The New York City-based robo added $1 billion in 11 months and (sources say) has bigtime RIAs contemplating it as a primary platform, CEO Jon Stein says

February 19, 2015 — 2:01 PM UTC by Brooke Southall

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Brooke’s Note: This is a story about Betterment but it could just as easily be a story about the remarkable way in which Fidelity is embracing the robo-challenge. The Boston giant, true to its private company hype, seems to be looking down the road as it gains valuable market expertise by helping out Betterment, which in some ways is looking to disrupt — even take some assets directly away from — it now. David Canter delivers candid comments about his firm’s approach and you can’t help but be struck by how the coopetition mentality differs from Schwab’s in-house robo launch, based on what it disclosed to the SEC.

On the strength of $60 million of venture capital it just raised on top of the $1 billion of AUM garnered in the last 11 months, Betterment Inc. is showing serious signs of cracking the RIA market — perhaps most effectively as an RIA custodian.

The New York-based robo-advisor and robo-custodian reported today that it closed a financing round with San Francisco-based Francisco Partners, with Bessemer Venture Partners and Menlo Ventures, both of Silicon Valley, and Milwaukee-based Northwestern Mutual Capital, joining in.

Betterment had fewer than $400 million of managed assets last March but since then the business has begun to explode — both as a utility to 65,000 end consumers and as a platform for 90 RIAs. The RIAs have mostly come in through Betterment’s collaboration with Fidelity Institutional Wealth Services on Betterment Institutional, a collaboration put into play last October. See: Fidelity and Betterment sign a deal with Steve Lockshin and Marty Bicknell as groomsmen at the altar.

“Every month is bigger than the last,” says chief executive and founder of Betterment, Jon Stein. “This suggests there is a momentum factor. It’s not just what we spent on advertising.” See: April Rudin taxis in to Betterment HQ to see how the robo-advisor will fare.

Stein adds that last year the average account size was $14,000 and it now stands at $21,000.

Peace of mind, pronto

With Betterment’s success has come ramped up expectations, which accelerated Stein’s plans to raise capital by a year. The robo raised $30 million last April and still has more than $30 million in the bank.

The firm will put its new money to use by investing more is in algorithms that address investors’ questions that currently go unanswered.

“The questions we hear from our customers are: How much should I be saving in my IRA versus my 401(k)? Am I saving enough relative to my goals? We want to give that peace of mind in five minutes. That’s not an easy task,” says Stein. See: How one 'robo-advisor’ got $25 billion on its platform with a Mint.com mindset, 401(k) friendliness, a merger and 16 years of work.

David Canter: It can be perilous to control the ecosystem or believe you are the ecosystem.
David Canter: It can be perilous
to control the ecosystem or believe
you are the ecosystem.

Supplying more advice on an automated basis will demand more engineers. The firm imagines hiring 90 to 120 employees and perhaps taking over a couple more floors of its office building in New York’s Flatiron District, dubbed Silicon Alley, to make room for them. Some of those employees will also be charged with a broader marketing effort for “getting the word out,” according to Stein.

“This new capital will allow us to grow even faster and increase the development of new products that will continue to reinvent investing around what customers want.”

Real, live advisors

The other way Betterment plans to fill the advice gap is — wait for it — with advisors. See: How to hold 1,000 hands: Robo CEOs lay out a stark choice for traditional advisors at MarketCounsel Summit.

One way the firm can get more human advisors using Betterment as their custodian and TAMP-like platform is by removing bottlenecks to partnerships with RIAs. That sign-on rate will grow if Betterment “irons out the sales process,” Stein says. Several RIAs per week are already opening Betterment accounts, according to him.

That aspect of Betterment’s growth gained much of its new impetus from its collaboration with Fidelity.

(By contrast, Schwab Advisor Services has yet to partner with any robo. TD Ameritrade’s embrace of robos has largely encompassed ones like Jemstep Inc. that don’t disintermediate its RIA asset custody role. See: New marching orders issued at TD Ameritrade’s conference in San Diego: Don’t join’em, beat’em!.)

On the job training

Fidelity Investments’ executive vice president, David Canter, has witnessed and then helped facilitate RIAs opening accounts at Betterment. The challenge lies in the branding, service level, personnel, pricing and other practice management considerations that go along with making automated portfolio management available to RIA clients.

Michael Kitces: [Robos like Betterment are] tools that human advisors would use, albeit disrupting existing players that serve advisors in the process!"
Michael Kitces: [Robos like Betterment are]
tools that human advisors would use,
albeit disrupting existing players that serve
advisors in the process!"

“We went in to this with our sights set on helping advisors with a digital strategy,” he says. “We wanted to learn how advisors would approach it and boy we’re learning and it’s a great spot to be in.” See: What to make of Fidelity Investments paying $250 million out of the blue for eMoney.

Stein is gratified to see startup RIAs using Betterment as their whole platform of custody and product, a feat previously accomplished only by TAMPs like AssetMark and SEI that do outsourced money management and take custody of the assets. But Betterment is also eyeing big, traditional RIA firms to make the massive transfer of assets to his platform, he adds.

Bigger tent

Canter also sees potential for Betterment to complete wholesale conversions of RIA books from legacy custody platforms.

“We have yet to see wholesale conversions but it’s coming. I have personally been part of three discussions.”

For now, Canter is seeing RIA chiefs like Grant Rawdin of Philly-based Wescott Financial Advisory Group LLC, and a member of the Fidelity Institutional Wealth Services Advisor Council, create a segmented business for the mass affluent under a separate brand from their high-net-worth business. See: A 17-year Vanguard veteran seeking new horizons lands at a Philly RIA with big plans.

But a segmenting strategy can morph, Canter adds.

“There are advisors who say: 'Irrespective of segment, as a passive investment strategy I think that this [automated investing] works for any of my clients and I’ll put a $10-million account in there.’”

New robo target?

Michael Kitces, author of popular blog Nerd’s Eye View, who has road-tested Betterment for his start-up RIA platform, XY Planning Network, sees Betterment’s ability to serve as an RIA custodian as one of its great disruption threats to the business-as-usual pace of legacy businesses. See: The 25 financial advisors with the biggest online presences — and a frank analysis of what online omnipotence does (or not) for them.

Steve Lockshin: I'm not sure that disrupting custodians is an objective; nor would I count them out.
Steve Lockshin: I’m not sure that
disrupting custodians is an objective; nor
would I count them out.

“The real threat of robo-advisors is against mutual and index funds, and against custodians, not against human advisors. They’re tools that human advisors would use, albeit disrupting existing players that serve advisors in the process!” he writes in an e-mail. See: How the new RIA competition is akin to the cup-holder dilemma for automakers.

Survival instinct in play

Steve Lockshin, an investor in Betterment and, separately, its RIA-serving subsidiary, Betterment Institutional, is not sold on the Kitces custody scenario — but he won’t rule it out.

“I’m not sure that disrupting custodians is an objective; nor would I count them out. The custodians have deep pockets and the ability to adapt.” See: Part II: RIA custodians’ answer to challenges to their monolithic control: We still have big-time scale advantages.

Canter acknowledges that Fidelity could be vulnerable to competition from its protégé. “The potential does exist,” he says. “But other custodians could be cannibalized. Then [for Fidelity] it wouldn’t be an assets conversion story as much as a net assets story.”

Therefore, doing business in an open manner could be a crucial survival strategy.

“It can be perilous to control the ecosystem or believe you are the ecosystem. Fidelity takes a more open approach. It’s about growth and innovating,” says Canter.

Fidelity shares in the revenues Betterment receives through RIAs it refers to Betterment.

Full-stack mode

Lockshin applauds Fidelity’s mindset. “Fidelity clearly took a step towards adopting the future,” he says, adding that one of Betterment’s overlooked innovations was the formation of its own broker-dealer.

Chris Dixon: If you can pull this off, it is very hard for competitors to replicate so many interlocking pieces.
Chris Dixon: If you can pull
this off, it is very hard
for competitors to replicate so many
interlocking pieces.

“Betterment’s decision to build a broker-dealer that allows for the fastest, most-efficient onboarding of clients, the ability to do cross trades at night (eliminates the bid-ask spread, takes commissions so low that Betterment just eats them), and flexibility of architecture will allow them to quickly pull away from traditional architecture,” he writes in an e-mail. See: The 6 biggest trends affecting the RIA business.

“The simplest example is the ability to open multiple goals ('equivalent to accounts’) without any new account set-up work. That means that strategic Roth conversions can become fully automated — something likely impossible if not cumbersome using traditional architecture. The same is true for Series GRATs and locking in gains/re-setting losses. And that’s just the tip of the iceberg.”

Such vertical integration is what Silicon Valley calls a “full-stack” approach and one that blogger and startup investor Chris Dixon vets in his cdixon blog.

“The full stack approach lets you bypass industry incumbents, completely control the customer experience, and capture a greater portion of the economic benefits you provide. The challenge with the full stack approach is you need to get good at many different things: software, hardware, design, consumer marketing, supply chain management, sales, partnerships, regulation, etc. The good news is that if you can pull this off, it is very hard for competitors to replicate so many interlocking pieces.”


Mentioned in this article:

Betterment Holdings Inc.
Financial Planning Software
Top Executive: Jon Stein

Fidelity Clearing & Custody Solutions

Top Executive: Sanjiv Mirchandani

Kitces.com
Consulting Firm
Top Executive: Michael Kitces



Share your thoughts and opinions with the author or other readers.

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Bill Winterberg said:

February 19, 2015 — 2:30 PM UTC

“How much should I be saving in my IRA versus my 401(k)? Am I saving enough relative to my goals? We want to give that peace of mind in five minutes. That’s not an easy task,” says Stein.

WARNING: financial planning algorithms ahead. Proceed with caution.

Nevertheless, congratulations Jon and the Betterment team and keep doing what you’ve been doing.

Gravatar

Mike said:

February 19, 2015 — 7:23 PM UTC

Congrats to Jon and the Betterment team on a fantastic win for fintech in NYC. I think you have it right Brooke, Motif and Betterment in a few years will be major players in the RIA custody space. More and more they are more of a TAMP than anything. This will open up the market for the Robo 2.0 players:

https://www.hedgeable.com/blog/2014/12/we-dont-need-robots-introducing-the-digital-wealth-manager-2-0/


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