Education - September 11, 2017
Robo-Advisors: Friend or Foe?
The Rise of Machines and Automation
It’s impossible to deny that the increasingly rapid advancement of technology in today’s global economy is meaningfully reshaping how businesses and customers interact and make decisions. Some of the most prominent technological advancements taking hold of firms’ R&D departments include artificial intelligence, machine learning, and robotics — areas that seemingly have endless applications: autonomous driving, robotic medical procedures and intelligent advertising — to name a few.
As a growing fintech firm, we at YCharts are naturally curious as to how these advancements can be leveraged to enhance our services. But, more importantly, we want to understand how applications of these new technologies, namely robo-advisors, will affect and shape the landscape of investment advisory and wealth management services.
The big question for many wealth advisors today is: what will the emergence and continued development of automated, low-cost robo-advisors mean for my firm?
While there’s no definitive way to predict the true impact of robo-advisors on the traditional RIA, some key insights and market research argue that “robos” may present themselves as friend, not foe — contrary to the beliefs of many pessimists in the market touting the death of active management.
A Shift in Client Base Demographics
When considering the changes in fintech utilized by investment advisors and investors, we must also look at the shift in the key demographics of advisors’ clients — which we touched on last month. Millennials and Gen Xers are quickly becoming the largest cohort targeted by businesses due to their enormous spending power and disposable income; this cohort should and will be treated differently than its predecessors, and for good reason.
The new investor’s unique spending and saving habits, ability to access information quickly, and exposure to the Great Recession will, in tandem, play an integral role in how and where they choose to invest their money.
According to a U.S. News and World Report study, 64% of “affluent” millennials and 48% of Gen X investors plan to allocate a greater portion of their assets to traditional financial advisors over the next ten years, as opposed to robos. The study also attributes the respondents’ answers to a rising level of uncertainty and concern under the current White House Administration. Decreasing levels of consumer confidence likely favor human advice, particularly for those who grew up in a recession and gravitate toward customer-centric businesses.
While levels of uncertainty and market sentiment will vary over time, downturns can lead to shaky hands that leave investors at risk of choosing to pull out of the market without the proper guidance. This guidance likely won’t come from a robo-generated portfolio of index funds, but rather the sound advice, assurance, and the data and technology necessary to steady investors’ hands. These resources and skills lead to a level of service that only human advisors can provide. Both Gen Y and Gen X, called “the future mainstay of the wealth management industry” by Accenture in a study of over 1,300 investors, tend to prefer a hybrid model that incorporates technology, automation, and human advice. The human touch and customer service of the RIA business model can provide a greater level of confidence to these savvy cohorts, particularly when advice is data-driven while utilizing cutting-edge technology (yes, this includes using robo-advisors within your own practice).
The Pitfalls of Reliance on Robos
While the true potential of machine learning and AI in the investment world is only just being tapped, robo-advisors, today, do have their pitfalls. Beyond the lack of communicative ability, robos, according to Seeking Alpha and the Q2 2017 Robo Report, are essentially mimicking index funds’ performance in exchange for higher fees. It could be argued that the higher fees are justified given the type of automated service provided — automatic allocation and rebalancing based on risk-tolerance, for example. This, combined with the assumed cost-savings of this “no-fee” advisor, can skew investors’ perceptions.
While robo-advisors may eliminate the fees associated with the typical RIA, they often provide a limited universe of securities and can have an algorithmic bias toward certain fund families. As Bloomberg points out, “Banks still employ armies of advisors and get payments from fund companies that want access to those advisors’ clients. There’s a risk that the banks’ robo programs could favor mutual funds and exchange-traded funds from companies that make such payments, according to disclosures by the banks.” As large banks continue to buy up these algorithmic investing tools, an opportunity arises for the RIA, whose fiduciary responsibility prohibits the investment of client funds in any biased manner and eliminates conflicts of interest.
In my personal opinion, having worked very closely with hundreds of wealth managers and investment advisors, the technological transformation of investment services provides an opportunity for advisors across the world. The majority of my clients are seeking out new, adaptive technologies and incorporating these into a customer-centric business model to stand out in a crowded market. From research and analytics platforms, automated risk analysis tools, and statistical investment advice engines, advisors at the forefront are rapidly adapting to the world of automation.
My hope and belief is that this trend will continue, and in doing so, allow advisors to efficiently improve their strategies through data and technology while spending more time where it really counts — with the client.
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