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Michael Katchen, co-founder and CEO of Wealthsimple, in Toronto on Sept. 25, 2019.

Markian Lozowchuk/The Globe and Mail

Michael Katchen hit $1-billion in assets, and the bombast started to flow.

Speaking at a Toronto startup conference in 2017, the chief executive officer of upstart online investment provider Wealthsimple revealed that in his early conversations with his business mentors, he told them the powerhouse he envisioned could become one of the world’s largest money managers – and it could grow faster than the giants he idolized ever had.

ETF pioneer Vanguard took 30 years to reach US$1-trillion in assets under management, Mr. Katchen said, while BlackRock Inc. took 18 years. “I think the next company to get to one trillion dollars is going to do it in 15 years or less, and I want to be that company,” he told the small crowd.

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Mr. Katchen called it “naïve ambition.” However you label it, the boast was certainly brazen, because at the time, Wealthsimple was still $999-billion short of this goal. Yet executives had some reason to hope they could reach their grand target because disruptive companies seemed to be taking down whole industries.

Three years later, Wealthsimple’s assets have hit $6-billion. That, too, is encouraging. But the harsh reality is that the company simply isn’t growing fast enough. Even more sobering, the whole sector is facing a reckoning. There are currently 15 robo-advisers in Canada and they manage a total of just $8-billion – a fraction of the $1.63-trillion invested in mutual funds alone.

Canadian assets by type

$210-billion

$1.6-trillion

$8-billion

Mutual funds

ETFs

Robo-advisers

global robo-advisers, 2019

Assets by adviser and country, in billions of dollars

Vanguard

$196.7

U.S.

$30.6

U.S.

Wealthfront

Betterment

$23.4

U.S.

Wealthsimple

$6

Canada

$3.4

Nutmeg

Britain

Wealthbar

$0.5

Canada

Nest Wealth

$0.5

Canada

wealthsimple’s asset growth

$6.0

In billions of dollars

$5.0

$4.3

$3.0

$1.9

$1.0

$0.4

April

2015

May

2017

Feb.

2018

Oct.

2018

May

2019

Aug.

2019

Jan.

2020

major investments in Wealthsimple

2015-2019, in millions of dollars

Year

Investor

Amount

2015

Power Financial

$30

2016

Power Financial

$20

2017

Power Financial

$50

2018

Power Financial

$65

Allianz X/Power

Financial jointly

$100

2019

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: company reports

Canadian assets by type

$210-billion

$1.6-trillion

$8-billion

Mutual funds

ETFs

Robo-advisers

global robo-advisers, 2019

Assets by adviser and country, in billions of dollars

Vanguard

$196.7

U.S.

Wealthfront

$30.6

U.S.

Betterment

$23.4

U.S.

Wealthsimple

$6

Canada

Nutmeg

$3.4

Britain

Wealthbar

$0.5

Canada

Nest Wealth

$0.5

Canada

wealthsimple’s asset growth

$6.0

In billions of dollars

$5.0

$4.3

$3.0

$1.9

$1.0

$0.4

April

2015

May

2017

Feb.

2018

Oct.

2018

May

2019

Aug.

2019

Jan.

2020

major investments in Wealthsimple

2015-2019, in millions of dollars

Year

Investor

Amount

2015

Power Financial

$30

2016

Power Financial

$20

2017

Power Financial

$50

2018

Power Financial

$65

Allianz X/Power

Financial jointly

$100

2019

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: company reports

Canadian assets by type

$210-billion

$1.6-trillion

$8-billion

Mutual funds

ETFs

Robo-advisers

global robo-advisers, 2019

Assets by adviser and country, in billions of dollars

$196.7

$30.6

$23.4

$6

$3.4

$0.5

$0.5

Vanguard

Wealthfront

Betterment

Wealthsimple

Nutmeg

Wealthbar

Nest Wealth

U.S.

Canada

U.S.

U.S.

Canada

Britain

Canada

$6.0

wealthsimple’s asset growth

In billions of dollars

$5.0

$4.3

$3.0

$1.9

$1.0

$0.4

April 2015

May 2017

Feb. 2018

Oct. 2018

May 2019

Aug. 2019

Jan. 2020

major investments in Wealthsimple

2015-2019

Year

Investor

Amount

2015

Power Financial

$30-million

$20-million

2016

Power Financial

2017

Power Financial

$50-million

2018

Power Financial

$65-million

Allianz X/Power

Financial jointly

$100-million

2019

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: company reports

It’s now clear the robo-revolution has been a flop. And Mr. Katchen is nowhere near as cocky as he once was. Wealthsimple executives declined to comment for this story, as did Paul Desmarais III, the scion of the Desmarais family who has bet heavily on the company and is also its board chair.

The slowdown has been painful. When Wealthsimple and rivals Nest Wealth and WealthBar launched in 2014, their allure was potent. Click on an app, answer a few questions about your finances, and an algorithm would assemble and manage a portfolio of low-cost exchange-traded funds (ETFs) for you for a fee around 0.5 per cent a year – one quarter the cost of many mutual funds.

The hope was that these platforms would be revolutionary for millennial investors who did not want to deal with bank branch staff or high-cost full service investment advisers. And when the fee savings were compounded over decades, those young investors might earn hundreds of thousands of dollars more for retirement – maybe even millions.

The reality: No robo has been able to get any real traction. Nest Wealth and WealthBar, the second- and third-largest robos in Canada, manage only $500-million each in their direct-to-consumer operations. Even the two Canadian banks that have launched robo products have barely seen any interest.

The low asset totals are a fundamental problem. The target demographic – millennials – simply doesn’t have much money to invest yet. Robo-advisers charge low fees, and when those fees are multiplied by the low totals there isn’t enough revenue for firms to cover costs and red ink flows.

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Canada isn’t unique in this respect. In 2015, management consultancy A.T. Kearney projected that American robo-advisers would have US$2.2-trillion in assets under management by 2020. The latest figures suggest total assets are just more than one-tenth of that, according to Backend Benchmarking.

“They fully overestimated the market potential,” Mattias Memminger, a partner at management consultancy Bain & Company in Frankfurt, said of robo-advisers after studying the sector extensively. “Trusting an algorithm is a leap of faith very few people are willing to make."

For all the hype, when it comes to investment advice, it appears most individual investors still crave human interaction. For many, managing wealth is on par with quantum physics, which is why clients want “someone to tell them that they are not doing anything daft,” said Holly Mackay, chief executive of U.K.-based Boring Money.

Crucially, she added, they don’t want to bear the burden of their financial decisions alone. “People still want a throat to choke if it all goes wrong.”

Fast out of the gate, slow to get scale

The robo movement in the United States caught fire a decade ago, propelled by a startup called Betterment. The New York-based company launched at the TechCrunch Disrupt conference in 2010 – an annual mecca for the “move fast and break things” millennial crowd.

Betterment’s main competitor was California-based Wealthfront. The expectation was that the new robo-advisers would shatter the traditional banking industry the way Uber would with municipal taxi services.

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The robos vowed to democratize investing by offering low-cost automated professional advice to the average investor. When opening an account, individuals are provided with an online risk-assessment tool that quickly calculates how they should invest based on age, financial goals and risk tolerance.

The platforms then provide each client with a recommended portfolio, all for much lower fees than traditional financial advisers usually charge.

What really made robo-advisers tick was their use of ETFs. For decades, costly mutual funds were the dominant product for retail investors and they were mostly sold by retail advisers, who also had to be paid.

But over the past decade, passive ETFs that track major stock indexes for a fraction of the cost of mutual funds have exploded in popularity. Many ETFs have fees of about 0.1 per cent a year, compared with 1 per cent or 2 per cent for actively managed mutual funds. BlackRock, the world’s largest ETF provider, currently manages US$7.4-trillion.

Canada caught the robo fever in 2014, when Wealthsimple and its competitors launched. In April, 2015, the sector got a huge shot in the arm when the Desmarais family invested $10-million in Wealthsimple through Power Financial, then added another $20-million later in the year.

Backed by one of Canada’s richest dynasties, Wealthsimple’s Mr. Katchen became the face of the movement – and, in many ways, he was the perfect millennial pitchman. Just 27 years old in 2015, he talked openly about disrupting big banks and how most investment funds were a ripoff. The media salivated; a Globe headline the next year suggested he was “terrorizing” Bay Street.

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For the first few years, these services truly were a threat to the old guard. Enticed by the potential, Mr. Desmarais III, the grandson of the family patriarch and a fintech enthusiast, kept throwing money at Wealthsimple in additional financing rounds.

By the end of 2018, the robo’s assets hit $3.4-billion. That helped to attract German investment giant Allianz, which invested $100-million early in 2019 alongside Power, bringing the total amount of private capital raised by Wealthsimple to $338-million.

Watching this growth from the sidelines on Bay Street, the Big Six Canadian banks started to get nervous. Executives wondered if they should build or buy competitive robo services.

In 2016, Bank of Montreal became the first of the Big Six to launch its own robo-adviser, called SmartFolio. Two years later, RBC followed suit with InvestEase. Taking a different route, National Bank of Canada invested $6-million into Nest Wealth in 2017, and began using the company’s online product with in-house clients.

Last year turned out to be the turning point – but not in the way the industry hoped. Across Canada, the United States and the U.K., it has become clear there simply aren’t enough assets flowing into robo-advisers, which is alarming because the business model relies heavily on scale. To make money, these companies need to multiply their low fees by hundreds of billions – or trillions – of dollars in assets.

Analysts at Morningstar, which specializes in fund research, recently estimated that American robo-advisers need to gather between US$16-billion and US$40-billion in assets to break even. A decade in, Wealthfront and Betterment are only now at the low end of that range with US$23-billion and US$18-billion, respectively.

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In Canada, Wealthsimple’s $6-billion falls well short of the bottom. More importantly, the firm’s average account size is only about $30,000. Clients with less than $100,000 in assets pay a 0.5 per cent annual fee. That means Wealthsimple is likely bringing in just $30-million a year in revenue. Meanwhile, its annual marketing budget alone has been estimated by industry sources to be about $20-million. (Wealthsimple does not publicly disclose this number.)

The result is that the firm has raised hundreds of millions of dollars with no return in sight.

To cut or not to cut

The simple fix, it seems, is for Wealthsimple to slash spending on its stylish ads, which are very sharp, hip and expensive. The company has disclosed that advertising is one of its top expenses, along with employee costs. It should be a relatively easy cut, because Wealthsimple shells out for several costly prime-time TV spots, including Super Bowl telecasts.

But doing that could also be a Catch-22, because the cuts might severely hinder growth. Independent robo-advisers are new brands and they have to compete with Canadian banks that have been around for more than a century.

Robo-advisers also started out as single-product services, so they couldn’t cross-sell to existing clients with mortgages or chequing accounts. A recent report by Ernst & Young LLP found that, for all the hype, fintech adoption in Canada has been limited, and the biggest reason why is that Canadians often don’t know what products and services are available.

“You need infinitely deep pockets to make this model work,” said Randy Cass, founder and CEO of Nest Wealth, in describing the direct-to-consumer robo model. “I think it’s an incredibly hard journey to move from a new brand to a viable financial-services operation – and to do it in any way that makes economic sense.”

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It all boils down to a metric known as the cost of customer acquisition, which is sales and marketing costs divided by the number of new customers. Mr. Cass estimates that for independent robo-advisers, this figure is between $250 and $1,000 a client.

Again, using simple math, if the average millennial has just $30,000 invested, a robo-adviser is only making $150 a year off that client. That means the payback period is probably between three and seven years – and that’s just to break even on the customer.

Because asset growth isn’t anywhere near where it needs to be, robo-advisers face some tough questions. The biggest: What if a lot of their assumptions about millennials are completely wrong?

When these services launched, the expectation was that millennials would flock to a snazzy digital offering – something that was, in Silicon Valley lingo, seamless. But Josh Book, CEO and founder of Parameter Insights Inc., a market research and consultancy firm, says that cool technology alone isn’t enough. “Mobilizing consumers into a new wealth-management space isn’t the same as having them try Uber,” Mr. Book said.

And what if millennials aren’t much different from other generations when it comes to finance? Educating Canadians on the numerous investment options available to them – and the cost of each – has been a cumbersome task for the industry for decades. Many consumers of all ages still do not understand how to use a tax-free savings account or how to invest their RRSP contributions.

Wealthsimple’s slick ads and marketing try to do two things: educate millennials about investing and build a highly distinctive brand. But many consumers still don’t know what the basic product is. Just 2 per cent of Canadians say they are very familiar with a robo-advice offering, according to research by Parameter Insights.

Then there is another fundamental question: Are there enough target clients?

Twenty years ago, there was a similar fever for online discount brokerages. As internet usage soared, tech gurus predicted that everyone would manage their money by themselves online.

But even now, only a small minority of the population feels comfortable enough to do that. In Canada last year, 80 per cent of all funds were sold through advisers, many of whom work at bank branches or investment dealers.

Robos, of course, were supposed to expand this pool because they help with things such as asset allocation, making it easier to start investing. But that only seems to work for younger clients who have minimal assets. Margin-rich customers aged 50 and older who have been saving for decades typically want help on a much broader array of issues, such as tax planning.

“If we segment the population into those who will not or cannot pay for financial advice, and then further segment into those looking to invest, but also willing to trust a digital brand and are happy to commit their money online without much advice or help, that is a finite pool of people,” said Ms. Mackay of Boring Money. In the U.K, she notes, robo assets are just 2 per cent of the do-it-yourself investment market.

So, what now?

The prospect is growing ever more remote, but the Canadian robo-advisory business may eventually get to a trillion dollars. It could simply take time for customers to get more comfortable with the idea of robo service. Currently, only 17 per cent of Canadian investors have tried an online portfolio manager, according to a report by Strategic Counsel. Academics who have studied disruption have shown that the process of dismantling and replacing an industry is often slow at first – and then suddenly takes off.

The trouble for Wealthsimple and other upstarts is that existing wealth managers – and in Canada, that’s mainly the big banks – are now attuned to the market. They learn from past mistakes. In the mutual fund boom of the 1990s, independent mutual fund sellers such as Trimark, Altamira and Fidelity grew quickly, but the banks then caught up.

The banks also dismissed the potential of ING Direct, the low-cost online bank launched in the late 1990s, then scrambled to offer competing products.

To prevent that from happening again, BMO and RBC have already launched robo-advisers, and others, such as Toronto-Dominion Bank, have come close, according to sources familiar with the plans. Those platforms could be ramped up quickly if the robo market explodes.

On the other hand, the direct-to-consumer robo business may continue to slow. If so, the upstart firms will have to pivot. In fact, this process is already under way.

In 2017, Nest Wealth shifted its focus to partner with existing wealth managers. While the company continues to operate its robo-adviser consumer business, it now predominately licenses its technology so that financial advisers can use it directly with clients. Nest Wealth now offers software as a service to fifteen firms.

WealthBar, meanwhile, was sold to CI Financial in 2019. With $130-billion in assets under management, CI is Canada’s largest independent money manager, but it was struggling to attract young investors. Like Nest, WealthBar continues to operate its direct consumer business separately, but it also brought its portfolio management technology in-house for CI’s financial advisers.

Mr. Memminger, the Bain consultant, believes this hybrid service will become the norm. “The winning model will leverage the strength of the digital service and the strength of the human adviser,” he said.

The reason why, he added, is something known as Moravec’s Paradox – a problem that has confounded artificial intelligence experts for years. In short, it means that everything humans are bad at, machines are good at – and vice versa. A human investment adviser isn’t the best at crunching investment data, but she or he has the soft skills to comfort a client.

In Canada, BMO already deploys a version of this model. To complement its SmartFolio robo-service, the bank now also offers digital advice for do-it-yourself investors who want access to a portfolio manager. The service does not auto-rebalance a portfolio or select investments for clients, but it gives users access to a human adviser by phone if they want to discuss stock selection or asset allocation.

Vanguard is the largest player in the U.S. robo-adviser space, accounting for US$148-billion of the US$275-billion in robo-products in the U.S., according to Backend Benchmarking. The Vanguard Personal Advisor Services requires a hefty $50,000 minimum, but gives all investors access to a team of financial advisers to help build individual portfolios for each client. As asset levels increase, clients will gain access to a dedicated adviser for their planning needs.

Even for Vanguard, however, the robo business is a niche. The company as a whole manages US$5.6-trillion.

Wealthsimple started to expand beyond the direct-to-consumer segment two years ago with “Wealthsimple for Advisors,” allowing financial advisers to access their portfolio-management tools for a discounted price. Late last year, however, the company sold this arm to Purpose Financial for an undisclosed amount. The divestiture means $1-billion in assets – and 500 advisers – will leave the Wealthsimple umbrella.

Mr. Katchen still appears to be determined to make his direct-to-consumer business model work. Flush with cash from Power Financial and Allianz, Wealthsimple has introduced new products that provide opportunities for cross-selling.

In 2019, the company purchased SimpleTax, a tax-filing service, and it has launched a digital stock-trading platform. In early January, it unveiled a chequing account service called Wealthsimple Cash with enticing perks. Chief among them: the promise to pay clients a high interest rate of 2.4 per cent on their savings – more than double the rate offered by the Big Six banks. The account also offered no monthly account fees, unlimited transactions, no low-balance fees, no transaction charges worldwide and ATM fee reimbursements.

But Wealthsimple isn’t operating in a vacuum when it comes to banking products. Within hours of launching its chequing account, rival digital bank EQ matched Wealthsimple’s interest rate.

It is also possible that, at some point, Wealthsimple will merge with another Power Financial company. The Desmarais family runs IGM Financial, the parent company of mutual fund provider Mackenzie Investments and investment brokerage IG Wealth Management (formerly Investors Group).

A merger could create enormous cross-selling opportunities. Recently, Wealthsimple filed investment documents to launch its own ETFs, set to be managed by Mackenzie. Meanwhile, IG Wealth is embarking on a plan to concentrate on high-net-worth clients. Its lower-end clients could be funnelled into Wealthsimple.

The struggle for Wealthsimple is that doing so would mean abandoning some of its founding principles. Mr. Katchen and his team wanted to revolutionize financial services – and for good reason. Mutual funds can be a ripoff, as he often used to say. The Investors Mackenzie Dividend Fund, for instance, charges a 2.4 per cent annual fees – and its returns don’t outperform those of the Horizons Active Canadian dividend ETF, which charges just 0.67 per cent.

But the IG Dividend Fund is also an insanely profitable product. With $12.5-billion in assets, it is double the size of Wealthsimple, and it charges five times the fee.

Given the trajectory of the robo market, at some point, Mr. Desmarais III will have to ask when he’s going to get a return on the hundreds of millions he’s invested.

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