[Editor’s note: This is the third article (see first article and second article) in a special series we are publishing from Wharton Fintech ahead of LendIt Fintech USA. They are covering topics that will be addressed at the big annual event next week. This piece is by Rittik Rao, Wharton MBA Class of ’22.]

Consumer investing is an industry in the midst of change; from mutual funds to hedge funds to brokerages, the traditional methods of accessing the market are under severe pressure from industry disruptors like ETFs, no-fee brokerages, robo-advisors, and more. These disruptors have already had a significant impact on the industry: over $1.5tn has left equity mutual funds since 2009; a quarter of asset/wealth managers believe that at least 20% of the business will be lost to fintech in the next 5 years; a tepid consumer market, lowering fees, and escalating competition have driven consolidation in the asset/wealth management industry to record levels. During all this, the retail investing landscape is primed for further disruption, specifically innovations in product and distribution.

Key trends driving disruption in retail investing

• Rise of passive – once a way “just to get market exposure”, passive has evolved to be a main vehicle through which many investors access the market. Contrary to the belief of some, passive is not “dumb money”; while some passive vehicles do chase broad market-cap indices like the S&P 500, much of the innovation in passive has come from being able to access narrow, specific markets, or from codifying sophisticated investment strategies into algorithms and being able to price them at pennies on the dollar. Active mutual funds, across asset classes, sectors, and geographies, have consistently and persistently failed to generate alpha for the last 15+ years, presenting an opportunity for passive. Investors have agreed and pumped over $3tn into passive funds within the same time frame.

• Demographic shifts – America’s aging population is introducing key demographic shifts, namely millennials entering their prime earning years and intergenerational transfers from baby boomers to gen X and millennials. Millennials prefer using technology at higher levels than previous generations, with some studies estimating them to be 30% more likely than gen X to use fintech. Millennials have been a large trend in CPG markets for a while due to their large consumption power ($1.4tn+), but in wealth markets they are just beginning to experience substantial growth (higher student loans, lower wages, etc.). Millennials stand at ~5% of investable wealth, up from 1% in 2013. While millennials are a key trend, it would be myopic to not account for gen X and baby boomers becoming more tech-forward over time.

• Tighter technology integration – technology is not new to the investment industry, but historically it was concentrated on the institutional side of the market (quant funds, institutional buyers, CIOs, etc.). Technology is being rapidly incorporated into the retail side of the market, from filtering investment options to apps that guide investing to the products themselves. A good investment option is no longer enough – consumers want a story of how they can invest in the future and want a modern platform to interact with their investment options.

Innovations in Product

The last wave of product innovation in retail investing dealt with getting investors access to broader swaths of the market and more sophisticated investment strategies. This meant making exposures like emerging markets, quantitative investing, hedge fund replication, etc. and strategies like retirement saving, growth, etc. broadly and cheaply available. While this brought in lots of assets, investor demand has now turned towards deepening exposures. 

The next wave of innovation is in access to thematic exposures, differentiated asset classes, and using unique data/sophisticated algorithms to create novel investment strategies. The “democratization” of finance is a theme echoing across fintech, and applies strongly in retail investing with Robinhood leading the way here as they popularized commission-free stock trading. Retail investors want the same access to investments as institutions. Firms like Solactive and Indxx generate indices inexpensively to deliver specific exposures like 5G, cryptocurrency, China internet, etc. Firms like Motif (now closed) and Thematic use large datasets and analytics to create thematic portfolios customized to investors’ preferences; this sort of “direct indexing” has been predicted to compete with ETFs in the future. Fundrise, EquityZen, SeedInvest, and others allow access to asset classes like real estate, pre-IPO stock, startups, etc. 

Innovations in Distribution

While product innovation has brought significant assets into the retail investing, this has led to a paradox of choice. Investors have more choices than ever, from ETFs to robo-advisors, and often struggle to find their ideal allocations. Distribution is key: a firm could have the best product, but if it is unable to communicate this to investors and get the product into the right hands, it cannot achieve scale. Robo-advisors have made some headway in piercing this fog of products; Betterment, Wealthfront, and others push portfolio recommendations to investors depending on assessments of risk tolerance. Some ETF issuers, notably iShares, allow investors to construct portfolios using component ETFs on their website. These efforts put financial products in perspective for this market: investors have goals and mean to use products to meet those goals; the product is not necessarily the end-goal, and successful innovation for this market needs to reflect this reality. 

Disruptions in distribution are happening on both the end-retail and wealth management sides of the market. In both cases, increasing investment knowledge by retail investors is driving a push away from fully trusting financial advisors or brokers and towards a guided, not directed, investment model. Investors want their needs made into customized recommendations and also be presented with flexibility in their options (ESG, thematic, other enhancement options). For end-retail, investors need more tailored investment options through gathering more data on lifestyle, risk, assets, human capital, total wealth, etc. This means a deeper understanding of a customer’s financial position and needs.

Some robo-advisors have certain elements to meet customer needs, but a unified player would speed the transition to truly autonomous finance, where investors can have both ease and satisfaction from dealing with an autonomous system. On the wealth management side, model portfolios ($2.7tn market) have changed wealth managers’ jobs, giving them scale from asset managers and allowing a renewed focus on fundraising. A newer phenomenon, “paper” models threatens the traditional sides of the industry by introducing free models and sophisticated implementation options from asset managers. This gives wealth managers more implementation options to bring to retail clients and allows for a greater degree of customization to client needs and goals.

As we gear up for the LendIt Fintech Conference, I’m most excited to hear how retail investing will continue to evolve during the panels on: Can Digital Banks Sustain the Momentum, featuring Chime, Dave, Current, and MoneyLion (Tues, 2:25pm); The Rise of Specialized Banking, featuring Cheese, First Boulevard, Daylight, and Ando Inc (Tues 4:20pm); The Digital Banking Divide – What Traditional Banks are Learning from Neo Counterparts (Thurs 2:25pm), and ESG Investing for Social Impact, featuring Betterment, Open Invest, Impact Shares, and Haitou Global (Thurs 3:35pm).