Why The Financial Engines/Edelman Financial Deal Could End The 401(k) Rollover Bonanza

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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 this blockbuster announcement, the M&A announcement of the week, that private equity firm Hellman & Friedman is buying Financial Engines and taking it private for a whopping $3 billion in cash as a purchase, and perhaps more importantly from the advisor perspective, will be merging mega-RIA Edelman Financial (of which Hellman already owns a majority stake they bought back in 2015) into Financial Engines.

Which is a big deal not just because Financial Engines got bought for $3 billion and has an estimated $169 billion of assets under management in the 401(k) space, but also because Edelman Financial itself has $21 billion under management and is one of the largest independent RIAs in the country, with almost 35,000 clients of their own for whom they do investment management and financial planning.

Which means, in essence, Hellman & Friedman just brokered a massive deal to pair together one of the largest players in managed 401(k) accounts with human financial planners from Edelman at a size and scale that a few others besides maybe Fidelity have even attempted.

And that's not only a big deal just as an opportunity for Hellman & Friedman, but it portends of what I think are some really interesting trends underway in the broader world of financial advice and how consumers get financial advice that I think will impact the financial advisor community for a lot of years to come.

Why Merging Financial Engines With Edelman Financial Is A Win-Win Deal [Time - 1:49]

First and foremost, I think it's worth recognizing what a brilliant deal it really is for Financial Engines to be merging with Edelman Financial. From the Financial Engines' perspective, this is an opportunity to add a new higher financial advice service tier for its top 401(k) clients, in a world where reportedly Financial Engines is only charging between 0.2% and 0.6% for its managed accounts, but Edelman's fee schedule starts all the way up at 2%.

Now, to be fair, that's what Edelman charges for individual retail consumers who come one at a time. I suspect that if Edelman Financial is going to distribute advice through 401(k) channels with big enterprise-level deals, that fee is probably going to come down a little bit. But the point remains that the pricing power for human financial advisors, much stronger than just managed accounts, great technology, and robo-advice.

And I think this was the strategic vision that Financial Engines tipped off a couple of years ago when they bought the Mutual Fund Store in 2015 and added 125 physical branch locations with local human advisors. Which is a big deal because Financial Engines has often been referred to as the original robo-advisors since they've been primarily a technology-driven managed solution to help with 401(k) plans going back to almost 20 years, and suddenly the OG robo-advisor bought 125 in-person branch locations with human financial advisors. That is a big strategic shift for Financial Engines.

Now, there's some debate out there as to why Financial Engines is taking the next step with Edelman and all of its advisor locations across the country merged in. So when the news originally broke, I tweeted out that it seemed like Financial Engines must have been so happy with the results of the Mutual Fund Store that they wanted to scale it up with more advisors. The buzz I'm hearing since then is that what may have precipitated this was more that Mutual Fund Store advisors didn't go deep enough with their advice, and was primarily a retail investment solution at the end of the day. They were not a provider of comprehensive financial planning, and that Edelman Financial gives Financial Engines kind of the deeper financial planning chops that provides greater depth that they need to really add a meaningful advice layer on top of what their managed accounts provide for an additional advice fee.

Either way, though, it still emphasized the point that even the biggest player using technology in the managed 401(k) space sees its future as layering more human advisors as a value-add on top of the technology, not as a replacement for human advisors, which I think is a pretty resounding victory for the future of human financial advice.

From the Edelman Financial perspective, though, this deal also looks like a huge win to me, because the magic question for Edelman Financial for years now has been, "How will Edelman grow without Edelman?" What happens when Ric retires? And while the company has been trying to diversify its marketing strategies, for years most of its growth and success over time has been anchored to Ric's books, Ric's radio show, and Ric's speaking. So what happens when Ric finally retires and isn't there to drive the marketing effort anymore? The answer: Give Edelman Financial an opportunity to be distributed to 1 million clients that Financial Engines already serves, which is about 30X the size of Edelman's client base.

So, to put it mildly, there's a whole lot of growth now that Edelman Financial can get through Financial Engines just crossing over financial advice to existing 401(k) plan participants, and it doesn't need Ric to do that in the same way that it did in the past.

Of course, not everyone in the 401(k) plans will want or need financial advice or be able to afford it, but it's important to note that Edelman Financial has always actually been the mass affluent wealth management firm. They are not focused on the high-net-worth space with $1 million-plus account minimums like so many other large RIAs. Instead, Edelman has about 35,000 clients and $21 billion of AUM according to their ADV, which, if you do the math, is an average of that client size of just under $600,000. And that's after a nine-year raging bull market lifting up their account sizes. And just a few years ago, their average was just about $400,000 per client household, which means there should actually be a pretty large base of more affluent Financial Engines clients who would fit well with Edelman's financial planning solution. Not all Financial Engines' clients, but a whole lot of them when Edelman already successfully delivers planning to the mass affluent at a pretty considerable scale with 35,000 clients.

And so Edelman brings the chops to Financial Engines to really learn how to institutionalize financial planning and bring it to market at scale, again, because Edelman serves already one the largest providers of human financial planning advice at scale, and now they get this opportunity to grow at many multiples larger, expanding into the Financial Engines' client base.

So my guess is Financial Engines and Edelman get about five to seven years to grow in this new merged thing, and the ultimate goal is Hellman & Friedman probably wants to re-IPO the combined entity at a much larger size and a much, much larger revenue base back into the public markets as all these human advice services provide a higher tier solution for the 401(k) client base at a higher price point. Which gets both a good ROI for Hellman & Friedman and ultimately gives Ric Edelman the victory of actually building an independent advisory firm from scratch that culminates in an IPO to become a publicly traded company. Which I think is not just an absolutely amazing achievement for Ric, but really for the entire independent advisor community. You know, it puts financial advice on the map in a new and different way when you can take a financial advisory firm from scratch in an independent model and IPO it in public markets.

The Future Of Fees For Advice Are NOT Robo-Advisor Fees? [Time - 7:24]

From a broader industry perspective, though, I can't emphasize enough the significance that the company that was arguably like the OG, original robo-advisor has been buying a series of human advisory firms, first Mutual Fund Store, now Edelman Financial, to deliver this increasingly sophisticated human financial advice to their robo clients.

The trend isn't unique to Financial Engines. We've been seeing it happen all across the robo-advisor space as their organic growth rates have been declining. A huge number of the original robo-advisor solutions competed against human advisors and have now pivoted to be technology platforms for human advisors. So BlackRock bought FutureAdvisor, SigFig partnered with wirehouses, Vanare or NestEgg pivoted to become AdvisorEngine with money from WisdomTree, Invesco bought Jemstep for advisors, etc., etc. And we're seeing now the next generation crop of, call it, B2B from the start solutions that have emerged more recently like RobustWealth and NextCapital. And of course, there's the fact that even Betterment launched a human advisor premium solution last year.

And the reason this is significant is that it's not just that the technology really is being proven out as a means to augment human advisors more than compete against them (which was something I'd been predicting back in 2012 when the current crop of robos showed up), but also that the robo-advisor price point isn't likely going to be the actual endpoint for financial advice after all. Because the real fear that cropped up in the advisory industry when robo-advisors first showed up was not just, "Oh, geez, they have better tech, we're all screwed. Consumers are going to pick robos," or anything like that, but there was a lot of fear of, "Oh my God, our fee is going to actually go down to 25 basis points, I don't think I can compete. I don't think I can run my advisory business with a fee schedule of just 25 basis points."

Except what the robo-advisors are now learning is that financial services kind of sadly is such a low-trust business, consumers don't automatically just buy the lowest-cost solution. Instead, they start wondering if something is hidden to make it a low-cost solution. Or they assume that lower cost equals lower quality. Not always the case but a common fear.

And moreover, I think the robo-advisors still fundamentally misunderstood what human advisors actually do to add value. The robo-advisors thought that all we do to get paid 1% is asset-allocated portfolio, which they said they could do with technology for 25 basis points instead, and what they're actually learning is that clients want to pay for that advice relationship. And we already had technology that minimizes the time we spend creating asset-allocated portfolios. It was only ever a small percentage of an advisor's time for a decade or more now where we've had rebalancing software for 14 years. It predated Betterment and Wealthfront.

And so what's really happening as a result now is robo-advisors are struggling to find profitability and scale at their 25 basis point price point and are increasingly trying to add human advisors on top to deliver more value and charge more as a result. Or stated more simply, the initial fear when robo-advisors showed up was that humans charged 1% and robos charged 0.25% and the humans were going to have to capitulate down to the robo level. And instead what we're finding is it's the robo-advisors who are capitulating up to the human advisor value proposition and then trying to price themselves back up because it wasn't the 1% human fee that was wrong, it was the 25-point basis point fee for robos that was actually wrong and not working.

And thus I think why Hellman & Friedman sees this mega-opportunity to merge Financial Engines' robo solution into Edelman Financial's human advisor so Financial Engines can have a higher tier service and charge more for human advice, to get paid more in advice fees.

Now, to be fair, I don't necessarily think this means all robo-advisors will come all the way up to the 1% fee because their technology probably does mean they can run a 1% fee model at something a little less than 1%. The case-in-point example is properly Personal Capital, which gets branded as a robo-advisor but it's really not, it's all human financial advisors. They're mostly based in Denver. They use technology to augment the human advisors. And they don't charge 1%, they charge 0.89%. So they're a little lower. Technology efficiency helps. But that's less about fee compression and simply the recognition that firms better using technology for efficiency can charge a little less and still maintain their profits because the technology just makes the firm more efficient so it's easier to charge a little bit less and still be as profitable as they were. That's what happens when technology augments humans instead of replacing them.

The Beginning Of The End Of The 401(k) Rollover Bonanza? [Time - 11:54]

All that being said, though, I think the biggest trend actually portended by this Financial Engines-Edelman Financial deal is the one that the industry has missed so far, and is that the rise of human financial advice solutions directly in the 401(k) channel, as Financial Engines is going to offer through Edelman Financial, may mean the beginning of the end of the giant 401(k) rollover bonanza that powers so much growth in the advice business today.

Which matters because the industry data is pretty clear, the overwhelming majority of advisors serve baby boomers who are approaching retirement or already in it, and we do that because that's where the money is. The people who've had the longest time period to accumulate their wealth tend to have the largest portion of it, so baby boomers who are at the tail end of their careers tend to have the largest pile of assets, which is where most advisors focus when most of us are in the assets under management business.

But historically, defined contribution plans like 401(k) plans were self-directed. So consumers both accumulated their wealth in a retirement plan and didn't have an advisor to help with it, which meant that the act of retiring was both a money-in-motion event. Financial advisors have used for 30 years now the defined contribution movement to grow their businesses because it put big dollar amounts that retirees spent decades accumulating in play all at once for a prospective retiree who probably never had an advisor to help with that money up until that point. That's the incredible opportunity. That's why there's so much focus on retirement rollovers from 401(k) plans and has driven a lot of success for retiree-centric advice firms over the years.

Until Financial Engines merges with Edelman Financial and starts offering human financial advice in the 401(k) channel to 1 million plan participants. Such that by the time those people are getting ready to retire, they may have already had an Edelman human financial planner for 1 or 3 or 5 or 10-plus years and they don't need to find a new financial advisor to roll over to, they just continue with their current Edelman advisor after they retire. And that entire market opportunity for independent advisors to grab all these 401(k) rollovers from unaffiliated consumers that didn't have an advisor begins to vanish.

Now, you may be wondering whether this creates conflict of interest issues for firms like Financial Engines and Edelman. I don't think it actually does because what's going to happen is that Edelman Financial will offer advice to the 401(k) plan participants while they're still in the plan. I don't think it's just about grabbing the rollovers. It's in the plan. So whatever Edelman Financial ends up charging for its human advisors in that, you know, higher volume 401(k) space, the ones who want to pay a higher advice fee for advice will already be paying their Edelman advisor.

So what happens when they retire and roll over their assets? Nothing. They're already paying the advisor. They'll just continue to pay the advisor. There's no fee differential. There's no conflicts like a rollover to us so we can make more in the outside advice fee than we made in the 401(k) plan. The same fee they're already paying will apply because it's the same advisor on both sides already providing that value-added layer. They'll simply move from an Edelman advisor helping with the Financial Engines managed account, the 401(k), to an Edelman advisor probably giving a Financial Engines equivalent managed account in an outside RIA for the same fee, for the same ongoing advice, for the same managed account solution, the same investments. Which means there's no conflict of interest for all those 401(k) clients already working with an Edelman Financial advisor.

Now to be fair, the shift isn't entirely new. Companies like Fidelity have long been trying to offer more advice and managed account services in the 401(k) channel in the hopes they can deepen that relationship with the 401(k) plan participant and have them stay at the firm. For Fidelity, that historically meant just trying to get them to roll over from a Fidelity-administered 401(k) plan to a Fidelity-administered IRA, but I think even Fidelity wants to go deeper.

I predicted this years ago when Fidelity bought eMoney that it wasn't just about serving the advisor community with this financial planning software they bought that's popular with RIAs and broker-dealers, but that eventually that eMoney dashboard would be offered to every Fidelity 401(k) plan participant out there to track their own financial well-being. And then when they're ready to retire, they just get this message that says, "Did you know you can already go to any one of hundreds of Fidelity branches and talk to a CFP certificant who can give you retirement advice on the spot?" Because the 401(k) participant already linked their accounts to eMoney, which means that Fidelity branch advisor can do financial planning on the spot. There's no data gathering. It's already in the software, and the branch advisor just starts giving advice on the spot.

Still, though, Financial Engines seems to be taking this to a whole other level because it looks like Edelman Financial won't just be there to give advice to Financial Engines' participants who are getting ready to retire and rollover, it may be offered to them directly while still working. That's the game changer. Which means they'll already be advice clients before rollovers are ever on the table, which means realistically, most of them will probably just continue to be the same advice clients for Edelman when the rollover occurs.

And that I think is the biggest part of this Financial Engines and Edelman Financial deal. Sure the financial wellness trend has been out there for a while, you know, offering some financial education to 401(k) plan participants as a way to charge 401(k) plans a little more to provide an additional service, but layering in a higher tier service (full-scale financial planning from Edelman advisors), that's the game changer, because it's a new distribution channel for human financial advisors. Which is why it's so great for Edelman Financial because it allows them to grow without Ric in the future.

But again, this goes beyond Edelman Financial. This is the potential, I think, to change the whole independent advisor space as well because if most consumers end up getting their financial advisor and paying for their financial advisor directly through their 401(k) plan long before they ever get to retirement, Edelman advisors just keep serving them in retirement. And the only way advisors now start winning clients away is niches and specializations that pull them away from their existing Edelman advisor.

I hope that helps a little as some food for thought and perhaps a unique take on the big news about Hellman & Friedman buying Financial Engines and merging Edelman Financial into it.

This is Office Hours with Michael Kitces. We're normally 1 p.m. East Coast time on Tuesdays. Obviously, I'm traveling this week, InvestmentNews' Retirement Income Summit, at MOKAN Trust Conference today, Philadelphia Estate Planning Council tomorrow, so I had to squeeze this in from the hotel room while I could. But thanks for joining us, everyone, and have a great day.

So what do you think? What are Hellman & Friedman's end goals for buying Financial Engines and merging Edelman Financial into it? Is this the beginning of the end of the 401(k) rollover bonanza? How will advisors compete with firms who are already serving 401(k) clients in the future? Please share your thoughts in the comments below!