05/11/2020 by Dominic Hobson 0 Comments
THE CURRENT AND FUTURE STATE OF DIGITAL TECHNOLOGY IN WEALTH MANAGEMENT PART I
A SUMMARY AND FULL REVIEW OF THE DISCUSSION AT THE WEBINAR ON 28 OCTOBER 2020
The wealth management industry in the United Kingdom is serving a maximum of 15 per cent of the market for financial advice in digital form, so it has massive growth prospects.
Majorities of investors in type, sizes and age groups wish to purchase ESG products, and wealth managers are scrambling to catch up.
Data capture, processing, integration and analysis is becoming central to the wealth management proposition, from ESG investing to fund distribution.
Wealth managers in the United Kingdom are not yet enthusiastic about security or illiquid asset tokens but are not educating clients about the opportunity either.
AI and ML algorithms are being applied to data sets in wealth management, especially by portfolio managers, but also in post-trade operations.
The operational inefficiencies and technological inadequacies in wealth management have attracted private equity investors which believe scalable technology can transform the industry.
Current technologies are adequate to service current levels and types of business but cannot meet the digitisation and data management challenges wealth managers now face.
A major challenge for wealth managers is integration of the internal and external systems and data sets necessary to deliver a full digital service to clients.
Wealth managers can build their own platforms or outsource to specialists. Outsourcing creates challenges in terms of initial and ongoing due diligence.
The global pandemic has accelerated investment in digitisation because client demand cleared internal obstacles rapidly.
Wealth managers remain behind retail banks in the sophistication and speed of development of mobile phone-based digital services in particular.
The difficulty FinTechs encounter in prising clients off wealth managers risks complacency setting in, but also implies that wealth managers must not risk client trust in the rush to digitise.
The best way for wealth managers to cross-sell while preserving the trust of clients is to use digital technology to free up the time of advisers to spend longer with clients.
The largely manual and paper-based client on-boarding process is ripe for digital transformation, and could become fast and seamless through the use of digital identities.
Wealth managers which fail to deliver an effective digital promise to their chosen client groups face retreat into a niche or extinction.
Wealth management in the United Kingdom is affected by a number of factors. The best known are an ageing population looking to sell for income or bequeath assets to the next generation, and a retirement savings market whose growth is guaranteed by the compulsory defined contribution pension schemes introduced from October 2012. Much less visible is the large number of people that are interested in taking financial advice in digital form.
A large appetite for digitised financial advice is not being met
At present, four and half million people in the United Kingdom are paying 27,000 financial advisers to help them manage their savings. This is less than half the ten million who say they are willing to pay for advice and cannot obtain it, and less than a sixth of the 30 million who say they are prepared to absorb financial advice in digital form. In other words, the digital wealth management market alone is populated by more than 25 million consumers.
Millions of investors, from Millennials to Ultra High Net Worth Investors (UHNWIs), want to interact with their manager digitally. Importantly, they also want their wealth to impact the world in ways that are not negative for the environment or society. The annual review of global wealth management by Morgan Stanley and Oliver Wyman predicts that environmental, social and governance (ESG) investments by wealthy individuals will be worth US$9 trillion by 2024.*
Demand for ESG products is growing faster than wealth managers can respond
ESG, unlike traditional forms of investment, also engages investors intensely in how their savings are managed. This is further reinforcing the need for digital interaction with customers from a marketing as well as a servicing point of view. It is driving investment in the data gathering and processing capabilities that drive ESG asset allocations, investment strategies and reporting.
This is why ESG is a mounting source of concern among wealth managers. In September 2020, UBS Global Wealth Management became the first leading wealth manager to advise clients to choose ESG investments over traditional strategies, because they are likely to deliver better long-term returns. When a US$2.6 trillion wealth manager places a bet of that kind, it attracts the attention of competitors of all shapes and sizes.
“Greenwashing” solutions can provide short term relief but are already attracting unwelcome publicity and might well cost assets in the longer run. Wealth managers seeking substance in the field are instead embedding their ESG strategies in asset allocation, portfolio management and sales and relationship management. Some are even opting for B Corporation status. Work is in hand to add non-financial returns to performance measurement.
Data management and analysis is essential to deliver ESG products and understand clients
The delivery of any of these components of ESG investing depends on accessing, processing, analysing and presenting the data that informs investment decisions, adds to investment performance measurements and substantiates the ESG reports given to clients and regulators. And gathering and using data entails investment in technology.
Wealth managers, like asset managers, are investing in better data about their clients too. This is complicated where firms sell through intermediary distributors that control access to end-investors, but improved data about which distributors are selling which funds and to whom provides useful information about which products to expand and which distributors to reward. It can also help mitigate the risk of mis-selling.
Blockchain technology is often touted as a way of circumventing the data obstacle set by distributors maintaining sub-registers of underlying clients, but this is unlikely to develop quickly. Where blockchain is cited less often, but may develop more quickly, is investing itself. Yet security and other asset-backed tokens that are issued traded, settled and safekept on blockchain-based networks are becoming mainstream.
Wealth managers in the United Kingdom are slow to embrace tokenisation
Crypto-currencies are an asset class some private banks in Europe support already. Investing in tokens is an idea they are also discussing with UHNWI clients, particularly in relation to ESG investments (such as renewable energy) and illiquid assets (such as real estate, fine art, classic motor car and rare coins. It makes sense: illiquid assets make up two fifths of global wealth, and UHNWIs own a lot of them.
The digitisation, fragmentation, issuance and sale of illiquid assets in the developing token markets also makes sense for UHNWIs as issuers. They can continue to enjoy the assets while releasing some of the capital invested in them. As investors, UHNWIs are usually the first into alternative asset classes, as they were with hedge funds, because they can afford to take the risks.
However, wealth managers in the United Kingdom are not yet convinced that the token markets are an asset class they wish to access on behalf of their clients. This is partly because they are not yet convinced they can perform effective due diligence on digital assets listed and traded on blockchain-based networks, but mainly because demand from their clients has yet to materialise.
Wealth managers should do more to educate their clients. They need to experiment, not just with UHNWIs but to appeal to small-print and technical jargon-phobic millennials and generation Zers poised to inherit wealth from their Baby Boomer parents. There are understood, for example, to be 3 billion gamers around the world. Yet recruiting clients through the “gamification” of wealth management – not just by offering rewards equivalent to air miles but by drawing on the insights of “nudge” initiatives - has scarcely begun.
AI and ML algorithms are being used in portfolio management and operations
What has begun is the application of artificial intelligence (AI) and machine learning (ML) algorithms to investment decision-making. They were adopted by quantitative portfolio managers some years ago to process conventional data such as earnings reports and to make use of alternative data sets such as satellite information and patent applications.
Now they are being used to collect and analyse information essential to ESG investing and reporting, which would be impossible to do manually. But AI and ML algorithms are also being applied to the data held by the operational side of the wealth management industry. The principal goal is to reduce manual and repetitive tasks, with the algorithms hosted by Cloud providers such as AWS and Azure.
The opportunity to scale wealth management with technology is attracting private equity
This is important work because buoyant ad valorem fee income from rising assets under management (AuM) has masked serious operational inefficiencies and technological inadequacies in wealth management. These are grave enough to have attracted the interest of the private equity industry, which has begun to invest in wealth management in the United Kingdom.
Private equity sees in wealth management an attractive combination of durable relationships (a wealth management client stays with a firm for an average of 12 years, against just three at an asset management house) with inefficient client relationship management (characterised by endless form-filling and paper-based interviews based on hit-and-miss income and capital submissions by clients) and crude risk management techniques (essentially, allocating clients to pre-packaged fund portfolios based on a questionnaire designed to measure their risk appetite).
In short, private equity believes that the profitability of wealth management in the United Kingdom can be transformed by applying the sort of technology that can make the business scalable. It is looking to buy and merge firms to achieve this. For clients, the potential benefits include more efficient on-boarding and reviews, a wider choice of products, an improved user interface, greater asset safety and, perhaps, keener prices.
Current technologies are insufficient to meet the challenges the industry faces
But the delivery of these gains is obviously contingent on the execution of the mergers. Changing the way any firm operates, and its underlying technological infrastructure, is a complex undertaking. However, private equity involvement has at least made clear to all parts of the industry that systems which are adequate to current business are not capable of meeting either the challenge of changing client expectations or the challenge of gathering assets from a new breed of client by digital means.
True, most wealth managers already possess standard marketing automation, personalisation and content management systems, but they are crude by comparison with the technologies used by new entrants, and customers of all kinds now expect sophisticated digital interfaces. Even mass affluent clients still expect a high degree of personalisation, and that can be delivered at scale by digital technology only.
The principal challenge is integration of internal and external systems
Delivering this complex blend of the digital and the personal ultimately depends on the ability to knit internal and external systems together, and it is this integration problem that lies at the heart of the technological challenge facing wealth managers.
Creating links between different internal systems to capture and present information holistically, and linking them in turn to the external systems and networks required to capture data and execute transactions beyond the internal workings of the firm, is impossible to achieve with the simpler technologies on which most wealth managers rely today.
The choice confronting wealth managers is therefore two-fold. They can invest in the transformation of their internal systems. Or they can rely on third parties which possess the requisite capabilities, such as Pershing or Platform Securities or – in the longer run - alternative providers whose offering is based on blockchain technologies.
Wealth managers which outsource face formidable challenges in due diligence and monitoring
Whatever technological platform a firm chooses, the second course has profound implications for the modus operandi of those wealth managers which choose it. They will in effect become concierges, managing on behalf of their clients sets of products, content and services manufactured and supported by specialist providers.
Any form of outsourcing changes the risk profile of a wealth management firm. Wealth managers that choose to orchestrate specialist providers rather than provide everything in-house will find that the linkages become points of vulnerability. The quality of due diligence, to establish the cyber-security and operational resilience of third parties from both procedural and technical points of view, will become substantially more important.
Moreover, orchestrating specialist third party providers effectively on a day-to-day basis requires management information, data and reporting as well as seamless technical and procedural interfaces. In addition, regulatory compliance has to be built into the management of the outsourcing providers. The complexity of that task obviously multiplies in line with the number of jurisdictions the wealth manager covers.
The global pandemic has accelerated client demand for digital services
But these challenges have to be met, and the global pandemic has added urgency to the task. Asset valuations came under pressure initially, threatening fee income. The surge in home-working accelerated the adoption of digital means of communication, with Zoom calls for client reviews becoming essential to relationship management.
The Morgan Stanley-Oliver Wyman report estimated that digital engagement by clients had increased between seven and ten-fold since the virus took hold in the spring of 2020 – and without diluting demand for advice from a human being either. But on-line interactions proved an unexpected success, surprising wealth managers wedded to face-to-face relationship management.
The sudden and intense pressure to go digital also cleared longstanding internal obstacles to investment and forced digital laggards in the wealth management industry to bring plans forward or develop new ones. That said, there remain plenty of laggards, and ample room for incremental improvements in existing services.
Wealth managers remain behind retail banks in their digital offerings
To take a vital example, the Morgan Stanley-Oliver Wyman report noted that the average wealth manager updates their mobile telephone app – now the primary means of communication with clients - half as often as the average retail bank, and one fifth as often as the average FinTech challenger.
One implication of this is that it will be easier for wealth managers owned by retail banks or which are prepared to partner with retail banks (as Schroders private wealth management arm has with Lloyd’s Bank, to provide financial planning services for affluent customers) to compete with digital challengers.
The FinTech struggle to win clients risks complacency but illustrates the wealth management USP
In reality, this leisurely approach has not mattered much yet. Wealth managers have not felt as much competitive pressure from digital challengers as, say, payment banks. Like payments banks, the digitisation of wealth management is inhibited by legacy technologies that make it harder for them to exploit digital telephony than a start-up. But it is equally hard for digital challengers to detach clients from established wealth managers, which build up considerable reserves of trust over the 12-year average life of a relationship.
Indeed, the major challenge for traditional wealth managers in digitising their client service and investment products is to do so without forfeiting their principal competitive advantage: the trust the customers have in the quality of their advice and their integrity. While the least valuable clients might be satisfied with a completely digital service, their most valuable clients want human interaction as well as digital interaction.
So wealth managers must now strike a commercially viable balance somewhere between the demands of UHNWIs – which invariably employ three or more wealth managers, so can switch to a competitor relatively easily - for more and better human interaction supplemented by real-time information and the grander opportunity to use technology to gather the assets of other groups by digital means alone.
The best way of preserving trust is to use digital technology to free up the time of advisers
One area where technology can help immediately is digital tools that augment human advisers. Using automation and on-line self-service apps to reduce the administrative burden on personal advisers is an obvious instance of this. Another is using technology to close the gap between what a wealth manager can do well and what their customers ask or expect of them.
The traditional options were to do non-core work badly or unprofitably or refer the client to a third party, for which they also collect no reward. Tax, pension, legal, mortgage or insurance advice tended to fall into this negative territory. Yet these issues are the core constituents of a holistic wealth management service, however reluctant wealth managers are to embrace them.
Fortunately, a great deal of advice can be mastered by a rules-based, data-consuming machine. In fact, it definitely will be mastered by AI and ML machinery as Open Banking evolves into Open Data, and computers can examine data about the income, expenses, assets, income tax position, insurance provision and debts of an individual customer over a run of years.
Even the relatively crude robo-advice technologies of today, which invite customers to answer ten to 12 questions, can deal with a great many rudimentary requests in these areas already. Where they cannot complete a request, they can still refer a partially completed answer to a fresh-and-blood adviser for a full and informed conversation in a way that cuts time and cost by as much as 75 per cent.
Clearly, if the time of a financial adviser is spent more efficiently, they can give better advice and sell more. But the potential of automation to increase cross-selling in this way will not be fulfilled unless wealth managers recognise the need to incentivise and reward staff for venturing into new products and unfamiliar areas of (regulated) advice rather than relying on their willingness to do whatever the client asks.
Digital tools help there too, because they can free up even more of the time of financial advisers by automating simple and straightforward requests, such as putting a small sum into an Individual Savings Account (ISA) or topping up a pension fund.
Even at the level of the UHNWIs, where the complexity of the questions posed by clients frequently necessitates drawing on other specialists, technology helps because it enables wealth managers to deliver in real-time the information - such as valuations, income statements and tax liabilities – on which the advice must be based.
Client on-boarding is an area of inefficiency ripe for technological transformation
Another area of wealth management ripe for digitisation is the client on-boarding process. Whether a wealth manager is on-boarding retail clients or distribution intermediaries, systems exist already that can complete KYC, AML, CFT and sanctions screening checks; exchange client or distribution agreements; open a new account; and register a new relationship in CRM and compliance systems, with manual interference restricted to approvals. Digital identities would vastly improve the efficiency with which retail clients are on-boarded.
Little is certain about the future of wealth management, but it is safe to predict that wealth managers which fail to digitise the client on-boarding process will be among the firms which shrink or even fail.
That said, an efficient digital on-boarding process will be of little value even to the winners if the subsequent experience of the client is largely analogue.
Wealth managers which fail to digitise will shrink or disappear
Digital technology is, for the first time in the history of wealth management, opening the industry up to serious competition for clients and their assets. The accumulation and decumulation of assets, including tax and pension wrappers, is already being digitised. So is client risk profiling and on-boarding. And digitisation is not going to stop or go into reverse but intensify.
Wealth managers which do not embrace digitisation will not survive - except in a vanishing number of ever more obscure niches – but those which do must also seize the opportunities digitisation will create. Digital technology can support distinction as well as scale. It will free up time to think as well as to service clients, and it will reward those firms which can combine the widest range of people skills - intellects, background and experience - with well-integrated technology and rich data sets.
Questions to be addressed at the next Wealth Management discussion
1. What is the nature and extent of the data challenge wealth managers face and how can it be solved?
2. Into what areas will robo-advice expand over time?
3. Are crypto-currencies an asset class wealth managers need to offer clients?
4. What will encourage wealth managers to adopt security tokens as an asset class?
*Morgan Stanley Research and Oliver Wyman, After the Storm: Wealth Management Blue Paper, 2020.
The Future of Finance is always open to hold further meetings to answer these and other questions and to continue the conversation. If you would like to sponsor such a meeting please contact Wendy Gallagher at the number or email address below. Also view our upcoming meetings elsewhere on www.futureoffinance.
Tel: + 44 (0)7725 160903