Advisor #FinTech As A Distribution Channel For Insurance And Investment Products

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#OfficeHours with @MichaelKitces Video Transcript

Welcome, everyone! Welcome to Office Hours with Michael Kitces.

For this week's Office Hours, I want to talk about a theme that's coming up more and more in a lot of my recent consulting conversations. The idea that technology can be a product distribution channel for asset managers and insurance and annuity companies, and how that's beginning to reshape the nature of product distribution for companies that work with financial advisors.

From the financial advisor's perspective, I think we've all collectively begun to notice that product companies seem to be getting more aggressive than ever in trying to compete for our attention. The number of inbound wholesaler inquiries that a lot of us get is just overwhelming. I know our firm literally gets multiple inquiries per day by email or phone call across our investment team adding up to literally dozens of contacts per week. It's so voluminous that we don't even have the time to politely respond, "No, thanks" to all of them, or we'd have to have a staff member that just said no to people.

And there was actually a recent Practical Perspective survey of advisors that found the majority of advisors are now winnowing down and spending less than 15 minutes a day on inbound wholesalers, and instead prefer advisor-focused websites and digital tools that let us contact the product company when we have questions. You know, basically a "stop calling us, wholesalers, we'll call you when we need you" approach.

From the product company's perspective, this is a real challenge. Good firms with good products are struggling to get advisor attention in the way that they did in the past. And new firms with good products are struggling to get any attention at all if they're getting started. And all the companies that are serving advisors I think are trying to figure out what the future is of getting investment and insurance and annuity products to market in an increasingly fiduciary future, where we're more and more using technology and doing our own research to make decisions about what we use in the first place. And so, in this context, I want to talk about the emerging trend that I've been observing over the past few years, which is the idea that technology itself is a distribution channel for financial services products.

Robo-Advisors As An Investment Product Distribution Channel [Time - 2:24]

The most apparent starting point for this shift of technology as a distribution channel I think was the rise of the robo-advisors. So the companies…the early ones started in the 2008 to 2010 timeframe but didn't really hit the industry radar screen with their current models until around 2012, and didn't really start getting momentum until 2014. And it was around 2014 that I started having some consulting engagements with a number of asset managers, particularly traditional mutual fund managers, who were watching the growing popularity of robo-advisors of ETF-based robo-advisors like Wealthfront and Betterment and started asking, "Do we need to launch our own robo-advisors or risk being excluded from this trend?"

And the response that I gave them was just to point out that there's really nothing unique about a robo-advisor that requires the use of ETFs. It just happened to be the product of choice for those particular robo-advisors. All that was really happening was robo-advisors were just a managed account and asset managers needed to treat them the way they treat any managed account opportunity; build our relationship with a manager, try to persuade the manager to use your company's funds in the managed account, which is basically the same relationship that already exists between wholesalers and independent advisors who manage portfolios today or large institutions where asset managers have national accounts relationships with them. So the robo-advisor technology was really just a way of managing the assets, and the technology was essentially just operating as a kind of distribution channel for the asset manager to target.

And this approach really got validated in 2015 when Schwab launched Schwab Intelligent Portfolios comprised almost 70% of Schwab proprietary products, their own ETFs, and the cash position being allocated to Schwab Bank, and then raised almost $5 billion by the end of the year. In essence, Schwab proved that you can use these kinds of technology solutions as a distribution channel for investment products, in their case, their own investment products, and raise some serious dollars.

And in fact, I think it was Schwab's momentum in picking up over $2 billion of assets in just their first 3 months with Schwab Intelligent Portfolios that ultimately drove BlackRock to the decision to acquire FutureAdvisor in the summer of 2015 at a price of $150 million dollars, which was not at all about FutureAdvisor's existing AUM but about the potential that BlackRock saw to acquire and offer FutureAdvisor's technology to broker-dealers, banks, and RIAs, and then put their iShares ETFs into the robo-advisor managed accounts in the exact same way that Schwab put Schwab ETFs into the Schwab robo-advisor managed account.

In other words, BlackRock didn't acquire FutureAdvisor for the opportunity to grow the robo-advisor business per se, they bought FutureAdvisor based on the AUM they thought they could gather into iShares products by making FutureAdvisor technology available to advisors. In essence, they were aiming to grow iShares ETF adoption through technology adoption where the technology becomes the distribution channel.

And likewise, this is why you saw on the subsequent year Invesco bought Jemstep because they wanted to include their subsidiary PowerShares ETFs in Jemstep model portfolios. And then why ETF manufacturer WisdomTree invested heavily into AdvisorEngine. Now, AdvisorEngine isn't typically thought of as a robo-advisor, but their roots were actually a robo-advisor called NestEgg. But in the end, AdvisorEngine is basically a robo-advisor for advisors technology tool or what some are now calling digital advice platforms, and they help facilitate model portfolios for advisors, which not surprisingly are probably going to include a few portfolios comprised of WisdomTree ETFs.

The Model Marketplace As A Technology Distribution Channel For Investments [Time - 5:59]

Over the past year, this evolution of technology as a distribution channel has gone one step further with the rise of the so-called "model marketplace". In essence, a model marketplace is a technology platform where advisors can select third-party investment models and then have the trades automatically executed in the advisor's own portfolio management and rebalancing software tools.

And so the distinction from the early robo-advisors like Wealthfront or Betterment or FutureAdvisor or Schwab Intelligent Portfolios is that the robo-advisor isn't the one responsible for executing the trades as the manager anymore, as though they're a TAMP or a third-party manager, instead the advisor actually remains the manager responsible for trading, but the trading is made very easy because the technology rebalancing software can largely automate the process anyway, especially once the third-party manager is sending signals to update the models for investment changes. So the advisor gets to run their own models with technologies but they don't have to pick the models because third-party managers make them available in the model place and the advisor just selects them with a click of a button.

Model marketplaces really kicked off at the beginning of this 2017 year. First at the TDA LINC National Conference, where TD Ameritrade announced it was going to launch a model marketplace inside iRebal rebalancing software so advisors would be able to select third-party models but retain control to implement the models themselves using iRebal. So you don't have to outsource to a TAMP and pay all the TAMP costs or a robo-advisor that acts like a TAMP, the advisor saves the cost by just paying for the software, which in iRebal's case is free for TD Ameritrade advisors, but gets to run the models.

And then just a few weeks later, Riskalyze announced their own model marketplace as a part of their expanded Autopilot platform, which would include both third-party models and a free set of Risk Number Models that were comprised of ETFs that Riskalyze was actually sponsoring through First Trust. So similar to Schwab Intelligent Portfolios, the Riskalyze solution included their own proprietary ETFs, but unlike Schwab Intelligent Portfolios, Riskalyze is still simply providing the models and letting advisors retain control to implement them with technology or even to choose some other models, although choosing other models means some costs for the advisor to use the technology. So Riskalyze didn't quite force advisors in their proprietary product the way that some others did but did try to incentivize them by waiving the technology platform fee in exchange for using their more expensive proprietary ETFs.

More recently, we saw the next natural step in the evolution of model marketplaces, which was the announcement that digital advice platform Oranj, which recently bought TradeWarrior rebalancing software, would be offering its own core software for free, a platform they're calling Oranj MAX, as long as the advisor uses the prefabricated model portfolios in the Oranj model marketplace to implement with TradeWarrior.

Why the requirement to use these prefabricated models? Because the models are created by asset managers like BlackRock who include their own proprietary ETFs iShares into the models and are now paying technology companies like Oranj for the opportunity to distribute to their advisor users. In other words, the technology is becoming a distribution channel that now asset managers are starting to subsidize the cost of advisor technology just to have a chance to get their funds into the hands of advisors that use the technology. That is technology as a distribution channel for investment products.

Financial Planning Software As A Future Product Distribution Channel? [Time - 9:16]

This trend isn't even just unique to rebalancing software and model marketplaces. Last year at the 2016 T3 Enterprise Conference, MoneyGuidePro announced a partnership with a company called Covr, where Covr would use client information in MoneyGuidePro to identify potential gaps in life insurance coverage, and then immediately recommend an appropriate insurance policy where the client can apply electronically on the spot from within MGP. In other words, we move away from just having finance planning software illustrate the need for insurance coverage and a gap analysis, the software now would actually facilitate an on-the-spot electronic application for insurance coverage. Which means for insurance companies, there's now a new opportunity to get in front of financial advisors and our clients with insurance policies by showing up in the insurance policy marketplace inside financial planning software.

And at this year's T3 Enterprise Technology Conference just a few weeks ago, financial planning software newcomer Advizr announced a similar initiative called Accelerate, which will both use a direct integration with Apex Clearing to allow clients to open new investment accounts on the spot while going through financial planning recommendations, but also the opportunity to apply electronically for insurance coverage with a yet-to-be-named insurance partner, which may or may not be Covr again or someone else.

Notably, MoneyGuidePro explicitly stated in their initial partnership with Covr that MGP was not going to participate financially in the implementation of insurance policies through the planning software. It was meant just to be an ease-of-use feature. But in the case of Advizr, it's not so clear whether the company may actually be participating financially in some of the insurance and investment product implementation. Particularly since Advizr also rolled out a solution called Workplace, that allows their planning software to be made available directly to 401(k) participants, who will have the opportunity to use the software to evaluate their planning needs and then implement immediately with insurance and investment products directly within the planning software, through Advizr, to the product companies, which means Advizr financial planning software has turned itself into a distribution channel.

Implications Of Advisor FinTech As A Distribution Channel – Opportunities, Innovation, and Conflicts Of Interest [Time - 11:19]

Even with all these innovations from robo-advisors to model marketplaces to implementing planning software recommendations, I think we're still actually in the early phases of this idea that advisor FinTech tools can be a distribution channel. Asset managers seem to just be figuring out this opportunity that the technology can be a way to get in front of advisors, including the especially hard-to-reach RIA marketplace. And although the opportunity is rather appealing for asset managers…because what I've seen so far is most of these deals are being structured as revenue-sharing agreements for basis points. So, if the clients are investing into the funds then some small allocation of basis points goes back to the technology company, similar to how other revenue-sharing distribution agreements work.

But the distinction here is that asset managers will only be paying for the distribution they actually get. If advisors don't adopt their funds through the technology, the asset manager has no cost beyond maybe the effort to do the outreach and formulate the partnership in the first place, which is pretty good news from a manager's perspective, because you only pay for what you get.

From the technology company's perspective, the good news of this emerging channel is that it provides a critical new source of revenue for a lot of advisor technology companies that can fuel investments in new technology and support new innovation. Realistically, the upside potential of product distribution revenue is probably what drove the big $20 million investment into Riskalyze last year, the $7 million Series A for Advizr, the $20 million investment that WisdomTree made into AdvisorEngine, and, of course, the famous $150 million acquisition of FutureAdvisor by BlackRock for what was probably about 50 times FutureAdvisor's revenue at the time. Because it wasn't about FutureAdvisor's revenue, but the product distribution potential of BlackRock bringing that technology to the financial advisor channel. In other words, attaching product revenue to advisor technology companies is drastically boosting some valuations and upside revenue potential right now.

Because the reality is that when it's just the technology, it's something we pay for as financial advisors, but when it's bundled into an insurance or investment product that the client needed anyways, it's a cost the client pays. And the simple reality is that as advisors, we have already shown far more willingness to have technology cost be borne by the expense ratios of insurance and investment products than by paying for the software directly. Because paying for the software comes from our pocket, it shows up on our P&L... on our profit and loss statement... but a product bundle cost doesn't show up on my P&L.

Of course, the ultimate cost has to be borne by the client, and there's more and more scrutiny on product costs these days, but you just have to look no further than the broker-dealer model where BDs take a percentage of the revenue that clients pay or the RIA custodian model which is still heavily funded by the expense ratios that clients pay, which translates into money market spreads and 12b-1 fees, sub-TA fees, and other revenue-sharing back-ends to the custodian. You just look at that line-up of how so much advisor technology is paid today to see that as advisors we have been much faster to adopt solutions that don't come off our profit and loss statement directly. We like free software, at least when it's good.

At the same time, though, I do think there are some troubling issues with this shift to technology as a distribution channel. First and foremost, the simple fact that I think a lot of the companies launching model marketplaces today are going to fail. And it's because most of these arrangements are revenue-sharing for basis points, which means if the software company doesn't actually get adoption and move money and attract new advisors, the asset manager pays zero and the tech company makes zero.

And it's an issue because most advisors figure out pretty early on what kind of insurance and investment solutions we're comfortable with. You know, we find the products we like, we find the managers, the stories, the investment philosophy we like, and then once we adopt it, we tend to stick there. Maybe some new advisors still trying to figure out how to build their business will be interested in marketplaces, but the majority of advisor assets are with existing advisors with existing processes who are comfortable with their existing approach in most cases, and I think are probably actually going to ignore most model marketplaces and just keep using what they're comfortable with, which, of course, is why wholesalers are struggling so much to reach them in the first place.

But the key point is that even for an advisor technology company, there's no assurance of success by attaching the company's revenue to product distribution because they still have to get the advisors on board using the software and implementing through their software something different than they are already doing in the first place. And because of that, I actually think the companies most likely to endeavor from this are the ones that already have advisor adoption. When companies like TD Ameritrade build a model marketplace into iRebal, which already has significant advisor adoption, there's huge potential. But when a new startup comes along to do the same thing, I think most are probably going to end up failing, because they just don't have the volume of advisors adopting in their software in the first place.

It's basically a redux of the problem that robo-advisors had in the first place. It isn't an "if you build it they will come" marketplace, especially once lots of competitors appear and the marketplace has become commoditized. Because the same big asset managers like BlackRock are pushing their models and products into every marketplace at the same time right now, which is great for BlackRock, because they'll win as long as any of the model marketplaces win, but challenging for the tech companies because they're all going to look increasingly identical in the composition of their marketplaces to advisors. And the more commoditized they get, the more likely it is the existing incumbents with size and scale and market share and distribution will be the winners. So just as Schwab and Vanguard leapfrogged the founding robo-advisors in assets, I think we're likely to see the same thing in model marketplaces.

Perhaps the biggest caveat and warning of this trend, though, is that it does introduce a lot of new conflicts of interests for technology companies that we as advisors have never had to deal with. We've seen the struggles from the broker-dealer and custodian channels. It can be very challenging to navigate that midpoint between getting paid for product distribution and trying to satisfy independent advisors, right? Just look at how many advisors or broker-dealers are up in arms that products are being removed from the product shelves lately, which a lot of broker-dealers are blaming DoL fiduciary for, but the truth in a lot of cases is just that they're using as an excuse to eliminate fund managers who wouldn't pay the money for revenue-sharing and consolidating in the asset managers who are sharing some cash.

Similarly, the recent debacle with TD Ameritrade's ETF Market Center basically came down to the fact that Vanguard wouldn't pay revenue-sharing and State Street would. As a result, TD Ameritrade had to disrupt all of its existing advisor-client relationships to swap Vanguard out for another product company that would pay them more on the back-end. And the more that technology companies become product distribution channels, the more of this we're going to see in the future.

The good news at least is that with technology, it's easier than ever to price shop for the best solution within a marketplace, but as we're seeing in these product line-up changes from broker-dealers to custodians, when the company controls what's in the marketplace, they still control access for advisors. That's the price we pay for getting free software. And so, I'm not sure actually whether some of us in the independent advisor community are going to be very happy with what we get, at least in some instances when these conflicts of interest start to manifest.

Nonetheless, though, I will admit that I'm excited to see how technology is going to reshape what we look at, what we see, what we pay attention to, and how it's impacting product distribution, including in some entirely new ways. The most notable recent one to me is Gainfully, which is a social media sharing platform that recently raised $2.5 million of seed capital with a business model of giving their software away free for advisors because the product companies are paying Gainfully to have their content on the Gainfully platform in front of advisors to view and share. We'll see if that works, but the mere fact that that model even exists is fascinating because it wouldn't have been possible just a few years ago. Product manufacturers would not have been willing to pay what they are now for distributing even just their content to get advisor attention until more and more advisors soured on wholesalers and started forcing this change in how products are distributed through advisor channels.

But the bottom line is just to recognize that a major shift is currently underway where, as advisors increasingly adopt technology, the technology itself is becoming a distribution channel for products. That opens new doors for asset managers, insurance companies, and annuity companies, who seem to be very willing so far to pay to get access to advisors in a competitive marketplace. And because I think these will just get more and more popular as more and more product manufacturers come on board, start chasing them, throw our dollars at them, and generating more buzz around them. Which, again, means more new tools for us, more new innovation for us advisors, but more new technology with the whole range of conflicts of interest that we have never had to deal with before. These are interesting times!

I hope that's helpful as some food for thought. This is Office Hours with Michael Kitces. Normally 1 p.m. East Coast time on Tuesdays, although unfortunately, we were a little bit late today. But thanks for joining and hanging out with us, and have a great day, everyone!

So what do you think? Is financial advisor technology becoming a distribution channel for insurance and investment products? Will advisors be willing to adopt solutions offered by start-ups? Will this trend create new conflicts of interest for financial advisors? Please share your thoughts in the comments below!