The American architect, R Buckminster Fuller, famously said “You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.” This is what the 2016 robo advisor is starting to do. The asset management landscape is constantly evolving; there have been some game-changing developments in recent years.
The industry faces tougher regulatory requirements, changing customer behaviours and expectations, as well as huge technological innovations. Innovative, customer-focussed, cost-efficient investment solutions are fast becoming the new industry normal. Disruptors are challenging the status quo and turning existing business models on their head. The ‘robo-advisor’ emerged over the past few years and industry attention has now turned to these new players, could innovative technology and algorithms make the human advisor obsolete?
What is robo advice?
A robo advisor is a digital, automated investment interface providing customers with easy access to financial markets and an interactive user experience. All this at a fraction of the cost of both traditional advice and mutual funds. A relationship with a robo advisor, or digital wealth manager, usually starts with a short survey. The entire on boarding process is quick and simple, it takes less than 7 minutes to sign up with Moneyfarm. The individual will answer a few questions on their personal details, financial understanding as well as their attitude to risk. These results are run through an algorithm, designed using the latest thinking in behavioural economics, and assign the user to an investment profile which aligns to a portfolio. This portfolio is built up of a mix of assets weighted to their attitude to risk. Portfolios are usually made up of vehicles such as exchange traded funds (ETFs) which provide a passive exposure to various markets at a low cost.
A key selling point for a robo advisor is the transparent fee structure, customers are only charged an annual management fee, which is usually much lower than the market incumbents (customers will also pay the ETF fees on the assets they hold, which range from 0.15-0.30%). The investment solution provided by robo advisors is typically independent, this gives retail customers an alternative to the products provided by traditional asset managers.
Technology has empowered many aspects of the portfolio design and management processes in robo advisory services. Technology has impacted account creation, compliance reviews, trading facilitation and reconciliation. All of these can be fully automated, which means robo advisors are able to operate at a much lower cost with fewer personnel, these cost savings can then be passed on to the customer.
To complement advisory and investment services, robo advisors, such as Moneyfarm, produce educational materials which are available on the platform. This helps the customer to understand both the investment platform and the wider financial markets; this aids individuals with financial planning and encourages them to engage with their investments.
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Who should use a robo advisor?
It is still to be seen whether or not robo advisors will convince the majority of investors to move away from their more traditional savings and investment channels. Nevertheless, investors who are comfortable with technology have been seen to move across to these new investment channels. As millennials accumulate wealth, the generation that grew up online could be a powerful source of potential growth for the digital wealth managers. Individuals who do everything online are beginning to expect the same smooth digital experience from their finance providers. There are some obvious similarities between the existing robo advisors, however, there are some huge differences in their operating models and approach to technology and investments. Some platforms rely on algorithms to manage all core activities from customer on boarding to asset allocation decisions; other firms, like Moneyfarm, offer a hybrid service for customers, where human inputs are added to the customer service and investment process, in order to better complement the use of technologies.
When Moneyfarm launched in 2012 (read our customer reviews) we offered a purely digital service but found that customers, despite being comfortable with the technology, still needed to have the option to speak to an advisor. The established robo platforms have focussed their attention on the lower net worth individuals in the retail investment market. These individuals typically have too little capital to be served by the traditional asset management institutions. The robo advisors have solved much of the operational efficiency challenge. Despite enjoying growth in both customer numbers and Asset Under Management (AUM) in recent years, the venture capital backed newcomers are still nowhere near as big as the industry incumbents they set out to disrupt.
However, the established investment firms are well aware of the robo advisors’ long term potential impact on the industry landscape and have been actively working together with the insurgents. Large institutions such as Charles Schwab and Vanguard have both developed their own low-cost, automated advisory service. These can be celebrated by robo advisors as a validation of their own business model. The world‘s largest asset manager, BlackRock, also acquired a US robo advisor, FutureAdvisors, to complement to their own product offerings. In light of this industry consolidation, more and more robo advisors are expanding their target audience from retail investors to institutional partnerships. Many offer ‘white-label’ versions of their platforms to traditional asset managers, or provide B2B propositions leveraging existing platforms.
What does the future hold for Robo advisors?
Just like traditional asset managers, the digital wealth manager business model will evolve. Changing needs of customers and continuous development in technology will make evolution essential. But the robo advisors have innovation at their core and lean technology platforms which makes for a fast pace of change. As the industry evolves we are likely to see the growth of more sophisticated, customer-focussed products through the robo platforms and the possibility of further industry consolidation and all round technology advancement among the traditional asset managers. The independence and cost efficiency of robo investment solutions have given retail customers a real alternative when it comes to their asset management needs. This will eventually force the traditional asset managers to lower fees and entry requirement for their services, which ultimately benefits the customers.
Robo advisors face a challenging task to continue to grow at the same pace whilst remaining competitive in the fast-changing investment environment. In addition to developing technology and streamlining the investment process, robo advisors need to focus on building a solid brand and leveraging the expertise of marketing professionals to seek cheaper and easier way to acquire new customers or increase existing customers’ lifetime value. Institutional partnerships and bespoke B2B offerings offer further avenues for growth. We can expect tremendous product innovation from the robo advisors, they will offer more intelligent and more interactive platforms as they continue to develop and adapt to more complex financial needs. The robo advisors will not only be providing investment solutions but will also help customers with all of their financial planning, from tax issues to retirement planning. We can expect investing to become part of the customer’s day-to-day life.
Digital wealth managers will also benefit from increased scalability and efficiency through the use of more sophisticated technology, which could enable robo advisors to achieve full automation of portfolio management, further improving the operating efficiency. Activities such as fund accounting, financial reporting, computer-generated content and automated customer support services could all potentially be on the cards and eliminate human error.
This is only the beginning of the robo advice journey. The impact these fintech players will have on the asset management industry will be huge. These ‘robo’ technologies will trickle into the world of established asset managers to create a truly customer-focussed industry. This is not a case of ‘robot versus human’ instead it is an arms race to ensure all asset managers have the best technology to service their customers. Those with the most advanced technology will be able to scale and grow much more quickly. The robo advisors entry to the market is only the beginning, we will see the entire asset management industry change in the years to come.