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Friday, January 22, 2010

What is a BrightScope?

Reported by Sean Hanna, Editor in Chief

What is a BrightScope? That is a question fundsters may be asking themselves this week as the San Diego-based, angel-backed startup won ink in publications from Ignites to the Washington Post. Our team of reporters at The 401kWire has been on the BrightScope case for more than a year (see here and here and here.

The quick answer is that Brightscope is aiming to become the "Morningstar of 401(k) plans". That is an ambitious goal, yet the press has spilled enough ink on the Alfred brothers to make the claim credible.

Actually becoming the Morningstar of 401(k) will not be as simple as saying it though. Morningstar itself had a near-debacle in trying to take over the 401(k) space. Its ClearFuture advice product became a money pit during the dotcom bubble a decade ago. While Morningstar eventually absorbed rival mPower and its client list, 401(k) advice never grew to expectations. Morningstar, of course, survived that experience, IPO'd without 401(k) advice as a core product and is doing just fine, thank you.

The Morningstar experience did reveal some challenges that the Mike and Ryan Alfred now face. While 401(k) plans now hold more than $3 trillion in assets, that pot of gold is spread across 82 million accounts, of which just 67 million are active (see the DoL data).

That means that the typical 401(k) account is much smaller than the typical retail brokerage account and just a fraction of an institutional account. For sellers of 401(k) services that small per account size means it is a struggle to collect fees that compensate for the work. Morningstar itself ran into that issue with ClearFuture. The one exception to the 401(k) problem is that asset managers who are able to deduct fees directly and outsource the low margin work to someone else will do well, albeit not as well as in pension land.

Morningstar itself learned that lesson and under Tim Armour brilliantly pivoted its business into the managed account space with Morningstar Advisor. That asset management advisory business is now the generator of Morningstar's growth and stock price.

The primary question facing Brightscope's investors is whether the Alfreds will be able to discover an investment management, fee-raking analog for their business. That may prove to be too much of a challenge, and not only because their entire business model to date is built around exposing the pernicious costs of fee raking and educating their clients to avoid it at all costs.

Their splashy debut has also caught the attention of competitors. Former 401(k) insiders have built a rival at Fiduciary Benchmarks. I am also hearing that Case Interactive's Asset International -- the publisher of Plan Sponsor Magazine -- may get into that game.

The real challenge for BrightScope, though, will be their decision to take venture capital and build the business quickly. No matter how well the Web site functions, Venture money tends to be impatient money and may not provide the Alfreds the time to discover a true business model. 

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