Do the current digital financial product offerings truly solve real investing problems that individuals face? There has been a race to the bottom in digital fintech (and, frankly, in all of finance) to drive fees down to zero. But, despite an industry-wide obsession to add value, there’s been little focus on the value customers actually derive from these new “free” products and services.
Is “free” what Millennial investors want? Or, perhaps, these “solutions” are placing emphasis on the wrong point. Maybe younger investors don’t see any value from the current product offerings and, therefore, don’t want to pay for them (upfront). Of course, I am being cheeky with the “upfront” reference since selling your trade order (via the Pay for Order Flow or PFOF model) means none of us are really getting a free lunch.
The real problem, in my opinion, is the lack of transparency in the entire investing process. Why should investors pay for something if they don’t completely understand it? More importantly, why should they pay for something if they don’t completely see the value?
Whether we are talking about traditional mutual funds, ETFs or even traditional robo-advisors, digital investing platforms have had a myopic focus on offering “fee-free” services to offer a value add to investors. Ironically, the opposite has occurred: Going “free” has forced these platforms to become asset-gathering businesses rather than customer-focused businesses. In basic layman’s terms: If an asset-management or wealth-management firm is experiencing an average revenue per user (ARPU) that is very low, to reach acceptable profitability levels, the firm needs to focus on volume. And a focus on volume leads to a lack of focus on value.
Limited focus on value offered to customers has, in turn, created limited product differentiation. In comparison to the private products offered to high-net-worth individuals, the Millennial customer receives the bare minimum. Forget about access to hedge funds. When have you ever heard a product for the individual investor market use terms like risk-adjusted returns or minimizing tail exposure. They don’t not because these terms are too complicated to understand; rather, they don’t because they aren’t available.
What is the result? A complete commoditization of investing solutions for the average Millennial customer. This reality helps explain the expansion in the wealth gap between high-net-worth individuals and the rest of us. The high-networth individuals have access to the best-in-class investing solutions, fund managers and more, while the rest of us get basic, vanilla products.
Therefore, the future of the investment-management industry, specifically the one focused on Millennial customers, will reside in the adoption of subscription models as a way of commercializing the relationship between the customer and money manager (or wealth manager). I am calling this trend the “Netflix-ication” of the Investment-Management Industry.
From the perspective of younger investors, the concept of a subscription for investing solutions is simple and transparent. After all, almost all our paid services are now subscriptions. Imagine the ability to simply subscribe to the investment manager or investing strategy of choice and have your money invested. No, I am not talking about social trading in which we follow our favorite influencer… I am talking about the ability to have your monies managed by one of the leading fund managers with the swipe of a button (to subscribe!).
From the investment-management industry side, the subscription model is highly disruptive. At the moment, the large mutual fund complexes have a leg up on everyone since the business model is purely asset gathering. This means that, the more assets you have, the easier it is to get more assets. And, if you are dependent on gathering assets to reach marginal profitability levels, the size of your assets under management becomes a wide economic moat that limits innovation in the marketplace. Is it any wonder that three to four firms control most of the assets under management?
By introducing a subscription model, the myopic focus on gathering assets is shifted towards what really matters: the value users feel they derive. At this point, managing churn rates is what is important—not hitting sales targets. The subscription model removes the necessity to focus on growing assets under management to drive greater profitability. Now all that matters is the value rendered to the customers.
Another dramatic effect of the subscription model is that, by removing a dependency on fees, we remove the natural cyclicality of the asset-management business model. At the moment, the asset-management business mirrors the Sin curve tendencies of the US stock market. The high correlations between profitability for investment managers and the behavior of the US stock market creates a feedback loop that drives a focus on cost-cutting, profitability maximization rather than on the value for customers. Contrary to some conventional misconceptions, in downward-drifting markets, really good money-management is very important. The beauty of the compounded-interest phenomenon is that, as long as you don’t experience too many down periods, you don’t need to capture the “big high” days. Your money just keeps compounding upwards.
Shhh… Don’t tell anyone, but that is the secret to successful investing! Those in the business like to obfuscate the concept to sound smart—and they call it a focus on risk-adjusted returns.
The future of the investment-management industry resides in the subscription model: greater transparency for customers, improved profitability for service and produce providers and, most importantly, greater value for the investors.