Innovation. What innovation

One of the great benefits of being semi-retired is spending time with people in the same situation or still working full time in financial services; particularly over a long lunch. And the other day an ex-colleague and I were talking about innovation in the long-term savings, investment and protection markets. Or should I say, the lack of it. In fact, it seems to me that most innovation has been driven by regulation. PEP‘s and then ISA’s are a good example. As are low cost workplace pensions and most recently pensions freedoms.

 

In the protection market I guess critical illness was innovative but of course that was originated in South Africa. Impaired life annuities would certainly qualify. However, extending the concept of underwriting to a product where life expectancy is important looks pretty obvious in retrospect. Several years ago, innovative, guaranteed unit-linked products emerged as a possible solution for people needing access to investment funds with a guaranteed income under-pin. Aegon, Axa, Hartford Life and MetLife entered the UK market. But low interest rates, adviser attitudes and capital requirements led to all these players closing down their products

 

One could argue that even though platforms were an Australian import they were innovative as they led to a fundamental change in the value chain and impacted the business model of many life companies. Institutions such as Aviva, Axa, Aegon, Standard Life, ZFS, Skandia, and Old Mutual decided to build their own to compete with the nimbler and more focussed new entrants such as Transact, Nucleus and Novia. The latter were, in fact. not just innovators but disrupters. And I guess their impact has cost UK life companies wishing to compete a total of over a billion pounds in platform development costs – so far.

 

Historically, disruption has been very scarce indeed. In fact, the only examples that come to mind are the Skandia open-architecture concept which resulted in life companies becoming distributors of their rival’s funds and the network concept invented by Ken Davy that allowed small “brokers” and direct sales people to build their own successful businesses on the back of higher commissions, back office support and authorisation

 

But more disruption is now coming; albeit slowly. Needless to say, it is being driven by technology. And it can be seen it two specific areas: The challenger banks and the challenger wealth management business – often referred to as robo-advisers. Both of these business models face significant hurdles. Access to capital, regulation and, last but by no means least, access to customers. Note “customers”, not clients.

 

As far as capital is concerned I have been surprised how much cash is being invested by institutions into the challenger wealth managers. But I guess I shouldn’t be. Anything that looks like a Tech proposition carries a very high premium. Even when it is not a Tech company. As was the case of WeWork; which was valued at $47bn when approaching its IPO and fell to about $10bn a month later when it was clear that their claims to be a technology platform for businesses rather than a property company were less than 100% accurate.

 

In the UK Nutmeg has raised about £120 million over the past few years and I believe it is now valued at about £250 million. Investors have included institutions such as Schroder and Goldman Sachs. Interesting given that Schroder is building a conventional wealth management firm with Lloyds and the rumours are that Goldman Sachs are launching an investment ISA via their Marcus platform. Nutmeg has also raised over £2 million via crowd funding from their customers. I have to say I am a bit uneasy about this as I would consider the business to be an illiquid fairly high-risk investment. The very opposite of the funds on the platform and only suitable for a small segment of investors. Other challenger wealth managers have received backing from institutions: Moneyfarm from Allianz, Wealthifly from Aviva, and WealthWizards from LV= to name a few.

 

So, raising capital does not seem to be a problem. But, clearly, making a profit is. And my guess is that if you look at all the players’ UK P&L you will see total losses in 2018 to be approaching £100 million. Why? The cost of customer engagement. And the more players in the market seeking the same consumer profiles the more they will all have to pay. Not a problem if you are Schroder and Lloyds, Santander or Goldman Sachs and other. They already have millions of customers.

 

Here are some interesting numbers. Goldman Sachs launched Marcus with a 1.5% interest rate offer. In about eight months it attracted 250, 000 new customers and £8 billion of deposits.  A pretty good base if they want to sell ISAs. Nutmeg has been around for eight years and has attracted around 60,000 clients and about £2 billion under management. Let me be clear, I am only using Nutmeg as an example as they claim to be the leader in this market. They may well be doing well against their peers but I recall they claimed that they were going to disrupt the market and that looks like a long way away. In fact, their losses keep increasing and their UK financial model could well be flawed. My belief is that players with existing client banks are likely to be the winners.

 

Will all the activity in the challenger wealth manager space, does it pose a threat to advisers? Probably not in the short term. And in any event a substantial number of advisers have limited capacity to take on new clients given their on-going client service commitments. However, I think advisers can, and should, think about the on-line proposition. After all, not every client wants face to face meetings and not every adviser wants to sit down with every client.

 

Over time, innovative online information and transactions technology will be a hygiene factor for financial advisers. And it will also be a solution to reduce costs and free up adviser time to meet up and engage new clients. Sounds sensible to me