Can New Business Models Improve Trust?

As with biotech or space tech, success in fintech requires a certain level of technical expertise and understanding of a regulatory environment. Most fintech entrepreneurs leave secure jobs with good salaries to jump into the unknown. What they share is a strong motivation to do business differently. Some are inspired by a desire to use different, more efficient services than were available for past generations. Others have experience managing assets for others and see both the technology and timing as being ready to support changes they sought over a long career. This article examines how several firms use different approaches to profit motives and client relationships.

Scott Nance, head of business development at ImpactAssets in San Francisco, calls himself a reformed hedge fund worker. After a career in business development for such names as ARK Global, Robeco, and Bank of America, Nance saw an opportunity to put his years of experience to work supporting a nonprofit firm that channels investment capital to assets with financial, social, and environmental returns—the famed “triple bottom line.” Founded in 2010, ImpactAssets now has $340 million at work in its main fund.

A financial services company, ImpactAssets offers a bird’s-eye view of various industries that are doing well by doing good. The firm serves family offices and donor-advised funds, providing custom impact investing as well as a platform available for all its clients. Educating potential clients as well as the public is a big part of Nance’s personal mission. “This is a terribly inefficient market,” he says. “The inefficiency demands education and the distribution of product data, and these are great combinations for innovation.”

Nance is not alone in his mission. His firm serves the impact investing sector as a whole by providing a vetted database that’s open for any client to search. It also publishes the ImpactAssets 50, an annually updated list of experienced impact-investment firms. “These are [not] necessarily the only 50 but are a sampling of the better firms in microfinance-, gender-, and environmental-sensitive players,” says Nance. “We wanted to shine more light on the opportunities that are out there.”

Nance points to one of those opportunities: Bright Funds, an ImpactAssets collaborator that specializes in providing companies with a way to align corporate giving with their employees’ personal interests. Through Bright Funds, staff members can vote for which charitable causes their companies fund. “Impact giving is personal,” says Nance. “This [approach] gives companies a way to empower employees and makes it easier for companies to match lots of innovations in philanthropy.”

Following a career in politics and law, Andrei Cherny founded Aspiration in 2013 to bring low-cost banking and wealth-building tools to the general public. Based in Los Angeles, Cherny previously worked with former Vice President Al Gore on climate change initiatives and with Senator Elizabeth Warren on consumer financial protections, and he also has prosecuted financial crimes. Aspiration’s industry-busting fee structure was inspired by the perception that financial companies do well while the customer does poorly, which has cratered trust.

Some investors share Cherny’s view and have supported Aspiration’s efforts, providing $20 million in outside capital. This funding buys the technology for online account access and community-building tools, throwing fuel on the fire of change. “The brick-and-mortar business model was really fundamentally not working for a lot of customers nor for businesses,” says Cherny.

The firm throws longstanding business models out the window, opting instead for radically different fee structures that allow customers to choose whether to pay and also how much to pay. As a registered investment adviser, Aspiration offers customers both a banking relationship and an investing relationship. Currently, three products fall under its pay-what-you-want model: a high-interest checking account called Summit, the Redwood Fund, and the Flagship Fund. Summit is offered through a partnership with Radius Bank, a federally chartered bank in Massachusetts with full FDIC account protection. The Redwood Fund has proven the best-performing sustainable large-cap mutual fund in America during the past year, according to data from Bloomberg and the US Sustainable Investment Forum. The Flagship Fund requires only a $100 minimum investment and has a goal of long-term growth with low volatility.

Aspiration makes a fee on products according to what the customer wants to pay, a compensation structure that aligns incentives between the customer and the institution according to Cherny. “We get queries about [how] it’s possible we can pay 1% interest and not charge ATM or monthly fees,” he says. “Banks make $2 billion in ATM fees and have net profits of $150 billion as an industry. They could still be making the $150 billion if they never charged; companies have to ask, ‘What are their values, their priorities?’”

More than 90% of customers choose to pay for Aspiration’s services. To Cherny, this figure reflects the success of the firm’s intent, which is to have the customer in control of the relationship. Customers feel part of a community, a movement, something they can become excited about, as opposed to the adversarial relationship many customers feel with their banks. (Despite this community feeling, of course, Aspiration has invested heavily in cybersecurity and fraud detection beyond anti-money laundering. As a former federal prosecutor, Cherny acknowledges that not everybody is an angel.) But Cherny and his team are working to earn their fees. “To pay what is fair builds trust in an industry swimming in massive distrust,” says Cherny. “We need to create a company that provides real value to a consumer who needs a financial partner.”

Although Aspiration’s customers range in age from 18 to 96, more than half are 32 years old or younger. “New-generation services demand new-generation marketing,” says Cherny.

The feeling of community begins online, even before prospects become customers. Aspiration’s social media engagement is among the highest of any US financial firm, and thousands of people share comments about the firm on Facebook and Twitter. Aspiration’s mission is to have multiple different touchpoints with its community during the course of a week, so it adds original content along the theme of social responsibility intersecting with personal finance.

Financial education and understanding are part of the social experience at Aspiration. A new offering, Aspiration Impact Measurement (AIM), supports these goals. For customers who sign up, Aspiration performs a background check on ethical practices for every company where an accountholder uses her debit card. Through AIM, customers receive an ethical-spending tally. Customers can also direct the charitable spending of a part of their fee, and Aspiration donates 10 cents of every dollar of firm revenue to charitable activities. One such activity is the Accion US Network, the largest provider of microloans in the US.

Even after 25 years of innovating in investment management, Scott MacKillop, CEO of First Ascent Asset Management in Denver, Colorado, has hit the industry with a startling change: He charges a flat fee on investment management accounts and is making money. MacKillop’s career tracks the history of institutional pension consultants creating and managing portfolios and investment instruments for independent financial advisers. Having retired after eight years as president of Frontier Asset Management, which serves financial advisers with innovative investment strategies, he wasn’t planning to start a new firm. But then new ideas began to percolate about how technology could cut operating expenses.

The result is a fee-busting portfolio-management company. First Ascent, founded in 2015, charges a flat fee of $500 per account—regardless of account size—to construct and manage portfolios in a world where—for generations—fees have traditionally been a percentage of assets. A quote from Amelia Earhart on the firm’s website summarizes the philosophy underlying the flat-fee schedule: “Never interrupt someone who is doing what you said couldn’t be done.”

Using technology to replace layers of staff, First Ascent’s specially programmed portfolio-account system (integrated with billing, performance accounting, and back-office systems) does the work with fewer people than a traditional firm and thus less expensively. Furthermore, MacKillop outsources the investment manager and service side. These actions have eliminated from one-third to half of the firm’s overhead and transformed fixed costs into variable costs for each account. “Then we had to decide what to do with the savings,” says MacKillop. “And we decided, rather than put it in our pockets, we pass it on to clients.”

First Ascent’s assertion is that, with technology, charging fees as a percentage of assets no longer makes sense. It takes no more work to manage a $1 million portfolio than a $100 million portfolio. “We need volume to make this [model] work, of course,” MacKillop says. “But this is a fair and better price, both for the advisers and the clients they work with.”

With advisers flocking to the platform, the firm’s flat $500 fee has the industry worried. The current fee structure wasn’t First Ascent’s first attempt. It tested other structures first, starting with a 50–bp charge for portfolios up to $300,000, with a cap at $1,500 per account. Although everyone liked this plan, it didn’t compel advisers to act and move their investors in great numbers.

Early in 2016, First Ascent began the single-flat-fee experiment, testing the waters with a small sample of advisers. “We could feel the nature of the conversation change,” says MacKillop. “They wanted to get in right away. The low fee is part of it, but we think the transparency and simplicity are also key.”

To First Ascent, the flat fee is such a simple concept that management was surprised no one else had implemented it yet. As the business flowed in, it became more obvious that the fee-on-assets compensation structure was way out of sync with the work being done. In the year since opening its doors, First Ascent has recruited 30 advisers and brought $10 million in house; agreements for another estimated $45 million are being finalized. “We’re way ahead of schedule in terms of the new advisers we projected,” says MacKillop.

The firm carries its theme of simplicity through to portfolio management. Using a combination of exchange-traded funds and active management in a core–satellite approach, First Ascent seeks to offer simple, elegant portfolios that make sense to clients. This approach keeps internal expense ratios between 7 bps and 23 bps.

First Ascent also uses technology to connect with both its adviser clients and the advisers’ investment clients. The firm’s website is designed to allow client advisers to connect with the firm when it’s convenient for the adviser. The site includes client education, fee structure information, and details about every member of the First Ascent staff and how they feel about their jobs. “We make it possible for advisers to go and learn about us and avoid wholesalers,” says MacKillop. “They will work pretty hard not to see wholesalers, so that distribution approach didn’t seem very useful.”

First Ascent not only charges a lower fee than competitors but also provides more service. Even though its customers are independent advisers, the firm extends its service to the ultimate client whose assets they manage. Being accessible to the end user supports advisers to attract new business, because investors consider the advisers’ investment approach as a first step in due diligence. “We haven’t done much in our industry about getting clients from point A to point B,” he says. “To do that, we have to give [investor] clients the basic understanding of how to behave in ways that benefit them long term.”

MacKillop stars in some of the educational videos First Ascent produces to address clients’ behavioral issues. Six of the one hundred targeted short courses are publicly available on the firm’s website. In two- to three-minute digestible presentations, First Ascent offers investors a foundation on such topics as identifying investment goals and understanding risk. The aim is for clients, armed with new knowledge, to behave better as investors and also to have more information when their accounts start to move up or down. Advisers see the videos as supportive of their efforts, conveying the kinds of messages advisers are telling their clients already. “Once we put this all together, we’re not just implementing a series of ideas but are implementing an overriding focus on doing what’s right by clients,” says MacKillop.

Felipe Vergara took a concept from an academic paper about how to finance higher education and is bringing it to life as the co-founder and CEO of Lumni, headquartered in Florida, with offices in Colombia, Chile, Mexico, and Peru. Vergara’s motivation was personal: Growing up in Colombia, he was more interested in sports than academics, and he readily admits he was not the best student. Yet Vergara went to college when many of his smarter peers who tutored him could not. This disparity seemed unfair. “I was not a good student, in the company of smart people who helped me,” he says.

Ten years later, following an MBA from The Wharton School and a stint as an associate at McKinsey & Company, Vergara felt he could address this situation using the power of the market. In 2002, he co-founded Lumni with Miguel Palacios, an assistant professor of finance at the Owen Graduate School of Management at Vanderbilt University, who was experimenting with income share agreements (ISAs) in his work on human capital in business. Through the Lumni ISA, investors pay for a student’s tuition today, and the student pays back the loan with a percentage of his future income for 10 years.

ISAs are an innovative financing vehicle in an ecosystem that previously included only debt and outright gifts through grants or scholarships. The innovations go beyond offering a new type of vehicle, however. From the point at which potential students and potential investors are identified through the pricing and servicing of the contract, their interests match. “We align incentives up and down the chain,” Vergara says. “When we tie payback to future earnings, part of the equation is the simple economics of how much certain professions offer in income.”

The program started in late 2002 with four students funded by senior executives with whom Palacios had worked in Chile. Now, nearly 15 years later, Lumni has funded 9,000 students with $35 million in investor funds. “Financial innovation sometimes takes a lot of time to work,” says Vergara. “We’re finally at an interesting moment with legal and regulatory environments changing, and people are seeking solutions to financing higher education.”

Lumni raises and manages funds to invest in ISAs. Since its inception, the firm has worked with more than 200 investors, including foundations, not-for-profits, corporate responsibility funds, family offices, and institutional investors. The firm offers house-branded funds and also white-label funds for client organizations. Lumni charges each fund an origination fee and a service fee that covers sourcing the loans, assessing risks, building a portfolio, and connecting students with the resources needed for success in their studies.

The ISA’s pricing is transparent and rests on three pillars: university quality, expected future income, and education required. Lumni’s focus on the quality of education offered by a university or institution makes potential students more sensitive to the school’s cost and quality—some students and some careers cannot be funded because the return is too low or the risk too high. Risk is also determined by the amount of future income expected based on the chosen school and profession. And, sensibly, the more education required to attain a degree, the more expensive the ISA’s payback terms.

Institutionalizing this cost–benefit analysis solves a key inefficiency of higher-education financing. “Traditional student loans don’t have a way to assess the quality and value of the education,” says Vergara. “So systemic incentives drive loans that don’t have good economic value.”

The quality of the education factors heavily into the alignment of incentives. The contract between investor and student includes a set repayment rate. Setting this rate, based on education quality and estimated future earnings, also offers students a built-in lesson in financial literacy.

Seventy percent of ISAs are made with students from low-income backgrounds, some very low income. Students often come from rural areas and include indigenous minorities. Lumni learned that the kids who are first in their families to attend university are the most at risk of not succeeding at school. Tuition money is often not enough to support success. So, Lumni connects investors and others for the purpose of mentoring students. Some organizations with white-labeled funds add other components, such as coaching systems, job placement programs, and connections with networks of potential employers. All students receive training in such soft skills as financial education, resume writing, time management, and job search strategies. “The beauty of these instruments is they create a win–win,” says Vergara. “The investor gets a good return when the student gets a good return.”

Lumni is gaining traction and expanding globally with both its impact fund and a white label for corporate social responsibility funds. With its platform growth doubling during the last few years, the firm is now focused on perfecting its financial components and organization servicing, adding new products such as a career “boot camp” or smaller programs built to serve investors with shorter time frames than the current ISAs. “This is an asset class that is very relevant because of the great combination of ability to provide financial returns by arming an individual with a strong education,” says Vergara. “We think this is especially an area where investing could grow beyond impact investors to more financial institution players.”

Will the new models gain enough traction to produce sustainable firms that still maintain their alignment with customer interests? ImpactAssets is aggressively educating investors about the impact space. First Ascent’s model works only if the firm hits volume targets. And Lumni needs to expand to fulfill its mission. Their leaders all agree that financial innovation can take time to work. The old models of fees as a percentage of assets, bank-funded student loans, and bank service fees have been around a long time and are baked into systemic habits.

Cherny and his team frequently wonder how Aspiration will maintain its goals when customers number not 100,000 but 100 million. The conclusion, echoed by all interviewed for this article, always comes back to firm culture.

Cherny points to the discipline inherent in matching fees with customer needs. If the customer is not satisfied—perhaps even not delighted—with the revamped fee structures, these new business models won’t generate expected returns.

“If they pay what is fair, that’s an insurance policy for them and for us,” says Cherny.