CEO Interview: Michael Katchen of Wealthsimple Financial

Based in Toronto, Wealthsimple is intent on bringing low-cost, technology-driven investment strategies and personalized service to every Canadian.

Wealthsimple, like most robo-advisors, creates diversified portfolios utilizing low-cost ETFs – no stock picking and no market timing.  They do not accept commissions. Rebalancing as an asset class drifts too far from its targeted percentage happens automatically.

The service is free to investors with under $5,000, 50 basis points for investors with between $5001 and $249,999, 40 basis points on accounts between $250,000 and $999,999, and 35 basis points on anything over $1,000,000. There’s a handy fee calculator on their website. Fees on underlying investment products are additional, and can run as high as 80 basis points. Tax loss harvesting is available on accounts of $100,000 and more.

Founded in 2014, Wealthsimple has raised nearly $12MM in two rounds from eight investors, including a $10MM Series A from Power Financial Corporation in April, which undoubtedly gives the firm a credibility boost with retail investors. Power Financial is the Montreal-based holding company that owns, among other things, Mackenzie Investments, Putnam Investments, and Great West Life.

We asked Mike Katchen, Wealthsimple co-founder and CEO, a few questions.

Q.   Mike, can you give us a quick overview of the Canadian wealth management market?

A.   It’s very different from the U.S. Banks dominate the distribution of products and advice in Canada, and we have five banks that are the dominant players here, which is very different from the states, where you have thousands of banks. In the U.S. people often have many financial institution relationships. In Canada, people have a handful at most, and – much more commonly – loyalty to a single financial institution over a lifetime.

Q.   How is Canadian wealth management generally priced? Is it on a percentage of assets? A fee per service?

A.   We have all sorts of models here. The most common is certainly a percentage of assets, and Canadians actually pay the highest fees of any country in the world for investment advice.

Q.   In the 1990s, I played a small role in helping a U.S. mutual fund manager launch a family of funds in Canada. My recollection is that mutual funds available to Canadian investors were very pricey, and that direct-to-consumer was an under-developed distribution channel. Is this still the case?

A.   The latest data that I’ve seen is that the average equity mutual fund in Canada still costs around 242 basis points.

Q.   So that hasn’t changed. Who is your target market?

A.   We have a very different demographic than a traditional advisor would have. About 80% of our clients are under 45, and 90% are under 50, which is the inverse of a traditional business. They tend to be young professionals with above average incomes who are well-educated and busy with their careers. They’re looking for a smart, thoughtful, but convenient solution for their money.

Q.   Do you sense a generational shift going on?

A.   For sure. I think it’s a very standard adoption curve. If you think about any new technology product, the earliest adopters are young and technology-adept. Over time that will change to be much more mass-market. If you think about the structure of the advice business, this makes sense, because a typical advisor has an account minimum of $100,000 or 250,000 or $500,000 or more. Young professionals don’t have those kinds of assets yet. They might be building wealth, but they simply don’t meet those minimums. So, we are the only option for them if they want any sort of advice, don’t want to just buy a mutual fund, and don’t want to do it themselves.

Q.   How are you attracting customers?

A.   It’s changing and we’re still learning. We’re still just 12 months old, but we have three channels that work really well for us. Our biggest channel is referrals. Clients are telling their friends and family about us, bringing them onto the platform. Second is media. We’ve been fortunate; we’ve had lots of positive media attention. The third is events. We do a ton of events focused on financial literacy.

Q.   We all know that inertia is one of the strongest forces preventing people from getting their investment lives in order. How do you motivate prospects to take action?

A.   We think about it as trying to remove all of the friction from signing up for an investment account. Our aspiration is to make as easy to sign up for investing as it is to sign up for Facebook. We’re not there yet. But that’s the aspiration.
When we launched the business 12 months ago, we were the first paperless investment manager. If you wanted to sign up for an advice account at any other company, you needed to print off 30 pages of paperwork, walk into a bank branch or mail it in with a copy of your passport and a check. That is a barrier that prevents people from getting started. So when you make it paperless, you make it easier, and you’re removing that friction that keeps people from getting started with an account.

Q.   You’re offering some free services that people can utilize to dip their toes in the water.

A.   That’s another way to do it. Rather than asking people to give you $100,000 off the bat, we say: “Listen, we’ll prove to you that we’re the best, so try us now for $5,000, and we’ll waive the fee on the first $5,000. You’ll get a feeling for the type of service you’re getting yourself into before you commit to anything more than that.”

Q.   What percentage of people go on to paid services?

A.   The answer to that is the majority. We have a tremendous number of people who have automated their contributions on a regular basis, so they’ve automated monthly deposits and that sort of thing. People consolidate their accounts one or two months after trying us.

Q.   Are your clients coming from banks? Brokerage firms? Are they new to investing, without enough assets to be profitable to traditional wealth managers but still in need of advice?

A.   It’s a big mix. But we’ve certainly over-indexed the early investor – the person who is just sitting on cash and hasn’t started yet, and the person who has a brokerage account but as they’ve really gotten going in their career they just don’t have the time so they’ve neglected it, and they’re looking for a convenient solution.

Q.   Is the bigger opportunity in taking customers away from the traditional firms or in convincing people who have savings but no investments that they need to become investors?

A.   The answer is both, but the staging is different. My expectation is that the earlier adopters will come from the new channel where they don’t have relationships, and over time we’ll see more of where existing relationships will migrate, but right now we’re not looking to pry people away from what they’re doing. We’re looking to help people get started.

Q.   How do you capture your customers’ objectives and get to know their tolerance for risk?

A.   We have two steps. We have a written step, a questionnaire, that they’re required to take online, and then when we match our clients with a dedicated advisor, and they’ll have a quick phone call with that person to review those results and answer any questions you have about your goals, your preferences, the things that would influence the sorts of portfolios that we can construct for you. And it’s a combination of those two steps that help inform what the portfolio and the investment strategy look like.

Q.   You call those advisors your Wealth Concierges – fully-licensed people who are full-time, non-commissioned employee of Wealthsimple. Where do your advisors come from? What sort of experience do they have and what kind of training do you provide them?

A.   We look for people that have many years of experience working in the advice channel, ideally with high net worth individuals, so they have seen a range of complexity and are knowledgeable. But we like to remove them from a channel where they’re commission based and give them an opportunity to do what they do best. Unlike a traditional advisor firm where they’re looking for hunters – the people who are amazing at sales – we look for people who are great with content, who are excited to sit down with clients and advise them and are happy just to help clients set themselves up for success, which is a slightly nuanced skillset compared to a more traditional firm.

Q.   Clients give Wealthsimple trading discretion. How much control over investment decisions do clients have over their accounts after they sign up?

A.   It’s a fully discretionary platform. We don’t look to get the clients approval in advance for each trade, but what we do get the clients approval on is the broad investment strategy and our approach to rebalancing so that they know exactly what kind of a system and approach it’s going to be.

Q.   And how much customization can you do? For instance, how do you incorporate existing investments into the plan? Can clients keep positions in specific funds or securities, or are they asked to liquidate their existing holdings, which could entail a significant tax hit?

A.   One of the value props that we offer is a world-class investment team that put together the portfolios to support our clients. So we don’t offer the ability to swap ETFs or to change the strategy entirely. However, if a client has an existing position, we’re happy to hold that and to try to tweak the portfolio around it so that it makes more sense with their other holdings. And I think we’ll do more and more of that as time goes on.

Q.   Can they make trades on their own in that account independent of you?

A.   No.

Q.   Who hold clients assets and who executes trades?

A.   Right now it’s a third-party custody provider called Virtual Brokers. They’ve been ranked in the top three brokers in Canada for years and years now by The Globe and Mail.

Q.   What kind of research and back-testing was done to test the performance of your portfolio recommendations?

A.   A lot. We have a really world-class team behind us. Professor Eric Kirzner is the head of our investment committee. He’s actually a gentleman who was on the team that designed the very first ETF in the world in 1989, the oldest public ETF. It’s a really wonderful team that helps us, and we have this very thoughtful approach to the way we design and execute these investment strategies.

The basic approach to thoughtful investment management is not that complex. So you can get 90% of the way there even if you were doing it yourself, as an individual investor being thoughtful about asset allocation, rebalancing, buying a pretty good low-cost ETF to get the exposure to each asset class. That’s pretty good. You’re 90% of the way there. The last 10% does come with the expertise of the backtesting models, some assumptions about the future, how you work in tax and the rest of it, the way you think about optimizing that portfolio. And certainly we spend a lot of time on that. It’s a pretty rigorous process and approach.

Q.   What is your approach to international diversification?

A.   It’s a hugely important part of any portfolio, and I think broadly speaking Canadians have a real problem – every country has this problem, but Canadians in particular. There’s a massive overweighting of Canadian portfolios to Canadian securities.

There are two reasons that’s a problem. One, the Canadian market is not sufficiently diversified. We have resources and financial services that make up most of our GDP here. And two, we make up a very small share of the global economy. So one of the huge things that’s important for the Canadian portfolio is getting away from that massive home bias and getting more broad international exposure, especially on the equity side.

Q.   How are you preparing clients for rising interest rates?

A.   This is something that we thought about for the portfolios from day one. If you look at interest rates from the ‘80s until now, it’s basically a straight line down to zero. One of three things is true going forward: Either interest rates will hover around where they are, they’ll go up slowly, or they’ll go up fast. So when we talked about portfolio construction, we needed a portfolio that was thoughtful about any of those three scenarios.

And so bonds are not, as we tend to think about them traditionally, this risk-free income-generating, passive class in the portfolio. That is not the way you think about bonds anymore. And so if you need an income-generating asset, you need to be broader about how you think about that.

First, dividends became an increasingly important part of the income piece of a portfolio. Second, we added real-estate. So: less exposure to traditional bonds, more exposure to other income-producing asset classes. And we took a thoughtful approach. Even on the real-estate products that we use, these are real-estate products that have interest rate hedge.

Q.   You say you are actively hedging against downside risk in your portfolios. How are you doing that?

A.   Our approach to investment management is long-term trying to track the market. So we’re not trying to outperform the market, but we’re trying to be more thoughtful about risk-management, trying to be down less in a down market. The way we do that is broad diversification across asset classes, and then the use of some risk-management strategies. The interest rate hedge would be one in the real-estate portfolio. The second is we use a product from a company called Purpose Investments, which is a practical hedge equity product that very simply moves from equity to cash in down markets based on a set of defined rules. The only reason it is used is to soften the downside in a fast-moving market to try to help our clients lose less in that sort of scenario.

Q.   Most of the investments you utilize are passive ETFs, consistent with your low-cost, don’t-time-the-market approach. But you also utilize four active funds – all run by the same firm – with management fees as high as 80 basis points. Is this consistent with your philosophy?

A.   We’re totally agnostic—this is important to understand—we’re agnostic about our manufacturers, and our approach is asset allocation first. That drives 90% of our returns long-term. And then there’s the question of what’s the best product to get exposure to each asset class. We actually have detailed on our blog our approach to product selection, but it’s a combination of the right strategy for an asset class, the right cost, and we seek to do broad exposure. We don’t believe in just market-cap weighted lowest cost ETFs for every asset class out there. We don’t think that’s necessarily the most thoughtful approach.

On the manufacturers we use, they may be the only ones with the sort of a product that we like. So for instance the North American real-estate product — they’re the only ones that have a North American real-estate product. And second is on cost. We’ve done our best to negotiate pricing arrangements with all of our ETF manufacturers, and we pass all of those savings on to our clients. We have preferred pricing on products that makes them much more attractive in our portfolios than they might be in a typical real-estate investor’s portfolio buying it on your own.

Q.   Tell me about the Power Financial relationship. How will they help you going forward?

A.   They’ve been really good partners for us. We started talking with them the week we launched the business and kept in touch regularly, and over time the conversation evolved into “Wouldn’t it be interesting to work together.” We came to an arrangement that worked really well for both of us. The partnership has been really helpful. Today it’s capital and support for us with the expertise they have across all the different businesses that we have now exposure to and access to, which has been great.

Q.   Power Financial has the option to invest up to $20,000,000 more over the next 12 months. Are there specific triggers built into the deal? How does that happen?

A.   That’s exactly right. There’s a certain milestone that we have to hit.

Q.   Are they expecting you to incorporate products offered by the other financial firms they own into client portfolios?

A.   No.

Q.   It’s at arm’s length? You’re still independent?

A.   We’re an independent company with an independent investment committee. We have this strict methodology for how we select products and do asset allocation. It’s possible that one of their products may become the best fit for some of our strategies, but we don’t use them out of a preferred relationship. That’s not the way we operate.

Q.   Do you plan to offer clients banking or life insurance options?

A.   We have no immediate plans for that. We’re still just 12 months old, and we’re really focused on our core offering, and we plan to focus there for quite some time.

Q.   Are you making your platform available on a white-label basis?

A.   We’ve had a ton of interest from different FIs and independent advisors in the industry. We’re actively exploring models right now that could work for us, so the answer is yes, we’re very open-minded about working with the industry and excited about that and we’re pursuing a few different models for what that might look like.

Q.   What will Wealthsimple look like a year from now?

A.   I think people should have big expectations. I think we’ve done a lot in a year and plan to get even more done in the next year. I think you can continue to expect big improvements in the client experience. What we talked about a little earlier about removing more friction from the experience, to try to make it the easiest place to manage your money.

I think you can expect to see interesting new product features that help our clients understand their finances better and make better financial decisions to set themselves up for long-term success. And we’ll be trying to push the envelope on innovation and continuing to lead the market in transforming the way we invest.

Q.   Are you planning to enter other markets or is there enough opportunity in Canada for the time being?

A.   We’re super focused on Canada for now.

Q.   What can you tell us about the FinTech innovation scene in Toronto?

A.   We love the FinTech community here. We’re certainly supportive and active members. It is still small but it’s growing. There are some really interesting things happening now.

We have the third largest stock market in the world here in Toronto, one of the most developed financial services industries globally, all based within a three block radius downtown. There are massive opportunities for financial technology companies to support and transform this industry. We’re now just starting to see some cool companies pop up and some cool VCs focused on supporting these companies. I would expect a lot more out of Toronto and Canada over the next three-to-five years in FinTech.

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