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May. 02, 2016

May. 02, 2016

“Robo-advisors” is the name given to providers of automated investment advisory services through web-based and mobile platforms. They are characterized by the absence of human interaction, and are therefore low-cost. Once a client fills in a description of their personal profile, wealth, investment ambition and risk tolerance, the machine generates an investment recommendation that’s based on algorithms and that can be rebalanced and revisited at any time.

The rise of these robots is, of course, linked to the emergence of new technologies and a millennial generation that is used to simple, efficient and transparent services where they can keep control of choices during every step of the process. As it’s happened with other industries, such as travel booking or retail shopping, the younger generations are cutting the middleman.

Because of the absence of an individual who employs time to follow their clients’ account, robo-advising is a cheap offering that has been labeled as private banking for the masses. Services such as Charles Schwab’s “Intelligent Portfolios” will build up a portfolio for free: no advisory or account fees, no commission. The space is further populated by start-ups such as Betterment and established firms and banks like Vanguard or Deutsche Bank.

Rapid Growth

A study conducted last year forecast that money managed by robo-advisors in the US will grow by 68% between 2016 and 2020, to about USD 2 trillion. The percentage of total invested assets that are managed by automated advisory services will grow to 5.6% in the period, from 0.9%, the report estimated.

There are parallels and links between robo-advisors and the growth in the past decade of exchange-traded funds (ETFs). Both solutions share the competitive pricing, on one hand, and the simple and transparent process, on the other. According to the Investment Company Institute, assets under management for US ETFs grew to 4.9% of total investable assets in 2013, from 0.2% in 1999. Analysts say robo-advising could witness an even greater rate of growth, spurred by new mobile and digital technologies, as well as internet penetration rates, that were not available only ten years ago.

Index Investing

Robo-advising is likely to further feed the expansion of standardized investment solutions such as index funds and index-based ETFs. Because of the unbiased and objective advise they aim to provide, intelligent portfolio advisors mostly recommend ETFs to fulfill asset, regional and sector allocation advice. ETFs not only keep the cost of the portfolio down – a priority for clients of robo-advisors – but also remove any bias and tracking error to allocation decisions.

Automated advisory will shift attitudes at both ends of the client-provider relationship for the overall industry, increasing demand for transparency and low-cost products, and prompting a review by existing clients of their current services. Fees are likely to come under pressure. While robo-advisors are a more economical solution, investors will need to bear in mind that a less-personalized service cuts part of the close due diligence provided by traditional, or “human”, wealth consultants.    

It is auspicious to see systems that foster the democratization of financial advisory for parts of the population who are left out of expensive services. While this presents challenges for traditional advisors such as private banks, there are huge possibilities for both established and new providers that embrace the trend. As with all new technology, it creates disruption and losers. But benefits are very likely to be widespread and welcomed by a whole generation of new investors.

 

 

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