The tidal wave of regulatory change is hitting the investment services industry. In this blog, we highlight the business opportunities it presents. In essence, we believe it could be a tailwind for our mission to get everyone invested.
The regulatory changes we have in mind are Europe’s Retail Investment Strategy, the UK’s Advice Guidance Boundary Review, and the ideas for a reformed Product Information Framework outlined in a recent consultation by the UK’s Financial Conduct Authority.
Yes, each of these initiatives will ultimately result in new regulations that will consume IT budgets to comply with regulatory must-do’s. But let’s take an opportunistic view for a moment. Each of these initiatives is also aimed at supporting the scalability of investment services, i.e. preparing for more people to start investing and improving the odds of them staying invested. In general, the goal is to increase the financial participation of retail investors by extending the reach of investment services through valuable digitization in a way that preserves investor protection.
In order to truly appreciate the business opportunities this entails, let me start with some context.
Since the 1950s, the investment management industry has been based on rationality and risk. The pioneering work from those early days is still known as “modern portfolio theory” even though it is about to celebrate its 75th birthday. “Modern Portfolio Theory” has many merits, of course, earning Nobel Prizes for founding fathers like Harry Markowitz and William Sharpe, and spawning an entire business that pays your bills and mine. Yet, we should keep an open mind for the evolution of thoughts.
Personally, I tend to always challenge the status quo. That’s what drives the research agenda of my academic work and the roadmap at everyoneINVESTED. I have a natural tendency to look for change that makes things better, change that makes a difference. And it is indeed relevant to do so in the case of investment services, because “modern portfolio theory” is proving difficult to digitize.
Why is that? Well, because its underlying assumptions, such as rationality and a focus on risk, treat the investor as if he or she were a cold-hearted robot. For many years, the negative effects of this have been remedied by putting the robo client next to a human advisor.
But today’s world is different, in two important ways.
First, investment service providers are seeking to increase the scalability of their operations through digitization. The motivation can be internal or external. An internal motivation could be that they want to increase the number of clients they serve without a proportional increase in human advisors. An external motivation could be the tidal wave of regulatory change mentioned above. Unfortunately, simply automating a human-assisted process and putting it on a smartphone screen is detrimental to the business. Conversion rates will drop. The most used functionality will be the SELL button. That’s not what we want.
The second difference can come to the rescue. Since the 1950s, our understanding of how people make decisions has improved dramatically. We have a much better understanding of what actually drives behavior. We can put it into models that drive your digital process, we can present it on screens that are engaging and trigger the desired action. In fact, customers will find the BUY button in your digital journey. Now the process is the machine, and the customer is addressed as a human. In fact, one of the pioneers of behavioral economics – Richard Thaler – opened his 2017 Nobel Prize acceptance speech by saying: “I discovered human life in a place where nobody thought it existed: … in economics!”. And indeed, we are now beginning to see successful applications in our industry, from refined investor profiling to more engaging performance reporting.
In conclusion, I believe the way forward to build scalable investment services in a digital world is to leverage technology and enhance existing processes with behavioral finance insights. It will enable you to comply with new regulations in a way that also increases your operational efficiency. And it will help me get everyone invested.
