Wall Street and the problem of “too many listed fintechs”

In this weekly series, CNBC takes a look at companies that made the first Disruptor 50 list, 10 years later.

A decade ago, the idea that a client in the investment industry preferred to never speak to a human seemed dubious. But it was among the soundbites from robo-advisory firm Wealthfront, which came to market with the backing of Silicon Valley elites and financial industry player Burt Malkiel, author of “A Random Walk Down Wall Street,” among the top executives.

Wealthfront also landed some notable clients in its early days, such as the San Francisco 49ers of the NFL, as well as employees at Facebook and Twitter who experienced windfall wealth from IPOs. But it was never just about celebrities or tech workers. Wealthfront was designed to reinvent the investment process for millennials who first sought to grow their wealth as a demographic increasingly choosing to conduct every aspect of their lives online. As then-CEO of the company Adam Nash said in a 2014 blog post, “Millennial investors have overwhelmingly made us the largest and fastest growing automated investment service in the country.”

At the time, Wealthfront had $1.3 billion in assets under management “from clients in nearly every conceivable profession living in all fifty states,” Nash wrote, and planned to “expand the benefits of automated investing to an even broader millennial audience.”

Earlier this year, Wealthfront was sold to UBS for $1.4 billion.

What happened in between? The reality of trying to turn around a financial services business that was ripe for disruption but where the spending and branding power of Wall Street founders is difficult for any firm, even a successful one, to overcome.

Wealthfront’s January sale was preceded by Personal Capital’s $1 billion sale to Empower Financial in 2020, leaving Betterment alone among the first generation of stand-alone robo-advisors poised to revolutionize the investment world a decade ago.

There were many things the robo-advisors understood. First, more investors have become comfortable conducting their financial lives online. They were also early adopters of the benefits offered by exchange-traded index funds by creating diversified portfolio solutions for investors that were available at a low cost. But their development also shows how tough it is to build economies of scale and marketing prowess in a low-margin, high-cost asset management business that is already dominated by investment giants like Vanguard and Schwab, and Wall Street banks.

Wealthfront achieved real scale from that 2014 milestone of $1.3 billion in assets, growing to approximately $27 billion in assets under management at the time of the UBS deal. But compare that to Vanguard, with roughly $200 billion in its digital investment platform, and Schwab, at $60 billion.

As David Goldstone, who has tracked the space for years in the Robo Report and is an investment manager at Condor Capital, told CNBC earlier this year, “It’s always been a much easier path for the incumbents.”

Disruption can achieve its highest distinction – and obstacle to overcome – when the established operators choose the concept. And that is what has happened in digital investment management.

Robinhood is another example. The disruptive idea of ​​free stock trading was a significant challenge to the status quo in the brokerage industry, but it quickly became the norm, with every major player from Vanguard to Schwab and Fidelity adding free trading. And then it becomes a game of scale and consumption, a tough road for independents in the financial industry with high costs and low margins. And for start-ups, it becomes a matter of what you disrupt next. Wealthfront expanded well beyond its core ETF portfolio service, offering high-yield savings accounts, lines of credit, direct indexing and cryptocurrency investing, but the underlying disruption—making investing a digital-first experience—wasn’t easy to scale to a Law 2 on its own.

JPMorgan CEO Jamie Dimon told shareholders earlier this year that the bank’s You Invest platform had reached $55 billion in assets “without us doing virtually anything.”

In the current market, being sold to a traditional behemoth doesn’t so much resemble the consolation prize of an IPO that it might have seemed just a year ago, even if the robo-advisor sale falls short. Billion-dollar IPO firms that Wealthfront once thought were likely achievable.

“Buy now, pay later” fintech Affirm recently traded as much as 86% of its fintech market cap; crypto broker Coinbase discount by 81%; and Robinhood, down 89%. Even the “traditional” fintechs have been beaten down, with PayPal – not long ago valued higher than Bank of America – now about a third of the bank’s size.

The roboadvisory shakeout speaks to a larger truth in the disruption of financial services.

“We have way too many publicly traded fintechs,” CNBC contributor and financial advisor Josh Brown said Thursday on the “Fast Money Halftime Report.”

“Too many venture-backed fintech start-ups waiting in the wings trying to go public. Most of them overlap each other’s businesses, and most of the problem is that there just isn’t enough growth to go around for all of them .” he said.

“I can’t tell you how many fintech companies I look at that have the same model,” added CNBC Contributor and private equity investor Stephen Weiss.

“They’re spending money on customer acquisition that can’t be recouped for years and years and years into the future, and they’re not growing organically,” Brown said. “Focus on how much money is being spent by traditional financial companies. They’re going crazy about technology. They’re not lying down, sitting there eating glue while these companies are building apps; they’re building their own apps that are extremely competitive.”

Dimon noted in his annual letter to shareholders that by 2021 $130 billion would be invested in fintech, and he meant that as a call to the bank and its shareholders to accept spending even more, with no foreseeable end in sight. “The pace of change and the magnitude of competition is extraordinary, and activity is accelerating… Technology always drives change, but now the waves of technological innovation are coming in faster and faster,” he wrote.

For UBS, there were several reasons to buy Wealthfront, including allowing it to better compete in the US against domestic rivals in a battle for the covered wealth management clients of current and future generations.

UBS CEO Ralph Hamers said on an earnings call earlier this year that Wealthfront’s 470,000 existing clients are an important new audience for the bank to sell more than just ETFs as well. “There are many reasons why we believe that what we paid for [Wealthfront] is absolutely worth the money,” he said, according to an account of the call by CityWire USA. Speaking to UBS’s past missteps in digital advisory, Hamers said on the call: “If you expect the P&L to come from a business like that in the first five the years, basically, you’re setting it up for failure because it’s not going to happen. Even if it’s digital, you need scale.”

Wealthfront still has a future as its own brand — the UBS chief said it will operate as a standalone, which he described as growing and successful, and eventually as the bridge to a service that includes both digital-first advice and remote access to human advisors. “We are planning similar models in the rest of the world,” Hamers said.

While the final chapter on whose consumption wins has not been written, Wealthfront’s decision to sell doesn’t seem so much capitulation as acceptance of something more fundamental about where the road ends for many disruptors: there are times when it’s better to join them rather than to keep trying to beat them.