Charles Schwab has thrown a gigantic wrench in the hot new “Robo Advisor” business model. Since announcing their free Robo offering (which does the same thing the other Robos do, but without the management fee) and their Institutional platform (which gives any financial advisor the option to use a Robo approach) we’ve seen a series of attacks by the various Robos on Schwab and also on one another. And the general gist of these attacks is “we’re not like the rest of Wall Street”. This differentiation sounds intriguing, but it is a business model destined for failure.
The reason why Schwab can offer their Robo service for free is because they have a diverse “Wall Street” business. Not only do they have their own ETFs, but they are also a bank. So, they can sweep cash holdings into their bank and they can charge fees on their own ETFs. The other Robos can’t do this because they’re not banks and don’t have their own ETFs. In essence, they are forced to charge their customers a management fee ABOVE what they charge on the underlying ETFs. So, if you open an account at WealthFront or Betterment you get some version of a “passive” indexing portfolio with the ETF fees PLUS you pay a management fee. At Schwab you just pay the ETF fees (and no, Schwab’s “cash” allocation is not a “fee” contrary to some misleading assertions).
This is where things get tricky for the smaller Robos. You have to be oblivious to use one of the other Robo Advisory firms given the cost advantage that Schwab offers. They are literally implementing the same service without the management fee. If there was ever evidence that the Efficient Market Hypothesis is wrong it’s that these smaller Robos still have some level of assets under management. But they don’t just have assets. They’re actually growing. In essence, people are choosing a higher cost version of what is essentially identical products. This makes zero sense and it is totally unsustainable.
The smaller Robos are in a branding bind here. They are hesitant to adopt their own ETFs because then they begin to blur the lines on being fiduciaries. It’s highly unlikely that their ETFs would command the same low fees as the same ETFs at Schwab or Vanguard (due to sheer scale). And they don’t want to become banks because then they look like the brand they are trying to differentiate themselves from. In essence, in order to survive these FinTech firms are going to have to become some version of old Wall Street. They must adopt their own ETFs, become banks or offer more traditional advisory services. This will become even more apparent in the coming years as there are rumors that Merrill Lynch, Fidelity and Ameritrade are all starting their own Robo services. Once these players get in the game it is game over for anyone who doesn’t have their own ETFs and/or a bank.
Competition is a beautiful thing. And the smaller Robos now have a difficult choice ahead of themselves. Will they become what they hate? Or will they bury themselves trying to uphold a standard that is uncompetitive? In my view, these firms are likely to become something they’ve tried to claim they’re not. They will slowly morph into some blend of a human/robo advisory business with arms in banking and product placement. If they don’t do this old Wall Street will simply adopt their technologies and slowly make them obsolete.