Robo-Advisors Won't Dent These 4 Firms

In 2015, positive sentiment toward robo-advisors was about at its peak with predictions of them disrupting the traditional wealth management industry. However, at that time we wrote a report titled “Hungry Robo-Advisors Are Eyeing Wealth Management Assets,” taking the opposite view, stating that the economic moats of established financial institutions would keep them safe. Additionally, we opined that due to the high cost of client acquisition and low profitability of robo-advisors that many of them would go out of business or be acquired.

Our negative view on them largely played out. Currently, all signs point to the largest, standalone robo-advisors being unprofitable; multiple robo-advisors have chosen to sell themselves, likely due to their uncertain future; and the established investment service firms are still going strong. In fact, some of them have developed digital advice services in the last several years that have gathered more assets than the standalone robo-advisors that have been around for about a decade. With all that said, the pendulum of market sentiment has likely swung too far to the negative side.

We recently updated our thoughts on robo-advisors, writing a report titled, "Robo-Advisor Upgrade: Installing a Program for Profitability," and now believe that select robo-advisors have a good chance of becoming profitable after having evolved their business model during the previous several years. Three key areas of weakness that they've come to address include: one, lowering the cost of client acquisition, such as through third party partnering and creating lead generation products; two, creating a high operating leverage business model even if they go the hybrid route and have human advisors on staff; and three, increasing their revenue yield on client assets through cross selling additional services or using proprietary products in their portfolios. It's the third factor of increasing revenue yield on client assets that is the main driver of us becoming more positive on the space, as it was their original business model with many of them having a 25-basis-point revenue yield that made us negative on them.

At the moment, we believe that some investment service firms like Credit Suisse, UBS, Invesco, and BlackRock are trading at attractive valuations and that they will continue to thrive despite the growth of robo-advisors and digital advice. Additionally, both of the robo-advisor special reports that I mentioned are currently available on the Morningstar blog and corporate site.