August 2011 The Big 5: technology trends changing wealth management The wealth management industry is being assailed by a range of cyclical and structural forces. FOFA is the most immediate concern for many, but rapid changes in technology may have a more telling long term impact. The internet, plus advances in platform, wealth management and CRM technologies are among the innovations threatening traditional business models. Yet these threats also present opportunities for enterprising wealth and asset managers. Technology is allowing underlying investor and planner needs to be served in different, cheaper, and more effective ways than the industry presently offers, delivering outcomes closer to what investors actually want. If the industry is to continue to be successful, it must absorb this lesson and respond to those underlying needs better than we have been doing. There are huge benefits to be gained for those who do so. The role of technology in wealth management As in most industries, technology has become pervasive in wealth management and a significant cost for participants, whether financial planners, asset managers, platforms, or service providers. But despite all the spend, technology is not often a source of competitive advantage. You can spend as much as you want on technology without ever delivering quality advice, decent stock ideas, good administration, or useful industry insights. Occasionally though, a big change in technology fans the winds of creative destruction - radically changing the industry in the process. It enables profitable new business models and can destroy those of the incumbents. A little history The last time this happened was the arrival of platforms in the early 1990s. Prior to platforms, planners assembled portfolios of mostly retail rollover funds and unit trusts, supported by manual administration and reporting systems. Platforms allowed planners to automate reporting and large parts of their back office but required fund managers to accept intermediation of their planner relationships, develop wholesale ranges, and run the risk of cannibalising profitable retail business. Page 1 of 5
Big profits were made as a result and not just by the new platform industry. Fund managers that made the jump to the new business model prospered too. Those that didn t faded as major forces. It created a great entry opportunity for new managers with no retail book to worry about. 20 years later there s a sense of déjà vu. This time though, it s not just one big change like the advent of platforms rather, several trends are transforming the industry: The internet. Advances in platform technology. The spread of wealth management technology. Financial planning software such as XPLAN. AQUA II and the listed operating model. 1. The internet Why it matters: slashes prices, disintermediates agents, enables online business models Ok, so we appreciate you ve heard of the internet. But have you really thought through its impact on wealth management? Even though managed funds are a standardised product, wealth management has been insulated from direct competition via the web thanks to the strength of financial planners as a distribution channel, the domination of platforms (effectively a private network), and regulation, all of which have retarded direct distribution of funds over the web. These are all still issues. So the market has responded by substituting products which are internet friendly which generally means listed on the ASX. Investors and (increasingly) financial planners are bypassing managed funds by building portfolios of direct shares (both ad-hoc and model portfolios), warrants, listed investment companies, and now ETFs. As a result, SMSFs have around 40% in listed securities and only 15% in managed funds. The resulting loss of business to the wealth industry is huge. At 15%, SMSF have around $65bn in managed funds. But if SMSFs had 75% in managed funds (as an advised client might), that figure would be $330bn a gap of $265bn, together with perhaps $2bn of revenue lost. Now that s the power of the internet. The internet has carved a path of destruction through one industry after another, with retailers of standardised products and intermediaries proving particularly vulnerable. Look at the impact of travel portals on the travel agents. Or CommSec on full service stockbroking. 2. Advances in platform technology In both cases, the internet has greatly reduced the number of successful businesses, and slashed margins. In the early 1990 s, brokerage was as high as 2.5% plus $75 for a stock trade. Now it s 0.3% via an online broker. That s a 90% reduction in revenue: Brokerage on a $20,000 trade Pre-internet $575 Now $60 Why it matters: broadens product choice beyond managed funds, enhances access to direct investments We were recently given a demonstration of the upgraded AXA North platform s investment capabilities. It s broadly comparable with other leading wrap platforms, but still awe inspiring in terms of the investment power being placed into the hands of financial planners. Reduction $515 = -90% Page 2 of 5
Advances in platform technology mean that a financial planner s universe of investments they can recommend has suddenly expanded from predominantly managed funds, to term deposits, direct shares, ETFs, equity models, SMAs and more. Managed funds are now just one choice and will almost certainly be diluted as a category a result. How this plays out will vary a lot by segment. Smaller clients (ie portfolios below $200,000) will likely continue to be substantial users of managed funds: These portfolios are not large enough to benefit significantly from direct assets (other than ETFs). Financial planners need standardised solutions for their smaller clients all the more so post FOFA. Small clients with complicated portfolios will not be manageable or profitable. This is not just about planners. The success of BT Super for Life shows that managed funds remain a good solution for smaller portfolios in the direct channel as well. 3. Spread of wealth management technology Why it matters: disintermediates managed funds via mass-produced model portfolios Wealth management technology is software which permits financial planners to build model portfolios that can be easily implemented across large numbers of clients. These are not platforms although they may be plugged into a platform to upgrade its capabilities. In this space are specialist software vendors, mainstream platforms building basic model functionality on existing technology, and platform entrants with sophisticated UMA technology. Model portfolios can consist of almost anything. In mainstream platforms, models are starting as combinations of managed funds, ETFs, and a selection of shares. But this is the thin end of the wedge. A model could be comprised largely of ETFs, in which case it substitutes for diversified managed funds, or an Australian equities model, defined by the dealer group, supplied by a broker, or by a research house such as Lonsec. Equity models are an area of strong growth, coming at the expense of Australian equity fund managers. In fact, if the planner is armed with an MDA licence, the planner is essentially becoming the fund manager. Fund managers have little presence in this market at the moment, other than equity SMAs, which are well behind the take-up that models have enjoyed. Over the next few years, fund managers need to focus on re-establishing their value proposition and pointing out the underlying risks in models. On the other hand, clients with larger portfolios and their planners are increasingly making use of the new tools available to them. Reduced use of managed funds is evident in both SMSF allocations and planner investment intentions. This may be reinforced by the opt-in provisions of FOFA, if legislated. If there is a need to obtain a periodic renewal from a client, planners may want to present new investment ideas as part of their value proposition something more likely to favour direct investments rather than managed funds. All this new platform capability does not come for free, with major platforms facing capex costs in the tens of millions in coming years. But at the same time, revenues are coming under pressure to convert from basis points to capped or fixed dollar fees, placing pressure on the platform business model. 4. Financial planning and CRM technology Why it matters: may (eventually) allow planners to dispense with platforms, and facilitates the move from managed funds to direct securities Platforms are also starting to come under pressure from financial planning software such as XPLAN which helps automate client management for financial planners. CRM technology helps provide planners with a single view of their clients, via integration of data from most platforms (although AMP in particular does not), and some investment product providers (Platinum being a good example ). Page 3 of 5
In doing so, XPLAN and its ilk are starting to weaken the bond between planner and platform in two ways. Firstly, it weakens the imperative for planners to centralise their clients onto a single platform for efficiency purposes. With CRM technology, a planner has a view of their clients across multiple platforms, so long as they are integrated. Planners may still gravitate towards a preferred primary platform, but with CRM technology, they now typically need a powerful incentive to move existing clients (eg a compelling price differential). 5. AQUA II Why it matters: will allow unlisted funds to be transacted via the ASX AQUA is a regulatory regime that allows investment funds to be quoted on the ASX. The biggest beneficiary of the AQUA rules has been ETFs, although they permit structured products to be quoted as well. Closed-end listed investment funds such as LICs, REITs, and infrastructure funds, where prices are determined by the market, are not covered by AQUA. The ASX is expected to launch the next phase, AQUA II, in the first half of 2012. AQUA II is not well understood by the industry at present, but one of its key aspects is the quotation and transaction of unlisted managed funds. Secondly, CRM technology can work to disintermediate platforms by making it easier for planners to move offplatform. With the loss of volume rebates, a platform based business model may be less attractive, while increased use of equities may allow planners to rely on XPLAN and an online broker as their solution. This is a lead user phenomenon. Although there is interest amongst planners, it is not yet a widespread trend and the large integrated groups which control the entire value chain may well be able to limit its advance. Further, CRM technology still falls well short of the functionality of platforms. But it s now possible for planners to substitute CRM technology for platforms. As CRM technology continues to improve, it will ratchet up competitive pressure on platforms. AQUA II will allow a fund and its last price to be quoted, and for orders to be placed to buy and sell units via the ASX. Trades will occur at the end of the day, rather than live like an ETF, and accordingly the price will not be known until the trade has been undertaken. But it should offer a range of benefits over existing unlisted fund processes, including eliminating much of the paperwork, manual payments, and time delays. The impact could be quite profound : It can create a single operating environment for investors and planners. You could potentially source 100% of your desired portfolio components, listed and unlisted, via your online broking screen. This would deliver significant efficiencies. It would enhance the ability of the managed funds industry to access and serve the SMSF segment. SMSF investors clearly have a preference for a listed operating environment, being avid buyers of direct equities and ETFs. AQUA II may create a direct channel which allows fund managers to engage SMSFs in a more effective manner. Page 4 of 5
What it means for your business Rapid changes in technology have delivered tremendous power into the hands of investors and financial planners, increasing choice and lowering costs. It has also increased the ability of investors to bypass both fund managers and platforms the main sources of revenue for the industry. This will initially impact most on those serving the independent and boutique planner channels - which have more freedom to respond to market forces. Aligned planner channels, on the other hand, are part of integrated groups which control the entire value chain. They are better placed to resist the forces of disintermediation, although these will still surface in planning businesses serving high value clients. Advances in technology come after several years of dismal returns from managed investments and super. The combination of poor investor experience, and increased ability to harness technology to make their own arrangements, is a dangerous one. The wealth industry -and its major participants has an imperative to re-establish their credentials with investors and planners, and to adopt the advances in technology to improve the experience. Otherwise this opportunity will be seized up by others, including non-traditional competitors. It must be noted that these technology trends are not all upside for investors. A world of direct investing, models, and freedom from fund and platform cost structures sounds very exciting, but comes with new risks models that blow up, assets that turn out to be worthless, new technologies that fail to deliver, and outright fraud. The latter is particularly concerning in the SMSF segment and its $440bn of largely unprotected assets. As recent events have has shown, defrauding SMSF investors is much easier and safer than robbing banks. Industry leadership in technology is also clearly in the interests of its investors. The industry still has a lot to offer, not least due to its own investments in technology and risk management (both investment risks and business risks). It should be able to deliver the benefits while protecting investors and planners from the risks associated with new technology. To paraphrase a recent Economist article, technology is doing away with the need for fund managers and platforms but in the process is also very likely to prove the need for them. For more information please contact Andrew Baker Managing Partner abaker@triapartners.com Mark Watmore Partner mwatmore@triapartners.com This email has been produced by Pty Ltd (ABN 14 108 209 721). We are located at Level 3, 275 George Street, Sydney, NSW, 2000. We believe the information contained in this email is accurate, but disclaim responsibility for errors and omissions. This email is general in nature and for the information of industry professionals. Your and / or your firm s specific circumstances need to be taken into account. We do not provide securities advice, financial product advice, or investment recommendations. Where we comment on certain aspects of investments or investment products, this is for the purpose of general discussion and information. Copyright - This email is copyright. If you would like to reproduce elements of it, please get in touch with us. Page 5 of 5