Robo advisors study

Betterment Investment Research
Sushant Reddy & Anuj Jindal
Over the years, wealth management and investment advisory has evolved into a professional
service, thanks to the emergence of multiple investment opportunities. While investment
opportunities have grown manifold, average financial literacy of investors has not kept pace with
this growth. And this is where a wealth manager or investment advisor adds value; By offering a
systematic long term plan to grow wealth, a financial advisor provides an investor a definite plan
to meet her long term financial goals. Recently this space has been invaded by automatic
platforms that try to provide the same service without a human interface. A pioneering company
in this robo-advisor space is Betterment. In this paper we look at the robo-advisor industry in
general and Betterment in particular. We will end by concluding whether an investment in
Betterment at this juncture is a good or bad investment for a VC firm. We reiterate that our
classification is solely based on whether a VC firm can realistically expect to achieve its IRR target
at the end of investment horizon.
A. Dynamics of current market
There are 4 important stakeholders in the personal wealth management space - wirehouse firms
which have a national presence and a full suite of services from brokerage to research to
investment advice (eg. Bank of America, Morgan Stanley, Wells Fargo Advisors etc.),
investment management firms (Fidelity, Vanguard, Pimco etc.), independent broker dealers who
get paid on commission basis (eg. Northwestern Mutual, AXA Advisors etc) and registered
independent advisors (RIA’s) who are fee-based having fiduciary responsibilities. Following
table describes how Americans are offered wealth management services:
A glance at the above table highlights the following important points:
- Only firms that were really serving the advisory needs of middle income Americans were
the brokerage firms who offered modest investment services
- Brokerage firms were usually incentivised on a commission basis based on the number of
trades executed on clients behalf. So they were encouraging their clients to have an active
investment strategy which was not necessarily a good strategy for retail investors

- Quality personal advisors who could recommend a systematic passive investment
strategy were not available to investors with investable assets under $100k
- Wirehouse firms were often receiving incentives for suggesting specific investments.
Advisors were not truly independent and were not necessarily working in best interests of
the customers
- Whole wealth management business was human-intensive and hence economies of scale
never really benefitted an average retail investor
Existing dynamics of high costs, an underserviced target market segment and a limited use of
technology were the key underpinnings of the wealth management industry before the advent of
robo-advisors.
B. Value proposition of Robo-Advisors
Robo-advisors specifically intended to target millennials with under $100k of investable assets
with an easy-to-access, intuitive digital interface. This segment, as mentioned above, was
uneconomical for the current market players. Assuming a fees of 1% of AUM and $100k of
investable assets, the fees resulting from this player would be $1000. This would be uneconomical
for most traditional players considering the cost involved in sourcing and servicing a client.
Robo-advisor firms like Betterment sort to address this market by leveraging technology and
providing a cheaper alternative for systematic investing. By using technology, Betterment has
reduced retirement planning into a 15 minute experience for a client. By asking simple behavioral
questions to the user, Betterment does a risk profiling of the client. The firm then algorithmically
assigns a passive investment strategy and programmatically rebalances the portfolio over time
without any investor participation. Investor can connect Betterment account with her bank and
schedule automatic deposit instructions at a specific frequency.
Betterment mainly focuses on three things:
1) A simple, easy to navigate technology platform
2) A simple, passive investment strategy
3) A generic investment algorithm that integrates with client’s risk profile
Clients in-turn benefit from three things:
1) Setup and forget - clients are not expected to actively manage the strategy
2) Quality investment management at a low cost
3) Liquid investments and easy cash-in and cash-out options
Investment grows with time benefitting both investors and Betterment alike at a cost which was
unheard of in the wealth management space. Investors are committing small investments on a
regular basis into a passive investment strategy and hence the stickiness is much better than
some actively managed brokerage accounts.
On an average, Betterment charges 0.25% of AUM as fees on an annual basis compared to a
traditional 0.8-1.3% of AUM charged by incumbents. To give an estimate of savings just on fees,

a $500 investment every month for a 25 year horizon will lead to savings of approximately 22,500
(on a compounding basis) which is roughly 15% of the AUM.
Additionally Betterment is providing its investors amazing tools that were earlier accessible only
to high net worth individuals. Some of these tools such as tax loss harvesting were offered by
players like Schwab for clients with a minimum investment of $100k. By introducing technology,
Betterment is bringing high quality at a low price.
C. Betterment and performance so far
“Given the many mistakes that human investors are prone to—selling after a market tumble,
trading too often, believing they can beat the stock market—dealing with money is perhaps best
left to computers.”19
Robo Advisors led by Betterment and WealthFront have seen a massive growth in AUM over past
2 years. According to some estimates, the total AUM for robo-advisors is ~$30B in mid 2015 with
expectations of total AUM reaching $50-$60B by end of 2015. Betterment and Wealthfront, the
east and west coast start-ups that pioneered robo-advisors, manage about $3.0B each in assets
as of Nov’15. Betterment crossed WealthFront in Nov’15 to become the #1 player amongst
startups in terms of AUM. They both have about 100 employees, costs of ~$40-50 million and
generate about $7 million in revenues. Schwab and Vanguard, late entrants to the automated
advising services, each manage >$5B in similar products.
Betterment (and Wealthfront) accumulated most of their $3B AUM in the last two years, seeing
on average 10% month-on-month growth in AUM19
. The following factors helped Betterment with
its early success -
1. Team - a big factor in Betterment’s success can be attributed to its exceptional team. Jon
Stein is an exceptional CEO and has created a phenomenal environment of innovation
within the firm. His ability to solve problems in intuitive yet simple ways led to the creation
of Betterment in the first place. Additionally, he has done a tremendous job of acquiring a
world class team and customers (Source: conversations with Menlo Ventures and
Francisco Partners). Daniel Egan, who is a Director of Behavioral Finance and Investing
at Betterment, is one such example of world class talent that Jon brought on board
(Source: Interview with Prof. Eric Johnson).
2. Low Fees Model - Since Betterment relies on computers to decide asset allocation, they
could manage to offer wealth management services at a significantly lower prices
compared to traditional wealth providers. Betterment’s average fee of 0.25% (ranges
between 0.15% to 0.35%) is far lower than fee of 0.80%-1.50% for investors with less than
$1m in assets. This helped Betterment to quickly acquire customers who either did not
have enough investable assets or found it too expensive to open an account with a
traditional wealth manager.
3. Appeal of product to Millennials - Millennials distrust traditional banking and wealth
management outfits and prefer transparency and DIY (Do It Yourself) products.
Betterment’s friendly user interface and online tools to educate customers helped attract
millennials. Betterment has about 120,000 clients with an average investment size of $25k

per client - a clear indication that millennials are the primary adopters of this investment
platform.
4. Industry Leading Products and Features - Betterment has been at the forefront of
launching new product features that have fueled AUM accumulation. From “Goal based
Investing”, to “Auto-Deposit” & “Smart-Deposit” to “Tax Loss Harvesting+”, Betterment has
delivered simple solutions to overcome behavioral hurdles in investing. Not only has this
helped to accumulate more AUM, this has also helped Betterment leapfrog to #1 position
ahead of Wealthfront, its older cousin in the robo-advising space.
5. Referrals - 40% of Betterment customers come from referrals (Source: Interview with
Francisco Partners). Their success with their early consumers led to an increase in
referrals. As a result, Betterment has lower customer acquisition cost compared to its
direct competitors.20
D. Funding History for Betterment
We provide a brief summary of funding history of Betterment and its main competitors below.
Betterment is backed by prominent VC firms such as Bessemer, Menlo Park, Citi Ventures and
Francisco Partners (source: PitchBook).
Table: Funding history of Betterment and key competitors
As robo-advisors gained traction in last 2-3 years, we see that valuation of these firms has
increased multifold in same period. For example, Betterment’s valuation increased 3.4x in 10
months between Series C and Series D. Similarly, Wealthfront saw its valuation increase ~2.9x
in 6 months between Series E and Series F. The most astonishing growth was for FutureAdvisor
(Xulu), a small competitor with ~$600m in AUM, that was bought by BlackRock in Aug’15 for
$175m, representing a 5.5x multiple in 15 months since its Series B funding.
We spoke to Menlo Ventures (lead investor in Series B) and Francisco Partners (lead investor in
Series D) to understand their investment thesis, key highlights of which are mentioned below -
1. Total Addressable Market (TAM) - With approx. $30T in retail investable assets in US,
investors feel that there is a huge market to be captured by robo-advisors (more on this in
the later section).

2. Demand - Millennials who do not trust traditional financial advisors are the primary
demand for robo advising services. Additionally, investors feel IRA and 401(k) could prove
to be another key product for Betterment, which they plan to launch in early 2016.
3. Team - Investors have expressed a lot of trust in Jon Stein’s leadership capability, the
current CEO. They also think he has done a great job of creating a flat organization.
E. Future Roadmap of Betterment
In this section, we look at the future growth opportunities that Betterment is trying to tap into and
analyze if the firm can significantly raise the game by changing gears in future. Betterment seems
to pursue its expansion across 3 verticals,
Retail: Increase its retail AUM by directly reaching out to new millennials
Institutional: Offer a superior product to higher income segment by tying up with personal
advisors
Business: Enter into the retirement space (401(k) plan offer and administration) and
directly compete against giants like Vanguard, Schwab and Fidelity
Betterment institutional
What we’ve seen till today is Betterment’s foray into the retail market by offering an automatic
technology alternative to individual investors (Retail). But the firm knows very well that there is a
large affluent population that still needs services of a personal advisor to do customized portfolio,
tax and estate planning. It is unlikely that these clients will make a switch to Betterment simply
because they provide a neat technology platform.
A recent phenomenon that is happening in the wealth management industry is that significant top
talent is quitting wirehouse firms and moving to become RIA (Registered Investment Advisors).
RIA’s have fiduciary responsibility to act in best interest of their clients and there is a greater
sense of independence working as an RIA (RIA’s are strictly fee based and do not receive any
revenue in the form of commissions). RIA assets are expected to overtake assets held by
wirehouses as early as AUM21
and this dynamics has led us to make 3 broad conclusions:
- Sophisticated investors are valuing independent personal advisors
- Investors trust the advisor more than the firm he/she works for
- Money is shifting hands from large companies (Wirehouses and Broker Dealers) to smaller
ones (independent RIA’s)
Today a lot of independent personal advisors use Schwab or Vanguard technology platform as a
back-end for their business. Betterment is positioning itself to become a preferred back-end for
these personal advisors so that it can gain an indirect access into the affluent market segment.
While Betterment Retail is a volume game, Betterment Institutional will be more about investment
per account. We believe that Betterment institutional product can coexist with the retail product
and Betterment can see an inorganic growth of its AUM if it is able to sign-up independent RIA’s.
Success of this business is largely dependent on the cost-savings for RIA’s in comparison to using
established platforms like Schwab and Vanguard. Simply from a technology standpoint, we
believe Betterment’s technology is more agile and contemporary than incumbents.

Betterment for Business: 401(k) retirement savings at $4.5 Trillion is perhaps the biggest
retirement saving plan in the United States. Betterment is trying to enter this space and offer
401(k) plans to plan sponsors along with personal advice to employees on their 401(k). 401(k)
plan administration and record keeping is a mature business dominated by large players like
Fidelity, Prudential, Schwab and Vanguard. Employees and plan sponsors find the entire 401(k)
process complex, unintuitive and expensive. Betterment is in a very good position to redefine this
business and challenge the bigger players in this space. If launched successfully, Betterment for
Business could be the biggest success for the company considering the sheer magnitude of this
business.
F. Opportunity and Market Size
As mentioned above, Betterment is looking at 3 business verticals for growth in future - retail,
institutional and business. Accordingly, we looked at the total addressable market (TAM)
separately for these three verticals-
1. Direct-to-consumer channel (Retail) - This category includes millennials and other
technologically savvy people looking for simple and cost-effective investment solutions.
Most simple investment strategies are passive and can be replicated by a mix of ETF
funds. According to a report18
, there were about $5.0T assets under management in this
category. This segment is expected to be disrupted by robo-advisors and we expect that
it will eventually capture ~50% of market share (Successful technology disruptions have
historically captured 50% of market on reasonable maturity).
The current AUM under robo-advising represents just about 2% of this section ($50-60B
in AUM, for total of $2.5T potential target segment), providing a huge growth opportunity,
both for new and old players.
2. Personal advisory channel (Institutional) - Traditional Advisory firms still hold the lion’s
share of assets under management in the US. This number is estimated to be around
~$20T18
. This section includes wirehouses, broker dealers and discount brokers. As
mentioned above, there is a distinct trend where wealth is shifting from broker-dealers and
wirehouses to independent, fee-based risk advisors.
Betterment recently launched its Institutional business segment, that partners with such
institutional advisors to help them better service their ‘rich’ clients. These boutique
investment firms can spend more time with clients and less time with operational issues
by simply using Betterment as their technology back-end. This market is yet untapped,
and some estimates say ~ 20-25% of this AUM, that is ~ $4-5T, may be available for
management under automated advice. This provides a huge growth opportunity for assets
under management for robo-advisors
3. 401(k) accounts - According to some estimates, there are about $4.5Trillion retirement
assets in 401(k) accounts17
. Since retirement advisory is more passive than active, we
believe this is a good target segment for robo-advising, with 100% assets capture target.

Betterment recently launched “Betterment for Business” with plans to target this segment
by providing a vertically integrated 401(k) service to employers, which is expected to go
live in 1Q2016. With its simple yet cheaper service, Betterment hopes to disrupt this space
as well - just as it disrupted the “direct to consumer” channel.
In a nutshell, there is a huge market (~$10-12T) potential for robo-advisors, while the current AUM
only represents 0.5% of the potential market. This provides a lot of growth opportunity for
Betterment in near future. Current state of AUM under robo-advisors is just the tip of the iceberg
and as more and more firms start offering these services, AUM for robo-advising will exponentially
increase in future.
G. Competition and market moves
“We add more assets to our firm over lunch than the entire assets under management of some
of these robo-advisor firms” - Anonymous Asset Manager
Competition from robo-advisor startups: Right at the time Betterment started its business on East
Coast, Wealthfront, another startup with the exact same concept, began getting market traction
on the West Coast. Both companies matched feature to feature and apart from subtle operational
and marketing differences, there is nothing much to separate the two companies. The AUM of
these two firms has also seen a similar growth curve over the years.
As the two firms gained traction, a slew of robo-advisor startups emerged with minor tweaks to
their business models. Major startups competing in this space with Betterment and Wealthfront
are Future Capital, SigFig, Personal Capital and Hedgeable. Betterment has been leading the
pack in terms of client and AUM growth and considering the nascency of this business, we believe
more startups help the market leader instead of hurting it. In our view, Betterment is well
positioned to take on these startups because
a. There is an element of client education needed to get a wider acceptance of robo-advising
(beyond early adopters). Marketing budgets of these startups help in client education
which benefits Betterment as well
b. Market penetration of robo-advisors is so low compared to overall investable assets that
there is room for growth for almost every player.
Emergence of counter-strategies from traditional players: The early success of robo advisors
caught the entire industry off guard. Traditional players took a while to wake up to the new
paradigm and reactions moved from ridicule to a grudging acceptance of the business model. As
one of the managing partner at an independent advisor firm said, “We usually overestimate
relationships in our business and assume that clients will stick around on the strength of this
relationship”. First line of defence for traditional players has been that technology cannot replace
client relationships and that clients that robo-advisors are chasing are anyway not their target
market. But as markets progressed, what these traditional players realized was that there was
‘immense’ scale in this business. Real validation of the business came when giant traditional
players started entering the robo-advising space.

Two big players, Schwab and Vanguard have launched robo-advisor platforms called Schwab
Intelligent Portfolios and Vanguard Personal Advisor respectively. There are reports that Fidelity
is testing its robo-advising product ‘Fidelity Go’23
. While Schwab expects a minimum investment
of $5k, Vanguard has a minimum investment size of $50k, a much higher commitment than
Betterment (no minimum size) and Wealthfront ($500). Vanguard offers a personal advisor for
each client account to provide a human interface with a robo platform. As of today, Schwab
Intelligent Portfolios has an AUM of $5 billion and Vanguard (still in pilot stage) has an AUM of
$17 billion. This compared to the AUM of Betterment and Wealthfront (~$3 billion each) is much
bigger but a large part of this initial AUM can be attributed to these companies simply shifting
some of their client’s assets to the automatic investing platform.
Our view on emerging competition from large investment management firms with an established
wealth management practice is:
1. A large number of ETF’s used by Betterment and Fidelity are managed by Vanguard or
Fidelity. So there will be a natural cost advantage for these firms to have a robo advising
platform (Schwab platform has no direct cost to customers although we found a hidden
cost when we talked to their support team while setting up our account).
2. They have a huge brand name and years of investment experience to back them. While
early technology adopters might not consider this as important, the second bigger wave
of market adoption will come from late adopters. This target segment will be more risk
averse and will attach a greater importance to brand name. So we believe Betterment and
other startups will have a tougher competition from these platforms in future.
3. Real disruption would be if one of these firms can successfully merge their personal
advisory business with robo-advising platform (Vanguard is attempting this). This would
give clients best of both worlds in investing.
4. Huge balance sheets demonstrating stability. In the investment space, people are usually
worried about ‘What-if’ scenarios; having names like Schwab and Vanguard brings in a
sense of stability that some of these startups cannot demonstrate.
5. It is a tightrope walk for these companies to sign-up new clients for robo-advising platform
and not lose their existing clients.
6. Increased competition from traditional advisors, who have extensive distribution and reach
to new customers, means the acquisition cost for new customer for Betterment (and
similar startups) is going to increase many fold. In an early sign of trouble, the monthly
growth of AUM at Betterment slowed to approx. 5% month-on-month by Oct’15 from an
average rate of 10% in the preceding two years. However, TAM is big enough for
coexistence of several successful players.
7. Additionally, the low fee model of the robo-advising would forever reduce the average
revenues from the AUMs, as more and more existing investors at traditional wealth
managers demand low cost investing services.
M&A activity: Another interesting play is the emergence of other investment management firms
onto the robo-advising market through the M&A route. These firms have chosen the strategy of
not building the capabilities internally but simply shopping around and acquiring an existing

company. As mentioned before, Black Rock had recently acquired Future Advisors at 5.5x of its
Series B valuation.
Betterment’s bigger plans: While firms like Schwab and Vanguard are trying to break into the retail
segment with their robo-advisor platform, Betterment is trying to take the fight directly to these
firms using its Institutional and Business platforms. These two verticals have been dominated by
large players and there are enough opportunities for technology driven disruption in this space.
Most of the people we spoke to during our research claimed that 401(k) space has a lot of
bottlenecks currently and market definitely has space for a low-cost, employee friendly platform.
Similarly, there is a general opinion among traditional clients that their wealth management
process has to be more transparent about costs. We see Betterement leveraging its retail
experience to bring some real innovations in both the institutional and business segments.
Our conclusions on competition are:
1) We don’t see a threat to Betterment from other startups
2) Traditional players definitely validate the robo-advisor space. This makes us more
confident about the future market opportunity
3) We see a bigger threat to Betterment from robo-advising platforms of these traditional
players.
4) Traditional players will not be as aggressive with the platform as Betterment because
they might cannibalize on their existing business
5) Betterment, with its experience in retail business, is well placed to compete with bigger
players in the Institutional and Business segments
H. Key risks and concerns
1) No downcycle yet: One major uncertainty is how robo-advisor companies fare during
economic down-cycles, like the one witnessed between 2009-10. Last five years have
been good from an equity investment point of view and any investment strategy
(rebalancing or not) would have led to a positive return (see below chart for S&P Index).

Betterment and Wealthfront have really started to grow in assets from 2012 onwards. Best
personal advisors have complained that clients panic when investments fall alarmingly
and that advisors/broker-dealers face a lot of pressure from investors to liquidate
investments during this time. Nobody is sure how big an impact such an event would have
on Betterment AUM but our hypothesis is that passive investing strategy adopted by robo-
advisors makes this impact less severe than other traditional players.
2) Negative press: There are multiple robo-advisor companies that have sprung up in recent
times and it is obvious that some of these firms are going to go down under. Unlike other
startups, these firms have different dynamics because they involve not just VC money but
money of common retail investors (mostly unsophisticated mom & pop investors). While
Betterment is SPIC insured guaranteeing investor money upto $500,000, the same cannot
be said about other smaller firms in this space. A senior practitioner from one of the biggest
discount brokers in US says ‘These firms are addressing a market that is new to the
investing business. Even if one of these firms goes down, there is going to be an adverse
ripple effect and the press will play it up because there is a lot of money involved here.
There will be potential regulatory action and events will be very swift. Silicon valley startups
are usually arrogant and underplay the risks associated with such events’
3) Flight risk for large accounts: Betterment makes money from two sources:
a) New accounts increasing AUM
b) Growth in AUM of existing accounts over time (increasing deposits and favorable
market movements)
Betterment expects that it can catch an investor young and grow with her as she
progresses professionally. This hypothesis does not consider one fact - this investor was
originally not a target customer of RIA/wirehouse firms but over time she becomes one.
Andrew Cooper, managing partner at a boutique investment advisory AJC Wealth, says,
‘Looked another way, Betterment is incubating our potential customers and educating
them about the utility of disciplined investing. Once these customers reach a particular
size, boutique firm like ours can serve them better because we can give a holistic view

about investments. Not all investments are ETF’s and clients will start expecting personal
advice once investments surpass a particular threshold’
4) Barriers for entry: At the core, Betterment has a dynamic rebalancing algorithm, a universe
of investable equity and bond ETF’s from Vanguard and iShares and direct fund transfer
facility with most banks. A rebalancing algorithm has multiple variants and every fund
manager has her own variant of rebalancing. At the core, we did not find any unique value
proposition that only Betterment can offer in the market. Almost every feature that
Betterment offers is available with its competition. The fact that Schwab and Vanguard
could come up with their own platforms in a relatively short time reinforces this fact that
barrier for entry is relatively low for established broker-dealer investment advisors.
5) Investment switching cost: A person with existing investments need to first liquidate the
investment and move on to Betterment. If the investments are profitable (on a cost basis),
there is going to be an immediate tax implication for switching the investments. This is a
huge deterrent for existing investors to switch their investments onto Betterment. This is
a double edged sword and makes it equally difficult for investors to switch investments
from Betterment to other entities. We believe that it is unlikely that people will take an
immediate tax-hit to transfer their existing portfolios to Betterment. This is significant
because this largely excludes the possibility of inorganic growth where massive portfolios
get shifted to Betterment overnight.
6) Existing investments: A core problem of robo-advisors is the assumption that an investor
is starting with only cash assets. Assets outside ETF’s such as real estate holdings, rental
income, stock options in public companies, stock and bond investments are not part of the
allocation logic. While this is not a big concern with small investments, it becomes a big
issue when investable assets exceed a 100k USD. This is where a personal advisor adds
maximum value as their allocation would include all assets held by an investor.
I. Our investment hypothesis for Betterment
Given the funding history of Betterment (Series D in Feb’15 at post money valuation of $430m),
and our conversations with the market participants, we understand that Betterment expects to be
valued at $1,000m or higher post-money valuation if it were to raise money today.
This valuation looks high if we factor in the current revenues and costs and also the prevailing
investor sentiment. At current AUM of $3B and assuming a multiple of 5% of AUM for Betterment’s
valuation16
(growing company, and higher operating leverage given technology costs will not scale
directly with increasing AUM), the company should be valued at ~$150m. For the company to
have a valuation of $1B, the required AUM is $20B.
This implies the market is factoring in a huge future growth in Betterment. Assuming a 2.5x cash
on cash return in 5 years (20% IRR, Scenario B), Betterment would need to get to $50B AUM by
2020. Assuming a 5.0x cash on cash return in 5 years (38% IRR, Scenario C), Betterment would
need to reach AUM levels of $100B by 2020.

Table: How much AUM is required by 2020 to justify current valuation?
Even though AUM of $50B or higher by 2020 from the current state looks ambitious, we provide
our analysis below to show why we believe it might just be possible for Betterment to reach these
numbers
1) Huge untapped market for Robo Advisors - as noted above, the total potential AUM for
robo advising in US could be ~$10-12T. Currently, only $50B = 0.5% of total potential
AUM is invested via robo-advisers, providing a huge legroom for growth.
According to a market survey by A.T. Kearney11
, AUM for robo advising is expected to
reach $2T by 2020, implying a growth of 40x. Even though bulk of this growth in AUM
would be absorbed by the traditional players as they move their existing customers to robo
advising (sometimes cannibalizing their existing revenues), we believe Betterment has a
nice traction going for them with high rate of referrals (approx 40% of their new customers
are referrals from existing customers) and new products launch (Betterment for Business,
401k). Consequently, getting to $50B (~17x in AUM) or $100B (~33x in AUM) for
Betterment even in a tough competitive scenario is not unrealistic
2) New Product and channel launches - Given the launch of Betterment for Institution (new
channel) and Betterment for Business (401k), we believe Betterment is well poised to gain
AUM at an increasing faster pace.
We are particularly excited about 401k plans, as with its one-stop solution (Vertical
Integration15
) and significantly lower fees for employers, Betterment’s 401k product seems
to offer better value than current market offerings. Given 50% of employers in Unites
States do not offer 401k accounts for their high costs, Betterment’s product could be a big
game changer for employers looking for simple solutions. We believe that small
businesses and growing startups could be a big customer base for Betterment. We believe
it is tougher to make existing employers switch to a new 401(k) plan provider initially but
if the firm brings a compelling solution that addresses present bottlenecks, Betterment can
break into the market controlled by incumbents. Our primary research suggested that
Betterment has already signed up 20 employers and has bagged a pilot project with one
of the biggest investment banks.

AUM assumptions for different Betterment Products
(i) Betterment for Retail: Estimated AUM by 2020 ~ $50B
Chart: Growth in AUM just for Betterment retail product (1 of the 3 products) without
assuming any marketing initiatives
The above chart shows that assuming Betterment stops taking new customers, assuming
a 6% growth in AUM (market returns) and the current rate of auto-deposit from current
customers, the AUM is expected to grow to $10B by 2020.
If we assume that Betterment sees the current rate of referrals (40% of all new customers
are from referrals) for the next 5 years, current and new referral customers are expected
to increase the AUM to $34B. Since Betterment would not stop marketing efforts to raise
AUM from new customers, we think the retail AUM could well be greater than $50B.
(ii) Betterment for Institution: Estimated AUM by 2020 ~ $20B
We believe Betterment would be able to capture ~ 20B AUM in this segment as it develops
more relationships with Institutional Investors, who would like to offer the automated
advice to their HNW to focus to more complex issues like estate planning, trust set-ups
etc.
Since, HNW bring in more AUM per account, Betterment would need to open smaller
number of accounts (compared to retail accounts) to reach the estimated AUM number.
With approx. $4-5T in potential AUM in this segment, Betterment is well poised to gain
market share.
(iii) Betterment for Business: Estimated AUM by 2020 ~ $60B
Chart: Growth in AUM for Betterment for Business assuming 100 business clients, each
with 15,000 employees and 35% market share for Betterment

We believe Betterment would be able to generate an AUM of ~$60B from Betterment for
Business just by opening 100 accounts with big employers (~15,000 employees or more).
We feel very comfortable with this assumption given Betterment offers an end to end
solution at a very low cost to employers for managing their employees 401k accounts.
The best part about this business is that these AUM would keep growing as employees
contribute to their retirement funds every month (passive investing with auto-deposit is
what most investors are preferring).
Given the AUM estimates from the above three scenarios, we estimate an AUM of approx
~$130B for Betterment by 2020. This would imply a valuation of $6.5B for Betterment in
2020, providing for a 6.5x cash on cash return (IRR ~ 45%) from current estimated
valuation of $1B. We agree with Peter from Francisco Ventures, who said that Betterment
needs just one of the three products to become successful for the company to become
super successful and return value to investors.
J. Downside Case for Betterment
If Betterment were to not meet the AUM targets we expect above or have huge cash bleed in
pursuit of new customers, we believe the brand and product that Jon Stein and team has created
at Betterment would have many takers (either an outright acquisition or a strategic alliance).
As traditional players are waking up to the robo-advising opportunity, they are trying to offer their
own product, either developing it in-house (Schwab or Vanguard), or by acquiring an external
player (BlackRock’s acquisition of FutureAdvisor). Such an acquisition for Betterment would
provide a potential exit in case company were to face difficulty in executing its growth plans on its
own (we feel this is highly unlikely)

Using last transaction of FutureAdvisor as a benchmark ($175m purchase price for AUM of
$600m)2
, we estimate Betterment’s valuation to be atleast $875m ($3B AUM for Betterment vs.
$600m AUM for FutureAdvisor).
Additionally, as we showed in analysis above, even if Betterment were to just get new customers
from referrals at the current rate, its AUM would increase to $35B, providing a valuation range of
$840m (assuming valuation = 2.4%xAUM)16
to $1,750m (assuming valuation = 5%xAUM).
K. Conclusion
It is evident that robo-advisors have created irreversible changes in the wealth management
industry. As traditional players embrace the idea of automated advising, more and more invested
dollars will move under robo-advising. This will shrink the margin for the entire industry, as robo
advising services are significantly cheaper than traditional services. There will still be a use for
human advisor but this service will supplement the robo-advising service. Every advisor and
investor might not embrace robo-advising to the same level but role of technology is only going
to increase in future.
New companies such as Betterment are revolutionizing the industry by bringing simple yet
transparent products in the market. Betterment, which has been termed “Apple of Finance”13
, is
at the forefront of financial innovation and is well poised to gain from the new shifts in the asset
management industry. Even though Betterment’s valuation seems high with respect to its current
revenues, we feel comfortable with its future growth prospects, and recommend an investment in
the company (see reasons for investment in “Investment Hypothesis” section).
The investment in Betterment is not free from some concerns. The biggest being how the
performance of robo-advisers will be in a market downturn and how they will adjust to increased
competition from incumbents. Both these risks are problems of a young and a rapidly evolving
industry and we have factored these risks in our investment recommendation. Keeping the growth
plans in perspective, we believe that the likelihood of making windfall gains from this investment
is reasonably high.

Bibliography
1. Betterment to Offer ETF-Only, Online 401(k) Plan
http://www.wsj.com/articles/betterment-to-offer-etf-only-online-401-k-plan-1441981950
2. BlackRock Embraces Robo Finance Advice with Acquisition of FutureAdvisor
http://www.wsj.com/articles/blackrock-embraces-robo-finance-advice-with-acquisition-of-
futureadvisor-1440594106
3. Why You Should Check Your 401(k) Plan’s Fees
http://www.wsj.com/articles/why-you-should-check-your-401-k-plans-fees-1447038127
4. Automated ‘Robo’ Adviser Lowers Its Investment Minimum
http://www.wsj.com/articles/automated-robo-adviser-lowers-its-investment-minimum-
1447855380
5. My Experience With a Robo-Adviser http://blogs.wsj.com/experts/2015/11/10/my-
experience-with-a-robo-adviser/
6. Fidelity Investments Tests Robo Adviser
http://www.wsj.com/articles/fidelity-investments-tests-robo-adviser-1448054477
7. Betterment SmartDeposit–Auto Pilot for Savers
http://www.doughroller.net/investing/betterment-smartdeposit-auto-pilot-for-savers/
8. The Role Of The Robo-Advisor
http://www.fa-mag.com/news/the-role-of-the-robo-advisor-23704.html
9. Robo-advisers are here. What’s a human financial planner to do?
https://www.washingtonpost.com/news/the-switch/wp/2015/11/05/robo-advisers-are-
here-whats-a-human-financial-planner-to-do/
10. Robo Advisors: Capitalizing on a growing opportunity
http://www2.deloitte.com/content/dam/Deloitte/us/Documents/strategy/us-cons-robo-
advisors.pdf
11. Hype Vs Reality: The Coming Waves of “Robo” Adoption
http://invest.events/wp-content/uploads/2015/06/Invest15-Hedges.pdf
12. McKinsey: Robo-advisors have a cloudy future but 'virtual advice' delivered by 24-hour
super-centers with experts and algorithms will win the day
http://www.riabiz.com/a/4984545384333312/mckinsey-robo-advisors-have-a-cloudy-
future-but-virtual-advice-delivered-by-24-hour-super-centers-experts-and-algorithms-will-
win-the-day
13. This startup captured $200 million of people’s savings by turning financial advice into an
algorithm
http://qz.com/87075/how-turning-financial-advice-into-an-algorithm-took-this-startup-
from-zero-to-200-million/

14. Betterment for Business: The Best 401(k) for Employers and Employees
https://www.betterment.com/resources/inside-betterment/product-news/betterment-for-
business-the-best-401k-for-employers-and-employees/
15. Vertical Integration: Better Business, Better Returns
https://www.betterment.com/resources/inside-betterment/our-story/vertical-integration-
better-business-better-returns/
16. Market cap to AUM is a great valuation metric for asset managers
http://marketrealist.com/2013/02/market-cap-to-aum-is-the-best-valuation-metric-for-the-
asset-managers/
17. Frequently Asked Questions About 401(k) Plans
https://www.ici.org/policy/retirement/plan/401k/faqs_401k
18. Investable Assets Hit $33.5 Trillion
http://www.financial-planning.com/news/practice/investable-assets-hit-335-trillion-
2691090-1.html
19. Robo Advisers: Does Not Compute
http://www.economist.com/news/finance-and-economics/21677245-growth-firms-selling-
computer-generated-financial-advice-slowing-does-not
20. Betterment: Columbia Caseworks
http://www8.gsb.columbia.edu/caseworks/node/155
21. Wirehouse firms losing top advisors
http://www.riabiz.com/a/11600418/fed-up-wirehouse-advisors-more-eager-to-leave-than-
ever-study-says
22. Betterment for Business
http://www.investmentnews.com/article/20150911/FREE/150919985/betterment-to-
become-first-major-robo-adviser-to-offer-401-k-plans
23. Fidelity testing its robo-advising platform - Fidelity Go
http://www.wsj.com/articles/fidelity-investments-tests-robo-adviser-1448054477?mg=id-
wsj

Meetings
We conducted following meetings over the course of last two months to gather data and form
our opinion about the opportunity we see in Betterment.
<hidden because of non-disclosure agreements>

Robo advisors study

Recomendados

Recomendados

Más contenido relacionado

La actualidad más candente

La actualidad más candente (20)

Similar a Robo advisors study

Similar a Robo advisors study (20)

Último

Último (16)

Robo advisors study