Investing - A spectrum of choices

In our last blog we introduced a number of ways how banks can activate the ever increasing amounts of saving deposits, by turning them into investments. However once customers have taken the decision to activate their money, they still have a variety of investment services and products to choose from.

Investment services

With regards to investment services, customers can typically choose between the following 3 types:

• Discretionary management where a professional party invests the money for them
• Advisory management, where an advisor (can be a human, but also a computer algorithm, i.e. a so-called robo-advisor) recommends in what to invest. Ultimately it’s still the customer deciding, but at least they are guided in their investment decisions and have the comfort knowing that their advisor will do the follow-up of their investment portfolio and will contact them when an action is required
• Execution-only, where customers take all the decisions themselves

Obviously the line between these investment services can be a bit blurry. The management by a very proactive advisor, who is well trusted by the customer, can strongly resemble a discretionary service. Or a customer in execution-only, putting all their money in a managed fund, can also be considered close to discretionary management.

Investment products

With regards to investment products, there are a wide-variety of products to choose from, like stock (equity), interest-bearing instruments (e.g. bonds, term deposits, cash certificates), funds, non-liquid investments (e.g. real estate, private equity, art​), derivatives (e.g. options, futures, swaps), etc.

Typically, a bank, wealth manager or broker, will specialize in one or more services and will associate a product scope to it.

Two axes

The features and types of products offered to a customer, will normally depend on 2 axes:

• The wealth of the customer, which determines the level of service, the type of products the customer can invest in and the degree of personalization of the service
• The time spent by the customer on their investments. Usually this has a strong dependency on the investment horizon, i.e. a customer with a shorter investment time horizon will usually be more actively involved with their investment portfolio than a customer with a long-term investment horizon

If we explore these 2 axes for the 3 types of services, we see:

• Discretionary management:
  • The wealth of the customer will typically determine how personalized the discretionary management will be and the type of investment assets. Ultra High Net Worth Individuals (UHNWIs) can get a very tailor-made discretionary management, where the customer can define very specific constraints for their portfolio. Furthermore, more complex products can be considered for these customers (like direct real estate, private equity, derivatives, etc.​). As a result, the management of these portfolios is very manual and labor-intensive. The High Net Worth Individuals (HNWIs) and mass affluent segments will typically receive a more standardized, semi-automated management via model portfolios, with typically more investments in individual lines (compared to funds) when assets under management are larger (as a smaller portfolio value cannot get the necessary diversification via individual line positions, without transaction fees excessively impacting the returns)
  • The time spent by the customer on their investments is obviously very low in this service level, as the main objective of the customer is to pay for a service where a professional takes over the asset management. Of course, the customer will pass an onboarding process (to know their risk profile and preferences) and can request to manage in- and outflows of money from their investment portfolio
• Advisory management:
  • The customer’s wealth will determine again the level of advice they receive and the selection of investment products (i.e. the wealthier, the more complex and tailor-made products can be invested in)
  • For the time spent by the customer, we typically make the distinction between Active and Passive advisory management. While in Active advisory, the advisor will pro-actively follow-up the customer’s portfolio and contact the customer with investment suggestions, in a Passive Advisory management the advisor takes a more reactive approach, i.e. advising the customer only when being contacted by the customer. Obviously an Active advisory management is much more labor intensive and as such also more expensive
• Execution-only management
  • The wealth of the customer again determines the choice of investment products, as certain more complex products can have very high minimum amounts and transaction fees can become too expensive if invested amounts are too low
  • The time spent by an investor is very differentiating for this service. Almost any broker, bank or wealth manager has a specific positioning here. While some focus on the day traders, others focus on more long-term professional traders or on amateur investors, who follow up their portfolio intensively. Finally, the large banks typically focus on retail customers with little or no knowledge of investing and that are not actively following up on their investments. For this segment, banks offer different ways to simplify investing, e.g. via investment plans or by automatically investing the rounding of each debit movement occurring on a current account

Obviously the tooling that supports these different scenarios can be very different. While an industrialized discretionary management requires tooling to reconcile a large number of portfolios (with similar management) automatically against a model portfolio, an advisory management requires extensive querying capabilities to easily identify customer portfolios requiring the advisor’s attention. A day trader on the other hand requires very fast market information and fast order input.

As a result it is almost impossible to create one tool, covering all these different use cases. As such specialization is required.

Evolutions in investment software

Nonetheless there is one common trend that allows to reduce the number of different use cases mentioned above, and that’s by reducing the impact of the "Wealth of the customer" ax. Via extensive digitalization and automation and increased competition, it becomes possible to offer a personalized service to retail customers, which before was only available for the (Ultra) High net worth individuals.

This is caused by evolutions like:

• Commissions dropping to zero: this trend started by Fintechs like RobinHood, but was rapidly taken over by other Fintechs and now also by larger incumbent banks. It means that a "Quick Trading" strategy (versus a "Buy and Hold" strategy) also becomes accessible to the mass retail. Before this strategy would have been impossible as commissions on each transaction would have eaten away all returns (as invested amounts would be proportionally too small)
• Reducing minimum amounts: many investment products are being democratized by lowering the minimum investment amounts. Some examples are the rise of crowd-funding (making Private Equity available at very low amounts) or Fractional Trading, allowing retail customers to invest also more easily in public shares with high unit prices (e.g. 1 Amazon share today costs around $3,000, meaning for small investors it is often not even possible to buy 1 share)
• Advisory services: advisory services used to be only available to the wealthy, as those were very labor intensive and costly. With new tooling and AI models, robo-advice can offer personalized advice at a fraction of the cost
• Access to market news and detailed insights: where before real-time news about the market was only available to professional investors via very expensive tools (e.g. via Bloomberg terminals), new digital news streaming services can now be easily plugged into an investment platform to get real-time news at a low cost, allowing financial service providers to also offer this to their retail customers.
  Furthermore as investor roadshows become more digital, it becomes possible for very small investors to follow investor roadshows in real-time via webinars and conf calls (before these type of meetings were reserved to the large investors)
• Access to detailed insights in your portfolio analytics, like real-time valuation, asset classifications per sector/region/currency/duration/etc.​, detailed performance insights (like individual performance of each investment, performance attribution, risk-adjusted return​), risk simulations (like historical and simulated VaR), correlation between assets in your portfolio, etc. The trick is to present these complex insights in a user-friendly and comprehensible way to users, who might not be acquainted with these analytics (cfr. Capilever’s Retail Securities Trading Tool (RSTT))
• Access to more complex products for trading, like derivatives or non-liquid investments, by more user-friendly trading flows, more explanations and training and more insights on potential losses while investing in those complex products, but also via easy security mechanisms (like automatic hedging) to avoid too severe losses for a non-professional customer
• Social investing (e.g. Wikifolio): marketplaces where customers can express their investment interests and share investment experiences (e.g. their investment choices, investment portfolio composition or fundamental/technical analyses on companies). With a possibility to "Find People Like Me" (with similar risk profile, knowledge, sustainability perspectives, investment return, etc.​) and mirror their portfolio, follow their advice or ask them to take a look at your portfolio, it becomes possible to get some kind of personalized (human) investment advice, at a much lower cost
• Alerting/Notifications: alerting on specific market news or when specific events occur on your investment portfolio or on a tracked instrument (e.g. drop/increase by X%, too much exposure in specific asset class/sector/region/currency, no longer in line with risk profile, etc.​), avoid a customer to continuously follow-up on their investment portfolio, but instead get automatic alerts/notifications when their attention is required
• …​

By eliminating or at least reducing the importance of the ax of "Wealth of the customer" via democratization (i.e. via automatization and digitalization as explained above), the only remaining ax is the time spent by the customer on their investments (continuously, daily, weekly, monthly or even less).

The role of APIs

While specific investment activities of customers should result in specific front-ends (optimized for a specific type of investor), the back-end services can be shared for these different profiles. It is therefore important to create a modular, component-based back-end, which can deliver different portfolio services to the front-end via easy well-defined APIs, e.g. valuation, return calculation, risk calculation, retrieve market news, buy/sell instrument, etc. When those services are designed in a flexible way to be real-time and to cope with different scopes (execution on one portfolio or on a list of portfolios), they can be perfectly shareable between the different use cases.

Once this backbone is correctly setup and the ax of "Wealth of the customer" is sufficiently reduced (or even removed) via automation and digitalization, it will be possible to offer different experiences for each user type at a relatively low cost. It will be interesting to see which Financial Service companies can serve all these different profiles using one common backbone. Such a company will have a strong competitive advantage, as it will be able to deliver a very personalized investment service at a fraction of the current cost.