Narrowing the Wealth Gap:The Future of Asset

Management

Debbie ChengChristopher HuangAnn Liu

Executive Summary

1

The United States faces a massive wealth inequality issue. A number of contributing factors have been identified, including the upsurge in labor incomes earned by top company executives and successful entrepreneurs. However, the main issue for this gap is a lack of savings by the middle class. Less than half of Americans are investing their money, and even less seek professionals to manage their investments.

A look at traditional asset management firms reveals the relatively inaccessible nature of such services. Additionally, these services come at a high cost to customers.

Enter the Financial Technology (FinTech) industry. Startups such as Betterment use personal algorithms to invest money and continually rebalance each portfolio according to market events. What is more, this online service is done at a fraction of the cost of traditional financial advisors.

This report investigates the potential impact FinTech startups have on the financial services industry - specifically, on asset management. Recent survey results show a strong interest in online-investment services. With these tools, the average individual can start investing their money and, most importantly, contribute to closing the wealth inequality gap.

Because of

FinTech, up to

22% of asset and

wealth management businesses will be at risk by 2020

The US has been dubbed the “Unequal States of America” due to the size of the wealth gap

Table of Contents

Introduction: The Widening Wealth Gap 2

Current Investor Habits

4

Traditional Asset Management

7

Spotlight on Betterment 6

The Advent of New Technologies in the Financial Services Industry

Technology, Transparency & Trust

13

5

Blockchain: Disruption in the financial services industry

8

Wealth Inequality Revisited

Introduction: The Widening Wealth Gap

All across the world, MEDCs are experiencing the same socio-economic divide -- an ever widening wealth gap between the haves and have-nots. This issue has never been worse globally but the US is a particularly bad example. Recently, the country secured the top spot in largest inequality gap among 55 countries studied, as a 2011 report revealed that the top 20 percent of families exceeded 80 percent of the share of total income (see Figure 1).1 Although a variety of factors contribute to the gap, it has been found that the main driver of this phenomenon is a lack of savings by the middle class. This, exacerbated by the lack of access to expensive traditional asset management services, has meant that the rich are able to amass more wealth while the poor are left at a huge disadvantage. However, robo-advisors -- asset management firms that use computer algorithms instead of humans to identify and manage investment opportunities -- are allowing lower income individuals to access the same financial benefits previously exclusively reserved for the wealthy. In this article, we explore what threats these services pose to the traditional asset management industry and whether such robo-advisory services are truly forces that can potentially narrow the wealth gap. First, we must consider how people currently invest their earnings and whether such an industry is vulnerable to disruption.

Top 20%

Figure 1. Actual distribution of wealth in America

The top 20% of Americans exceed 80% of the share of total income

Distribution of Wealth in AmericaNext 20%

1

Current Investor Habits

79% of respondents in their 50s had not planned for retirement in the last three years

Research into current investor habits show that the majority of individuals do not use asset management services to help grow their savings. Of those that do, a large proportion are wealthy individuals, alluding to the potential positive impact robo-advisors could have on personal wealth management for the masses. The University of Southern California’s Understanding America Study (UAS) conducted a Financial Management Survey to understand financial habits of Americans since recovering from the Great Recession. They found that less than half of respondents have investments. Of those, only 44 percent report using professionals to manage their investments.

Data relating to savings habits in preparation for retirement is not promising either. In the same study, 79% of respondents in their 50s had not planned for retirement within the last three years, and of those, 25% had not determined whether they had enough money to retire.2 The Economic Policy Institute found that the average retirement savings for American families is $95,776 - not nearly enough to retire comfortably.3 However, trends in online banking services are growing, indicating clear opportunities for FinTech startups to improve the saving habits of ordinary Americans and to disrupt a historically alienating industry that has, until recent times, been dominated by traditional money managers.

2

Traditional Asset Management

Traditional asset management firms are financially exclusive and socially divisive, widening the wealth gap by disproportionately benefiting the wealthy and not the poor. Traditionally, there are two methods by which individuals can apply to grow their wealth -- invest directly into the market or invest in alternative assets such as real estate, artwork, and wine. The former requires a great deal of time, a good understanding of finance, and a clear grasp of market trends whilst the latter is commonly inaccessible to those out of the loop. Additionally, asset management firms that specialise in alternative assets usually charge high fees and carefully select their clientele based on their net worth. Such self-selection within the industry has meant that only those that can afford the time and/or capital investment are able to reap the lucrative rewards that this industry is able to provide. According to BCG, total industry profits were $102B in 2014. By definition, the asset management industry is widening the financial rift that pervades most societies in the 21st century.

The asset management industry is contributing to the wealth gap

Key Issues

MarketRequires a clear grasp of market trends

Alternative InvestmentsFirms that specialise charge high fees for services

3

The Advent of New Technologies in the Financial Services IndustryHowever, with the advent of new technologies, the reputations of the old guard of traditional asset management firms are being eroded. In a world that will soon belong to millennials, seamless and elegant interfaces are replacing financial advisors as the first point of contact when one decides to invest their money. Analogous to the flagrant use of Wikipedia quotes in high school and university essays, millennials are more likely to trust a web platform than any demographic that has previously existed. As the world transitions towards ever more automation in services that have long been considered crucially dependent on human input, the asset management industry is starting to feel the heat.

“The Big Squeeze” -- a phenomenon affecting the industry -- describes how money managed by traditional methods withered from nearly 60% in 2003 to 40% in 2016. In parallel, the Assets Under Management (AUM) in low cost exchange-traded funds and index funds have grown from $3T to $10T in 10 years.

Consistent with these shifts in investor habits is an explosion in venture capitalist investment in financial technologies with $10.5B invested in 2015. These “robo-advisory” services promise affordable fees, demand no minimum deposit, and are available to anyone interested. Computer algorithms are replacing the intellect of fund managers, and web platforms are replacing offices.

Hence, at its most fundamental level, technology is driving the democratisation of asset management, giving anyone the opportunity to grow their wealth. With greater access to substitutes that offer better ROIs in the vast majority of cases, the power base is being shifted away from money managers and towards money holders, indicating a pivotal time in the industry. Few quality investment opportunities have existed for individuals with less than $1M in net worth, yet these investors represent a $147T market globally.4 If these “robo-advisors” are able to tap into this market, the financial benefits for all parties involved are truly significant.

Standalone local advisory firms are

beginning to feel “The Big Squeeze”...

...but robo-advisers is a key driver

in the democratisation of

asset management

4

One company that is leading the robo-advisory market is Betterment - an automated investing service that provides optimized investment returns for individual, IRA, Roth IRA & 401(k) accounts. By using computer algorithms, Betterment is able to offer professional-level financial advice to the masses, enabling all individuals, regardless of economic background, to invest and grow their money for a low fee. Based on the client’s profile and his/her financial goals, whether it be buying a house or preparing for retirement, the platform is able to analyze a variety of different stock and bond options to best fit the risk that the client is willing to take. Once done, the system is able to accept and freely manage the fund according to the specifications offered by the client.

Based on past performances, any investment made with Betterment in 2004 would return +117.5% in 2016 compared to +68.4% with the average client investor. Additionally, for any deposit greater than $100,000, Betterment charges a flat rate of 0.15% compared to approximately 1% for traditional asset management firms. It seems clear how within 14 years, Betterment has grown its AUM to more than $5B, representing an exciting paradigm shift in how the asset management industry will change as such technologies mature further.5 However, services like Betterment will never narrow the wealth gap if the low- and middle-class are not interested in investing their money. To investigate the matter, we carried out a survey to gauge whether low-income individuals are interested in managing their money by using services like Betterment.

BettermentWhat: Dubbed the “Apple of finance,” Betterment is an online-investment adviser providing fully automated investment management

Products & Services: Financial advice and investment management to customers

Value Proposition: Better returns for less money than the typical financial

adviser

How does Betterment compare?

Spotlight on Betterment

Figure 2. Portfolio returns6

5

From our surveys, it is clear to see that all people, regardless of financial situation, are interested in using robo-advisors to invest their money (see Figure 3). One insight that we derived is that millennials are “optimizers” when it comes to personal wealth management, that they’re more inclined to seek out the best path that will lead to the highest return on their investments.

Additionally, the trust of the investor is a crucial element that must be secured in order to attract capital. The increased sense of control in using a personal wealth management tool that operates based on algorithms rather than human resources, which may be biased and prone to error, is appealing. Such a tool also offers a degree of transparency in how one’s money is being deployed -- affirming one’s trust in the platform.

Technology, Transparency & Trust

Millennials are inclined to seek out the “optimal” path leading to the highest return on their investments

Would you use an automated investment service that handles your investments for you based on a personalized algorithm?

Figure 3. Survey results

6

Blockchain: Disruption in the financial services industry

On top of that, when used in conjunction with high-security record-keeping systems such as Blockchain, the ability to preserve detailed records and maintain a widespread network of accessible financial information for customers again bolsters the relationship. Securing the trust of the investors is a critical success factor of robo-advisors, and the wealth gap can only be closed if such services prove to be trustworthy.

Another driver of the use of robo-advisory platforms is the overwhelmingly negative sentiment that shrouds the pervasive socio-economical problem. Out of the survey results we collected, approximately 90% of people believe that the global wealth gap is a serious issue that is hard to solve. Whilst there is no easy fix to this dilemma, the increased access to personal wealth management tools such as Betterment creates the possibility of a never-before-seen solution to the wealth gap, thus allowing people from any background to maximise their earning potential.

A Closer Look at Blockchain

What is it?A distributed ledger that combines a number of mathematical, cryptographic and economic principles to secure from tampering or revision.

Why does it matter?According to a global PwC report, use of blockchain platforms could result in large gains in transparency that could be positive from an audit and regulatory point of view.

How do we respond?57% of respondents from a PwC survey said they were unsure or unlikely to respond to blockchain trends. However, the best way to combat significant risk is to incorporate them into new business models for a competitive advantage in the coming years.7

7

Wealth Inequality Revisited

8

Robo-advisory services

are set to become

the new norm for the vast majority

of individuals

With the inherent wealth gap widening, new technologies such as Betterment make it possible for individuals to more easily manage their own money. However, with skepticism in mind, any technology being so disruptive in the financial field will not enter with complete ease--there are pros and cons to shifting towards a human-machine algorithm based system completely free of human-to-human interaction. Some individuals are more inclined to trust a more human element in the financial advising process, a sensitive topic in some cases, while others are more inclined to leave it to computer systems to best optimize a return. Whatever the case may be, with the attention of major financial institutions, robo-advisory services are set to become the new norm for the vast majority of individuals. People, with little knowledge and exposure to the financial world, will be able to use these tools to make smarter, more informed, and more transparent investment decisions -- paving the road towards a more financially egalitarian future.

Fintech will pave the road towards a more financially

egalitarian future

References1 Matthews, C. (2014, October 31). Wealth inequality in America: It’s worse than you think. Retrieved August 31, 2016, from http://fortune.com/2014/10/31/inequality-wealth-income-us/

2 Carvalho, L., Kapteyn, A., & Saw, H. (2015). How Americans Manage Their Finances (p. 18, Working paper No. 2015-020). Los Angeles, California: CESR.

3 Elkins, K. (2016, March 04). Here's how much the average US family has saved for retirement. Retrieved August 31, 2016, from http://www.businessinsider.com/how-much-average-family-saved-for-retirement-2016-3

4 Stefanova, K., Teten, D., & Beardsley, B. (April 11). Asset Managers, Prepare to Have Your Business Disrupted. Retrieved August 31, 2016, from http://www.institutionalinvestor.com/article/3544388/asset-management-equities/asset-managers-prepare-to-have-your-business-disrupted.html#/.V4T9hDWlyug

5 Satter, M. Y. (2016, July 18). Betterment is first robo-advisor to pass $5B in AUM. Retrieved August 31, 2016, from http://www.benefitspro.com/2016/07/18/betterment-is-first-robo-advisor-to-pass-5b-in-aum

6 Why Betterment - Betterment. (n.d.). Retrieved August 31, 2016, from https://www.betterment.com/why-betterment/

7 Yazdani, D., & Weber, G. (2016). Blurred Lines: How FinTech is shaping Financial Services (pp. 17-18, Rep.). New York City: PwC.

Images:

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The Team

Debbie ChengSan Francisco, CA

Business Administration at the University of Michigan

Christopher HuangHong Kong

Molecular and Cellular Biochemistry at Oxford University

Ann LiuWashington, DC

Systems Engineering and Social Entrepreneurship at the University of Virginia