Large, Fragmented, and Stratified: Venture Opportunities in WealthTech
Tags: Investing, Startup, Wealth, Venture Capital, Finance

This post is the first in a series on WealthTech written with Charge by me, Renee Li, a full-time MBA student at Columbia Business School. Prior to B-school, I was an Investment Associate at BlackRock. By building this investment thesis publicly, I want to create a resource for others like me who are trying to break into VC.

The wealth-management industry, a market with $487 billion in value in 2019, is large and fragmented. UBS, the global leader, has a 3% market share. There were more than 270,000 personal financial advisors working in the US in 2018 according to the Bureau of Labor Statistics.

Despite the abundance of wealth advisors, the vast majority of the market is underserved. The industry stratifies customers in a manner similar to airlines. The result is that mass-market consumers, the ones that need advice the most, get little to no service. “Affluent” clients, with between $300,000 and $1 million in assets, get premium-economy treatment i.e. may talk to advisers by phone and choose from ready-made funds. “High-net-worth” clients, with up to $15 million, fly business class, picking stocks and getting in-person advice from advisers. Flying private are the “ultra-high-net-worth” individuals, who have access to alternative assets, currency hedges, dinners and golf outings. While high-net-worth individuals typically pay no more than 1% of assets in fees each year, the mass affluent often pay over 2% for inferior service[1]. Cattle class gets no service at all.

The Business of Wealth Management and its Discontents

The majority of wealth advising firms operate under the “brokerage” model, where licensed financial advisors are paid on a commission basis and are responsible for all aspects of serving their clients, including selling, onboarding, advising, as well as portfolio management. The brokerage model contrasts with the “banking” model, where financial advisors are paid on a salary basis and are part of a large wealth management company with segregated Relationship Managers, Investment Specialists, and Support Teams who serve clients collectively.

While the brokerage model has its obvious benefits (e.g. clearer incentives and revenue ownership), it presents many challenges for wealth advisors. It burdens wealth advisors with many non-core tasks that take up a lot of their time. From my conversations with wealth advisors, many complain about the amount of time and hurdles that they have to jump through to serve their clients. For example, when a certain client becomes identified as a “high risk” individual, advisors spend hours on obtaining the relevant checks in order to serve these clients. According to a survey conducted by Forwardlane, wealth advisors spend less than 50% of their time on servicing clients (see chart below).

Processes in the Wealth Management Business

Source: Oliver Wyman, Winning at All Costs — Cost Management As Key Success Driver

The advisors take a “commission”, or “asset-based” fee, although the industry is transitioning to “fee” based. Fee-based revenue now contributes 69% of overall gross production, up from 49% in 2015. The industry is challenged by declining margins. Annual fees for new accounts (for households with $1 million to $1.5 million invested) averaged 1.01% in 2019 down from 1.07% in 2015[2]. Dwindling margin is another reason why the wealth management industry must adapt to increase their operational efficiency and client engagement.

Another trend is the proliferation of Registered Investment Advisors (RIAs). These are independent, fee-only firms regulated by the Investment Advisers Act of 1940 that are required to be fiduciary. This contrasts with the traditional “wirehouse” full-service brokerage firms such as Morgan Stanley, Bank of America’s Merrill Lynch, UBS, and Wells Fargo, who are incentivized to sell their own products and services. As consumers become savvier and realize the conflict of interest of these non-fiduciary investment advisors, they migrate to RIAs, resulting in the number of RIA clients soaring 85% over the past eight years to 43 million[3].

Source: McKinsey, The state of North American retail wealth management

Given the demographic profile (high net worth, ~65 years old) of the clientele as well as the advisors themselves (~50 years old), wealth management is a highly relationship-driven business. Most clients are acquired through referrals of families served. Other channels include conferences, networking events and centers of influence (accountants and attorneys). Advising is typically conducted through in-person conversations, dinners, or golf outings.

However, the high-touch, relationship-driven, business model is fundamentally unfit for today’s digitally native millennials. Millennials are defined by DIY culture, prefer to compare features before making decisions, and have little patience for inefficient service. While some LeadGen startups have emerged to serve millennials, much more can be done in this space. Moreover, millennials view their banks as transactional and not relational. On the other hand, financial advisors have traditionally preferred serving clients more holistically (rather than serve clients who may be spreading their assets across different advice providers). From 2015 to 2019, average accounts per household served have climbed up to 3.1 in 2019 from 2.7 in 2015[4], showing a deepening of client relationships. Therefore, we believe that there are opportunities for lighter-touch wealth advising business models to serve the millennial segment.