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Robo-advisor

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Robo-advisors are a class of financial adviser that provide financial advice or portfolio management online with minimal human intervention.[1] They provide digital financial advice based on mathematical rules, so called algorithms. These algorithms are executed by software and thus financial advice no longer requires a human advisor but a software that utilizes its algorithms to automatically allocate, manage and optimize clients’ assets. Robo-advice emerged as early as 2008[2] in the United States but didn’t really kick off until 2011 and has since spread around the globe. Today there are over 100 robo-advisory solutions on the market[3] and they are expected to attract a significant amount of assets over the coming years.[4]

While today robo-advice is still mostly used for investment advice, there are also applications in the space of mortgage and insurance advice. With regards to the investment management application of robo-advice, it’s considered a breakthrough in liberating formerly rather exclusive wealth management services, bringing them to a broader audience, as typically financial advice provided by robo-advisors comes at a fraction of the cost compared to traditional human advice.[5]

Robo-advisors typically allocate the customer property on the basis of their individual investment- and risk preferences as well as their desired target return. While technically robo-advisors have the capability of allocating client assets in all sorts of investment products such as stocks, bonds, futures, commodities, real estate and others, the funds are often directed towards ETF Portfolios.[3] Clients can choose between offerings with strictly passive asset allocation techniques or active asset management styles.[3] But the innovation lies not in the asset management component, which has been available to retail and especially wealth management clients for long years,[6] but in the digital advice component.

Presence

While robo-advisors are most common in the United States, they are also present in Europe,[3] Australia,[7] India,[8] and Canada.[9]

Definition

Legally, the term "financial advisor" applies to any entity giving advice about securities. But most robo-advisors limit themselves to providing portfolio management (i.e. allocating investments among asset classes) without addressing issues such as estate and retirement planning and cash-flow management, which are also the domain of financial planning.

Other designations for these financial technology companies include "automated investment advisor", "automated investment management", "online investment advisor" and "digital investment advisor."

The many robo-advisors existing today can be distinguished by their service offerings and area of operations but also by the sophistication of their features / functionalities. Consultants at Deloitte have divided the companies into four different Groups:[5]

Robo-Advisory evolution

Robo-Advisor 1.0: Clients receive a suitable allocated assets portfolio proposal via software-as-a-service (saas). There is no bank- or broker-API managing the execution, clients have to buy and manage a real product-based portfolio on their own by using their online brokerage accounts and manage future adjustments. Product variety include stocks, bonds, ETFs and other investment vehicles.

Robo-Advisor 2.0: Investment portfolios are created as fund of funds which have to be bought via stock exchange or directly from the client’s wealth manager. The product-portfolio allocation is realized on a manual basis by dedicated fund managers.

Robo-Advisor 3.0: Clients receive customized investment portfolios answering online questionnaires prior their individual portfolio allocation based on individual risk appetite. Investment managers take care of investing and adjusting the client portfolios. The realization is semi-automatic as investment managers oversee the investment algorithm and define rule sets.

Robo-Advisor 4.0: After answering online questionnaires clients are automatically and directly invested via a self-learning (artificial intelligence: AI) investment algorithms which shift between different asset classes as required based on changing market conditions and individual investment needs like profit, risk appetite and liquidity aspects.

The earlier robo-advisors included Betterment, Wealthfront, Schwab, Vanguard, and TradeKing, to name a few.

In Canada, Bmo smartfolio and Wealthsimple are examples of early players.[10]

Total assets under management

Collectively, robo-advisors directly managed about $19 billion as of December 2014, according to a study by Corporate Insight. This figure represents a 21 percent increase in assets under management since July, and a 65 percent increase since April.[11] By 2020 the global assets under management of robo-advisers is forecast to grow to an estimated US$255bn, according to a research report by MyPrivateBanking Research.[12] As of August 2015, Charles Schwab, Wealthfront and Betterment lead the pack in gathering assets regarding robo-advisors.[13] In July 2016, Betterment's assets under management surpassed $5 billion, the first robo-advisor to do so.[14]

As of February 2017 the assets under management of the leading robo-advisors are reported to be as follows:[15]

Assets under management (AuM in million U.S. dollars)
Company Country AuM
Vanguard U.S. 47,000
Charles Schwab U.S. 10,200
Betterment U.S. 7,360
Wealthfront U.S. 5,010
Personal Capital U.S. 3,600
FutureAdvisor U.S. 808
Nutmeg Great Britain 751
AssetBuilder U.S. 671
Wealthsimple Canada 574
Finanical Guard U.S. 454
Rebalance IRA U.S. 403
Scalable Capital Germany 125

Industry context

The tools they employ to manage client portfolios differ little from the portfolio management software already widely used in the profession. The main difference is in distribution channel. Until recently, portfolio management was almost exclusively conducted through human advisors and sold in a bundle with other services. Now, consumers have direct access to portfolio management tools, in the same way that they obtained access to brokerage houses like Charles Schwab and stock trading services with the advent of the Internet.[16]

Robo-advisors are extending into newer business avenues. In June 2016, robo-advisor Wealthfront announced a partnership with the State of Nevada to offer a 529 college savings plan. This development comes during overall growth in the college savings marketplace.[17]

The customer acquisition costs and time constraints faced by traditional human advisors have left many middle-class investors underadvised or unable to obtain portfolio management services because of the minimums imposed on investable assets.[18] The average financial planner has a minimum investment amount of $50,000,[19] while minimum investment amounts for robo-advisors start as low as $500.[20]

In addition to having lower minimums on investable assets compared to traditional human advisors, robo-advisors charge fees ranging from 0.2% to 1.0% of Assets Under Management,[21] while traditional financial planners charged average fees of 1.35% of Assets Under Management according to a survey conducted by AdvisoryHQ News.[19]

In the United States, robo-advisors must be registered investment advisors, which are regulated by the Securities and Exchange Commission. In the United Kingdom they are regulated by the Financial Conduct Authority.

References

  1. ^ "Financial Advice for People Who Aren't Rich".
  2. ^ "The History of Betterment".
  3. ^ a b c d "Robo-Advisory in Wealth Management" (PDF). Deloitte Consulting GmbH.
  4. ^ "Hype vs. Reality: The Coming Waves of "Robo" Adoption" (PDF). A.T. Kearney.
  5. ^ a b "The expansion of Robo-Advisory in Wealth Management" (PDF). Deloitte Consulting GmbH.
  6. ^ "First Look: iRebal-"The Intelligent Rebalancer"".
  7. ^ "ASIC's Greg Medcraft says 'robo advice' can reduce fees and conflicts".
  8. ^ "Robo advisory could change distribution". http://www.livemint.com/. Retrieved 2015-12-09. {{cite web}}: External link in |website= (help)
  9. ^ François Desjardins (October 17, 2015). "Préparer sa retraite, un texto à la fois" [Preparing your retirement, one SMS at a time]. Le Devoir (in French). Retrieved December 5, 2015.
  10. ^ Aston, David. "Find out if you should go robo". MoneySense. Rogers Digital Media: Publishing - News & Business. Retrieved 19 December 2016.
  11. ^ "Robo-Advisers Now Manage 21% More Money Than They Did 5 Months Ago".
  12. ^ "Dawn of the robo-adviser".
  13. ^ "Everyone Wants a Robo-Advisor, Right??".
  14. ^ Verhage, Julie (14 July 2016). "Robo-Adviser Betterment Hits the $5 Billion Mark". Bloomberg. Retrieved 14 July 2016.
  15. ^ "America Is The Realm Of The Robo-Advisor". statista.com. 16 February 2017. Retrieved 19 February 2017.
  16. ^ "Best of the Online Investment Advisers".
  17. ^ "Wealthfront leads robo expansion into college savings plans". Retrieved 2016-07-14.
  18. ^ "The Real Hidden Cost That Has Been Inhibiting Financial Planning For The Masses".
  19. ^ a b "How Much Does a Financial Advisor Cost? (Average RIA & Financial Advisor Fees in 2016)".
  20. ^ "What is the Best Robo Advisor?".
  21. ^ "Cost-Income Ratios and Robo-Advisory" (PDF). Deloitte Consulting GmbH.
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