According to Albert Einstein, gravity is a property of the universe that regulates the interaction between energy, mass and spacetime. What would happen if gravity would not be there? … most likely an unregulated system!
Today’s financial markets seem just that, a universe without gravity, where Market Authorities and Central Bankers attempt to revise the risk/return forces and their time interactions within a workable model: by increasing costs of capital and strengthening fiduciary standards.
What is gravity in Wealth Management? Good Advice indeed, hence Goal Based Investing.
The Global Financial Crisis has shown that financial institutions were “defying gravity”, by interpreting the asymmetry of information inherent in the Wealth Management relationship like a marketing process centred on financial products only loosely related to actual client needs, instead of advice centred on customers’ goals. This transformation will differentiate successful Digital Advisors from traditional firms.
The Wealth Management universe contains three major “sources of energy” which must relate the one to the other: risks, returns and fees.
– The value of a financial investment (whose projection is always uncertain) should be aligned to its potential return over time;
– The price of risk of a financial investment (which is derived from the estimate of the potential loss) would be what is put at stake over time;
– The cost of a financial investment (made of transaction costs and fees) should be the price to pay to enter an informed financial transaction.
Way before the Global Financial Crisis, the system started to deviate from a viable equilibrium among the forces: the value of financial assets got disconnected from underlying economic conditions, exacerbated by a deluge of global liquidity (think of the consequences of Quantitative Easing); costs have been soaring for taxable investors, without being reflected in effective added value (think of active versus passive management); risks have been mis-priced leading investors to buy risky assets without understanding the underlying risks (think of sub-prime backed securities … but also FinTech-like Peer to Peer lending).
Why a need to change the Wealth Management relationship and centre it on clients first? Because clients are the major mass in the Wealth Management universe and should not be neglected in modeling financial relationships!
– In a product centric industry, the potential value of financial securities tend to be oversold (ever higher expected returns) to induce transactions (hence revenues).
– In a client centric industry, personal ambitions tend to be cautioned to facilitate more reasonable risk management of portfolios and more realistic financial planning for the long term (hence less AUM volatility).
Nowadays, the only way to reinstate gravity is to transform Wealth Managers from product-centric marketing channels to client-centric advisory mechanisms. That is, Goal Based Investing or placing the client at centre stage.
Robo-Advisors have sincerely made a first attempt to realign the gravitational system for they:
– reduced the costs of investments;
– simplified the value proposition of financial products;
– exploited goals/thematics to engage clients on seemingly more personal investment decisions.
Yet, Robo-Advisors are far from being good enough mechanisms to truly personalise personal finance. Financial institutions, willing or needing to follow their path, should learn very fast to do more when digitalising their businesses, if they truly want to achieve more sustainable cost/incomes.
This is not easy, because the change is not about technology but business models.
Albert Einstein will pardon me for the analogies.
If you want to read more about the topic, you can pre-order on Amazon my new book “FinTech Innovation: from Robo-Advisors to Goal Based Investing and Gamification“.
This article first appeared on Linkedin Pulse