The Robo-Advisors Business Model: ULTIMATE GUIDE [English]

The worldwide FinTech market has been subject to a real boom in the last decade. Open banking, digital finance, wealth management 2.0 are the propulsion which fueled an exponential development of the worldwide market. Carried by the biggest financial centers in the world, the FinTech ecosystem offered to the market crypto-currencies-based services, 100% digital banking and, especially, Robo-Advisors.

In this article I will identify a general guideline which can inspire any business modeling for Robo-Advisors, with a particular focus of the products currently offered in the GCC area.

Introduction

Until today, only high-worth individuals and high level professionals have a real access to the world of investing. Savers and small-middle investors are totally excluded by the market. They can only address their capital to long-term, vinculating and low-returns bank saving plans. Also, a traditional financial advisor would be extremely expensive and not always efficient. In other words, the low financial inclusion in the GCC region and the total absence of investing user-friendly tools produce a multi-millionaire unfilled market gap.

The Problem

In the current market configuration, a big barrier separates millions of potential small savers from financial investing. This barrier is the mere effect of:

(a) Budget limitation: Low financial accessibility due to high minimum capital amount that is required for investments

 (b) Financial knowledge limitations: Average people have limited knowledge about investing so they are usually dependent on financial advisory, which are extremely expensive

The Opportunity

In order to break the barrier, the challenge will be to make the financial investing accessible to the currently excluded 50% of GCC population. According to the World Bank, the total savings volume across the GCC region is about 628 Billions USD. One can easily assume that the GCC total addressable market is 589 Millions USD (BD 233 Millions), corresponding to the 0.01% of the total savings volume in the region.

Business Environment

 The pandemic impact on the economy made people reevaluate their financial management. In the new “normality” people will review their financial behavior, start saving more and make sure that their savings are properly allocated with satisfactory returns. Until today, the GCC small and middle investors have addressed their savings to Pension Funds or Bank Savings accounts, vinculating their money in very low-return solutions. Millions of small and middle savers would willingly use a service which could make their savings grow automatically, in a more flexible way and at higher return rates than the ones offered by the banks and pension funds.

Feasability

 In a nutshell, an automatic robo-advisor address your money automatically to a basket of stocks, bonds, equities and other financial products. In the 99% of the cases, the user’s capital is invested to ETFs with different compositions and balance between percentage of stocks and bonds in the same basket. The choice of whether to invest in a specific ETF or in another is motivated by the risk profile that the user selects a priori.

From the IT infrastructure point of view, the implementation of the algorithms is complex and expensive, since transactional functions have to be combined with AI codes which allow the robo-advisor to stay updated about the performance of the worldwide ETFs and to choose the best one. On the other hand, some hybrid robo-advisors may have to sustain lower cost of IT implementation if they just provide a brokerage service to other robos.

Sources of Cost

 In the most generic case, the following sources of cost have to be taken into account:

-      IT Development

-      IT Infrastructure Set-up

-      AWS/Azure (Pricing per hour and per usage)

-      APIs (particularly expensive in the case of open banking of for 3rd party connection)

-      FX: it’s the currency exchanger service provided by online operators (which are the main providers also for the trading platforms)

-      Payment System: Since customers will have have to pay in order to open a new investing position, one needs to choose the cheaper solution. Traditional payment gateways take between 0.15% to 0.90% which is too much is compared to the robos management fees. Of course this solution has to be excluded. If your robo is shouldered by a licensed fund, will be easier for the customers to subscribe investing plans. Otherwise, additional e-payment fees will have to be payed

-      Taxation Policy: the customers investing in financial markets (directly or indirectly) are subject to taxation laws according to the local jurisdiction. By the way, the taxation is solely related to the individual regardless the headquarter geographical location of the broker or the fund

-      Yearly Licensing Fees: According to whether the product is registered through the Regulatory Sandbox (see Bahrain case of CBB) or as an Investment Company, annual licensing fees will be due.

-      Promotion: As per every digital product, promotion is an essential part of the enterprise growth. More investments in promotion means more visibility, more visibility means more customers which fuel the revenue growth

Fees & Commissions

 There are essentially three revenue stream coming from three different fees that a robo-advisor can set. These are:

-      Management Fee: Regardless the position performance, the robo will charge it

-      Performance Fee: Over a default performance threshold value, the robo will charge an additional fee

-      Withdraw Fee: this is often fixed, but can also be charged as percentage of the total amount that the user is actually withdrawing

The Robo-Advisors which are not shouldered by Funds will eventually invest in other funds that will charge the Robo with the conventional pricing (as it was an individual customer). This means that there is another 0.10% - 0.25% additional ETF fee that will be charged to the end user.