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CommerzVentures: the rise of the robo advisors from an investor’s perspective

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Over the course of the last few years, the so-called robo advisors have gained significant media coverage in the financial technology (Fintech) space. Invested assets in automated investment services more than doubled from 2014 to 2015 and no Fintech conference has taken place without a newly established robo advisor. Additionally, there have been inflows of hundreds of millions of dollars in venture capital backing into the start-ups behind the robo advisors. Betterment, for example, one of the most famous and largest robo advisors, raised USD100m venture funding in March 2016. We have also started to see the adoption of automated advice by traditional banks and investment managers. This article serves as an introduction to CommerzVentures and our view on the rise of the robo advisors.

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CommerzVentures: the rise of the robo advisors from an investor’s perspective

  1. 1. The rise of the robo advisors from an investor’s perspective HEIKO SCHWENDER FOUNDING MEMBER AND SENIOR INVESTMENT MANAGER COMMERZVENTURES heiko.schwender@commerzventures.com Over the course of the last few years, the so-called robo advisors have gained significant media coverage in the financial technology (Fintech) space. Invested assets in automated investment services more than doubled from 2014 to 2015 and no Fintech conference has taken place without a newly established robo advisor. Additionally, there have been inflows of hundreds of millions of dollars in venture capital backing into the start-ups behind the robo advisors. Betterment, for example, one of the most famous and largest robo advisors, raised USD100m venture funding in March 2016. We have also started to see the adoption of automated advice by traditional banks and investment managers. This article serves as an introduction to CommerzVentures and our view on the rise of the robo advisors. Founded in October 2014, CommerzVentures operates as the corporate venture capital fund of the Commerzbank Group. It backs early and growth stage companies in the broader financial services and insurance industry. We aspire to invest in the very best players in a given market segment with the main objective of generating a financial return. CommerzVentures’ portfolio companies have scalable and attractive business models which have already shown to be marketable and in need of THINKING AHEAD, JUNE 2016 | ISSUE 84 3332 THINKING AHEAD, JUNE 2016 | ISSUE 84
  2. 2. industry in terms of access, price, and transparency. It also addresses the evolution of customer needs and experience. Moreover, automated investment advice scales through technology not people, which is something that we always look for. Consequently, hundreds of millions of dollars were invested in this space over the last couple of years. At the same time investing in robo advisors can be challenging for the following reasons: •Online customer acquisition and brand building in financial services is costly and revenues per customer tend to be small. Robo advisors typically charge somewhere between 20 and 50bps. So building a company with USD100m or more in revenue would require assets under management of more than USD20bn which is approximately six to ten times the current customer assets of leading robo advisors •Commoditisation and margin erosion: Passive portfolio management may become a zero cost game, at least for small investment amounts •Limited horizontal value chain integration: Typically, robos provide an appealing user interface, a smooth onboarding process, and some kind of algorithm for the automated portfolio allocation and rebalancing but neither has proprietary products, nor access to large liquidity pools and trading books. This results in a cost disadvantage and lower profitability in comparison to traditional players •Differentiation: There is only limited differentiation in the business model among many robo advisors Q: How do you see the market for robo advisors developing? We expect to see a market consolidation. We are already seeing robo advisors joining forces with traditional advisors or the outright acquisition of robo advisors by traditional players. The next phase would be mergers between robo advisors to achieve scale. Robo advisors need to move beyond basic asset allocation and attract clients other than millennials. In addition, they will have to differentiate from other robos and the offerings of incumbent offline players. Besides providing an excellent user experience, differentiation can be driven by product or advisory opportunities: Product opportunities: •Access to alternative asset classes •Active portfolio management •Customisation and personalisation at the securities level •Advanced analytics and individual recommendations Advisory opportunities: •Holistic goal & financial planning (retirement, insurance, tax) •Transfer of wealth to the younger generation •Online interaction with human advisor (chat, voice, video) Mass-affluent and affluent customers will likely be served by fully automated advice, offering limited revenue opportunities, but generating a huge amount of valuable data. We believe that ultra high net worth customers will be served in a hybrid model combining automation with access to a human advisor. But eventually even this might change over time as wealth is transferred to Generation X and advisory solutions leveraging artificial intelligence mature. Q: What applications do you see for robo advising in banking/financial services? Banks can leverage digital automated platforms to offer a low cost investment service. The depth of a solution can of course be customised depending on the customer segment. Robo advising platforms can support compliant and optimised investment and rebalancing proposals based on the customer’s portfolio and preferences, which implies added value in contrast to today’s practice where banks often apply a rather generic approach to portfolio recommendations, even for high net worth individuals. Embedded in the banks’ infrastructure, these platforms can generate important data about clients and their behaviour which supports the overall servicing of both an individual client and their peer group. We also see business opportunities for investment banking to provide services to a bank’s digital, automated advice platform, by providing investment strategies, proprietary products, liquidity, or brokerage services. The robo advisor space is still a young phenomenon, but one with a strong growth trajectory. Automated investment advice will likely become the new standard for the mass-affluent and mass-market and it will also influence other investor segments. Human advisors remain important, but will likely focus on sophisticated individual advice which allows them to charge a reasonable fee. The rise of the robo advisors has just begun. investment to support further growth. The regional investment focus of CommerzVentures is Europe, Israel, and the United States. To date, CommerzVentures has invested in five companies: •eToro: The world’s largest social investment platform and active trading community, offering traders easy access to the currency, stocks, commodity, indices, and ETFs •iwoca: A leading European player in the market for online short-term loans to the self-employed or small businesses •Marqeta: The first developer-centric debit card processing and management platform which takes significant cost and friction out of implementing new prepaid card programs •GetSafe: One of the fastest-growing digital insurance brokerage firms in Germany, which is shifting the traditionally offline distributed insurance business to the mobile channel •Mambu: The cloud-based core banking system for alternative lenders, challenger banks and micro-finance organisations, with clients in more than 30 countries to date Q: Which areas within Fintech are of special interest to you? CommerzVentures is a specialist investor as we invest only in companies in the banking and insurance sector. As an investor our job is to invest into those companies that will develop into big businesses in the course of the next 3–7 years. Obviously, picking the right companies is fraught with a high degree of uncertainty and risk. We are looking for companies which solve a real problem in a huge market, scale via technology, and have a defendable USP. These characteristics allow for an attractive exit valuation, especially if the company is led by ambitious and visionary founders. Within Fintech there are a great multitude of investment opportunities. Having met with hundreds of companies we currently focus on the following areas: •New retail banking services and applications •Trade finance and FX in corporate banking •Marketplaces and platforms for capital markets •Big data analytics and artificial intelligence •Compliance, risk management, and cyber security •New, tech-enabled products and business models in the insurance industry However, we are talking about a very dynamic environment, so naturally over time we develop new areas of interest, while others might become less important. Q: What is a robo advisor? A robo advisor provides automated investment advisory and portfolio management services with minimal, if any, human interaction. Launched around 2010, the first wave of robo advisors targeted the millennials segment, specifically tech-savvy and cost-conscious affluent and mass affluent customers seeking investment advice. Wealthfront and Betterment, both US-based, are two of the first companies in this space. These early robo advisors were focused on providing a great user experience and product distribution at a low cost. Building a new consumer brand in financial services turned out to be very costly. Moreover, incumbent financial service providers, such as Charles Schwab, Fidelity, and Vanguard, started entering the market with their own automated advisory services. Therefore, the second wave of robo advisors focused on white label platforms that they would license to established brands in consumer financial services. Some of the early consumer focused robo advisors followed this trend, pivoting into Business to Business to Consumer (B2B2C) enablers. Additionally, robo advisors started to provide more sophisticated services. In addition to expanding the product offering from mainly ETFs to stocks and other investment instruments, they started providing active portfolio management and other value added features such as tax loss harvesting solutions. The combination of these developments has led to digitally automated advice becoming attractive even to wealth management customers. Q: How large is the market? According to Bloomberg and Aite Group, approximately USD50bn was invested in assets in automated portfolios at the end of 2015, which is just a small fraction of the multi-trillion dollar wealth management market. But automated portfolios grew by 210% last year and we expect a massive growth in assets under management in the coming years. But this strong growth is also driven by assets allocated to the newly established automated investment platforms of incumbent players. Q: What is CommerzVentures involvement in the robo advisory space? At CommerzVentures, we are watching this space closely. The elementary idea of robo advisors is highly attractive to venture capital investors; it disrupts the wealth management Commerzbank disclaimer The views expressed in this article are those of the author, and may differ from the published views of Commerzbank Corporates & Markets Research Department and the communication has been prepared separately of such department. No representations, guarantees or warranties are made by Commerzbank with regard to the accuracy, completeness or suitability of the data. THINKING AHEAD, JUNE 2016 | ISSUE 84 3534 THINKING AHEAD, JUNE 2016 | ISSUE 84

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