors know the HNW market. Schwab’s discount brokerage reps and consultants would love to get into that business because they know that the robots can already do their job faster, better and more cheaply.
Either way, applying a set of tools built for the discount brokerage client to HNW investors may not be the solution anyone was hoping to see. But I’d be happy to be proved wrong.
And for all the advisors who were already feeling the competitive pressure from platforms like Schwab and Merrill Edge: time is getting short to evolve or race to the bottom.
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