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Shot exclusively for Report on Business magazine by Jamie Campbell

Michael Katchen might be young, but he's taking on Canada's advisory firms with Wealthsimple, a millennial-friendly investing approach backed by some surprisingly big guns

As King Arthur was backed by Lancelot, so too is Michael Katchen (Lancelot the Wealthsimple office dog).

As King Arthur was backed by Lancelot, so too is Michael Katchen (Lancelot the Wealthsimple office dog).

If Wealthsimple ever gets to realize its ambition to be a global fintech company geared to millennials, we can expect to hear many retellings of its very cool, and very millennial, creation myth. "This is my favourite part of the story," says Wealthsimple co-founder Michael Katchen. "The very first idea I had was not to create a business."

After he and some friends came into some money, the now 28-year-old Katchen created a spreadsheet to show his pals how to pursue painless investing via low-cost exchange-traded funds (ETFs). And he did it in one night. "The feedback I got from my friends was, 'Mike, we're lazy. We love the system, but can you just please do it for us?'" he says. "And they became the first 10 clients of Wealthsimple."

In September, 2014, Katchen and a handful of colleagues launched the automated online investment service—a so-called robo adviser—from a small warehouse space in downtown Toronto. Click on the app from your smartphone or computer, answer a few questions about your finances, goals and investing knowledge, and it spits out a recommended portfolio of ETFs—all within minutes. Open an account, and it will automatically manage your holdings for the rest of your life, if you wish.

The goal is to corral millennials who may not be wealthy now, but could very well be some day, and who don't have the time or desire to deal with a human investment adviser. More than a dozen veteran Canadian venture capitalists were so impressed with Katchen's idea that he raised $2 million in seed funding in just over two weeks. Then, in April, 2015, he landed a whale of a backer: the Desmarais family's Power Financial Corp., which put in $10 million, and agreed to increase that to $30 million if necessary.

Wealthsimple is now the biggest robo adviser in the country, with $500 million in assets under management, and growing. The buzz over the firm in the financial services and tech businesses also keeps getting louder. But is that mostly due to Katchen's promotional flair and the backing from the Desmarais family? Or will Wealthsimple prove to be a unicorn—one of those rare tech start-ups that delivers in spades on its promise? If it does, it means Canada's big banks will finally face some serious disruption.

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Identifying a vast untapped market is pretty much de rigueur for a winning pitch to VCs by start-ups, and Katchen often mentions the figure $1 trillion. He thinks that automated investing platforms could be managing that much money in Canada within 20 years—or less.

He's not blowing smoke. As Katchen and other analysts point out, in 1990, before the national mutual-fund boom hit high gear, Canadians had just $25 billion invested in funds. The total now is $1.3 trillion.

Yet if you look at potential consumers, only about half of all Canadian households deal with an investment adviser of any kind—either at a full-service dealer, an RSP adviser at a bank, an insurance agent, or an independent financial planner or sales representative. In a 2014 Ipsos Reid survey, 43% of Canadians said they had a financial plan, but among those who did, one-third acknowledged that their plan is "in their head."

Millennials are particularly loath to deal with conventional banks and advisers—they tend to view them merely as salespeople. They also prefer to bank and move their money around online. And they want to be able to check on their finances instantly.

High account minimums also scare millennials away from established investment dealers. Many advisers are under pressure to dump clients with less than $250,000 in savings. And that's not surprising if you do the math. Plans based on a 1% annual fee are now common. So, if a client is at the threshold, that's $2,500 for the adviser and the dealer. For that, they have to choose and rebalance client investments, keep records, send out statements, keep up with regulatory requirements and do a lot of one-on-one hand-holding—phone calls, quarterly meetings or lunches, rounds of golf and whatnot. It adds up.

If it's bad for the adviser, it's worse for the client. The minimum means that "no 29-year-old can be a client," says Katchen. "But the young guys need help, and they've got their whole investment horizon in front of them."

Can an automated platform take care of things more cheaply and efficiently, even for small accounts of a few thousand dollars? In the United States, several robo advisers have been doing it for years. They include Betterment, with $4.2 billion (U.S.) in assets under management, and Wealthfront, with $2.8 billion (U.S.).

If you're trying to raise serious money to build a Canadian unicorn, it often helps to have a U.S. model. Of course, you also need an impressive track record.

Katchen could have walked out of central casting for tech visionaries—he is that personable and inspiring. After graduating from Western University's Ivey Business School in 2009, he went to work at giant McKinsey & Co. as a strategy and marketing consultant in Toronto.

Then, in 2011, he moved to Silicon Valley, where he co-founded 1000memories, which created an app that allowed users to scan photo prints with their smartphones. The start-up quickly attracted the attention of angel investors, and in October, 2012, Katchen and his colleagues got their windfall when bought the firm for several million dollars.

Katchen's 10 friends asked him what to do with their money. "They knew that I had been investing since I was 12, and that I loved to do it," he says.

So Katchen told them: "The first thing you should do is not hire anybody to do it for you. Do it yourself." He then went home and built an Excel spreadsheet that showed them how to build and maintain a simple portfolio. "Buy a set of ETFs," he said, and he listed a handful in different sectors. "Once a quarter, go in there and rebalance. When you're ready to put more money in, use this spreadsheet—it'll show you how to rebalance. And that's it."

At that point, Katchen says, "I thought there shouldn't even be an investment management business." To him, the basics of choosing investments and monitoring them should be easy. "But we discovered through this process that you could build something simple that created a huge amount of value for people who were never going to do it [otherwise]," he says. "It just automated it for them, and took that piece of stress out of their minds completely."

In 2013, Katchen decided to move back to Toronto—partly for personal reasons, he says, but also because there were few robo advisers in Canada. And he figured he could scoop up enough programming talent to build not just a Canadian fintech leader, but a global one. "It's a turning point for tech in this country," he says. "There are some pretty amazing companies being built here."

He also displayed a knack for finding influential backers and winning them over quickly. One of the first, in 2014, was Daniel Debow, who had hit the jackpot with two start-ups of his own: Workbrain, which was sold for $227 million (U.S.) in 2007, and Rypple, which was sold for $65 million (U.S.) in 2011. Debow referred Katchen to Joe Canavan, who was a pioneer during the mutual-fund boom of the 1990s, first with the Canadian division of Boston-based Fidelity Investments, then at his own firms, and finally at Assante Wealth Management.

It took a couple of meetings for Katchen to land Canavan, but once he was in, another 13 backers signed on within just over a week. Canavan says that Wealthsimple and other fintech upstarts remind him of the early days of the fund boom. Newcomers have found huge gaps in the market. There is that estimated $1 trillion in unadvised money in Canada. Wealthsimple basically combines low-cost ETFs with automated advice. "Nobody in Canada has built the technology before," Canavan says. "It's not rocket science, but most successful businesses aren't."

Among those other backers in Wealthsimple's first round was Som Seif, founder of Claymore Investments, a pioneering ETF provider that was bought by New York City-based giant BlackRock Inc. in 2012. Katchen also landed celeb business academics Roger Martin, former dean of the Rotman School of Management at the University of Toronto, and veteran investment finance professor Eric Kirzner, who is John H. Watson Chair in Value Investing at Rotman.

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Kirzner also advises on investment strategy and process at Wealthsimple—which makes eminent sense. He was one of the first to write about and recommend North America's first ETF, the Toronto 35 Index Participation Fund. In 1997, he put together an Easy Chair asset allocation—20% cash, 30% bonds, 35% Canadian stocks and 15% U.S. stocks. Both were based on efficient markets theory, which teaches that it's almost impossible for an active money manager to pick winning stocks consistently. For most people, it's better just to set your asset allocation and diversify by buying the index—a so-called passive investing strategy. "Wealthsimple has basically adopted what I've been writing about for 40 years," says Kirzner.

As for the biggest Wealthsimple backer, Katchen was introduced to Power Financial vice-president Paul Desmarais III by Seif in September, 2014. Seif and Desmarais were having lunch in Toronto and talking about Canadian fintech. Seif suggested they stroll over a few blocks to Wealthsimple's office, which then consisted of just Katchen and a handful of colleagues.

"We basically spoke to every emerging platform at that time," says Desmarais, 34. But three things made Wealthsimple stand out. One was its engineering talent. "A lot of people outsource the building of the platform. They've done everything in-house," he says. The second was the company's product development ability. And third was its "authentic voice." Katchen and his team are resolutely focused on a mission of "bringing low-cost portfolio construction to the masses," he says.

Desmarais decided to not only take his big early-stage plunge but to become chairman of Wealthsimple. He won't say how big a stake Power has. (Power itself, however, confirms that as of June 30, its position is actually a majority, at 60%.) Desmarais is clear about why he's made such a big commitment: "They can operate with the freedom to be innovative, but at the same time not worry about having to raise money every three months."

Creating Wealthsimple's online platform and eye-catching marketing have been the easiest parts—or at least the firm has made it look easy. You hit the "get started" button on Wealthsimple's website, and then answer 13 questions. And voilà: a recommended portfolio of a handful of ETFs. You can do this in two minutes, then open an account in a few more.

Fees are set low to attract millennials, even those with minimal savings. The annual fee is 0% for your first $5,000, 0.5% up to $250,000, 0.4% up to $1 million and 0.35% beyond that. Right now, Wealthsimple has about 20,000 clients, which means an average account size of just $25,000.

Katchen concedes that the firm isn't profitable, but says it soon will be, even for small accounts, thanks to technology. Last December, Wealthsimple bought Canadian ShareOwner Investments Inc., a small Toronto online investment dealer, to do its actual transactions. "ShareOwner has enabled us to create a fully scalable platform," he says.

Even with ShareOwner in the tent, Wealthsimple is a tiny, lean and focused operation compared with a full-service investment dealer. It has a staff of about 40, spread out over the third floor of a renovated warehouse on the far western edge of Toronto's downtown. They're mainly software developers and marketing people. But there's also a handful of "wealth concierges," qualified advisers whom clients can talk to by phone, if they wish. ShareOwner has another 10 people or so, who recently moved into the same building.

Katchen at Wealthsimple's Toronto office, prior to the arrival of a new batch of staff.

Katchen at Wealthsimple’s Toronto office, prior to the arrival of a new batch of staff.

Wealthsimple's website content and ads are targeted almost totally at millennials, with the message boiled down to its barest essence. The national TV spots and billboards—which are ubiquitous in some downtown hipster neighbourhoods in Vancouver and Toronto—feature two views of the same person: "you and future you," the latter aged about 30 years. The slogan is "Take care of yourself."

Start-ups typically try to keep ad costs low and spread out their budgets. But Katchen launched the "Take care of yourself" campaign by buying TV commercial time during this year's Super Bowl in February. Bold, yes, but he argues that it was cost-effective too. Super Bowl spots cost just $170,000 in Canada, versus $5 million in the U.S., and they reach a greater proportion of the population here.

Wealthsimple's Twitter feed has lots of posts about investing, but it also has had a guide to building a whisky collection, and recently ran an exclusive: "@KylieJenner Tells Wealthsimple Why She Buys Cheap Makeup And Rolls Royces."

Very 2016. But the trouble is that those millennials are going to get older, not all of them will become wealthy, and the ones who do will require a lot more guidance and hand-holding—the kind that the banks and their full-service investment dealers give.

For all its buzz, basically all Wealthsimple has done is automate a passive investing strategy for millennials. And even Kirzner acknowledges that the passive approach "isn't for everybody." Many investors still want or need to beat the index to reach their goals, either by investing in an actively managed mutual fund or by trying to pick stocks and bonds themselves. "Look, I teach a course in value investing that is exactly that," he says.

The cost of pursuing an active strategy is also coming down. Competition and clearer fee disclosure are finally starting to squeeze the fees on actively managed mutual funds. The annual management expense ratio (MER) embedded in the popular Mawer Canadian Equity Fund is now 1.22%. That's still high compared to the biggest Canadian ETF, BlackRock's iShares S&P/TSX 60 ETF, which has an MER of just 0.18%. But average annual returns on the Mawer fund have beaten the S&P/TSX Composite Index by several percentage points over the past five, 10 and 20 years.

Whatever strategy investors pursue, even Katchen concedes that they usually need more advice as they age. "If you need help with advanced tax planning, detailed financial plans, dealing with your family and so on, that's where a traditional full-service adviser can really add value," he says.

The leading full-service investment dealers—the ones owned by the Big Six banks, plus the likes of Power's Investors Group—are, needless to say, much bigger than Wealthsimple. Each has thousands of advisers, and even National Bank Financial, owned by the smallest of the Big Six, has $75 billion in assets under administration.

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The banks aren't digging in their heels in the face of the fintech invasion, either. National and BMO Financial Group have already launched robo adviser platforms, and the other four giants are certain to follow. National was the first of the Big Six out of the gate with InvestCube, launched in October, 2014.

BMO, Canada's fourth-largest bank, launched its SmartFolio service in January. Joanna Rotenberg, BMO's head of personal wealth management, says the bank's senior leaders concluded in early 2015 that "the market is going in a certain direction." Millennials, in particular, clearly wanted faster and better online services.

Getting SmartFolio to market took six months and a team of 200. For a bank, that is speed. "It made us work very differently," Rotenberg says. "There were no passengers. It was a flat structure." She's also proud of the simplicity of the result. Signing up with SmartFolio starts with a 10-question risk assessment—it has more jargon than Wealthsimple's, but is almost as fast—and then gives you a model portfolio right away (whereas Wealthsimple actually allots the funds).

Katchen smiles when comparing Wealthsimple's development process with the banks. "We push code to production many times a day," he says. "If you're a great software developer, having the chance to do it that often, versus once a month or once a quarter, is very good for our value proposition [as an employer]."

But the banks also have vastly more technological firepower than Wealthsimple does, and they can deploy it in many more segments of the market. Cameron Fowler, group head for Canadian personal and commercial banking at BMO, says his team's current priorities include payment systems for retail and small business, lending processes, digital authentication and "more foundational platforms" such as blockchain, which organizes and secures transactions data.

Fowler says BMO's clients want to speed up and simplify all aspects of their financial experience, and millennials, in particular, want to use mobile for just about everything. Yet the bank's surveys of its millennial customers also show that "77% of them think that it's important to have human contact and advice when buying a home, making investments and other big life choices," he says.

So Fowler is not worried about being displaced any time soon. Technology will augment BMO's full-service advice. "I don't think there is an Uber moment going on in the financial services industry. I think there is a customer moment," he says. But he adds that Wealthsimple and other upstarts "are bringing some capabilities that the incumbents need to learn from."

The banks' reach is important to major investors in tech, too. Take the case of Jim Orlando, managing director of OMERS Ventures, the venture capital arm of Ontario's giant municipal employees' pension fund. Fintech may be an expanding market segment, but Orlando says robo advisers don't look particularly attractive as venture or early-stage investments. In the U.S., robo-advisory services are already becoming a commodity. In Canada, "there's not a lot of opportunity in the area," Orlando says. "They're competing against the likes of the banks." Instead, he's looking for new fintech firms that develop genuinely innovative technology that they can sell to larger players.

Even Katchen and Paul Desmarais III are careful in talking about long-term plans for Wealthsimple. Power has invested in several fintech start-ups, but Desmarais says it's premature to say if it will absorb any of them. "We're really focused on maintaining a careful balance between providing them the capital and the support they need, when they need it, but having Wealthsimple keep its flexibility to be innovative and disruptive."

Katchen seems to be looking several moves ahead. He says Wealthsimple is fundamentally a tech company, rather than a financial services provider. "We see ourselves as an enabler to the financial services industry. We don't want to be seen as a competitor." To that end, in May the firm introduced a platform called Wealthsimple for Advisors. It's hard to see it making inroads at bank-owned full-service investment dealers, but at least it signals that Wealthsimple isn't an enemy.

Katchen insists that he wants Wealthsimple to keep growing as a stand-alone entity—not formally part of Power. His goal is to take it public, and to build it into a Canadian-based global business. "Who knows if we'll get there," he says. "But that's certainly the ambition."

But the history of financial services in Canada teaches that the banks and other big established players almost always adapt and prevail, and swallow competitors. Katchen often begins presentations and speeches by saying he co-founded Wealthsimple "to make smart investing simple, transparent and low-cost for everyone." He may succeed, but he may not be the one doing it in the long term.

Watch those fees
Wealthsimple isn't always so simple

Wealthsimple promises to make investing simple and cheap—much cheaper than a traditional financial account. But fees are seldom simple, and even with Wealthsimple, some of them are hidden.

To illustrate, let's assume that you're a modestly flush 29-year-old with $25,000 in savings to invest (Wealthsimple's average account size), and that you want to save for the long term (more than 10 years).

The sticker price

Wealthsimple is up front about the fact that it charges a basic management fee of 0.5% a year for accounts from $5,000 to $250,000. Its software assembles a portfolio of exchange-traded funds (ETFs) for you automatically, whereas a full-service investment adviser might charge 1% to design a portfolio and guide you over time.

The hidden price

Unfortunately, in addition to the fee you pay Wealthsimple directly, each of the ETFs has a fee embedded in it called the management expense ratio (MER).

The Wealthsimple site plays down this fee, noting that it is not charged directly by Wealthsimple and that such fees on ETFs are "approximately 0.2%."

So imagine our 29-year-old's shock when she answers the online "Get started" questionnaire, chooses to invest in a socially responsible fashion, and is provided with a portfolio of ETFs with an overall embedded fee amounting to 0.43%. Add Wealthsimple's 0.5% annual management fee and the total is 0.93%.

That might not sound like much, but, at this point, Wealthsimple is effectively charging just as much as some mutual funds—for instance, the Mawer Balanced Fund, which holds both stocks and bonds. It has an MER of 0.94%, and it has outperformed global stock and bond indexes for many years.

Wealthsimple offers some cheaper portfolios if you choose not to invest in a socially responsible way, but as this example shows, there's a fundamental problem here: One of the main advantages of investing in ETFs is their low cost, but after you add Wealthsimple's management fee to the embedded MERs, that advantage can all but disappear. Our 29-year-old might as well buy a low-cost mutual fund instead.