Robo Advisors

When Asset Allocation becomes a commodity through a Robo Advisor, how can investment advisors adapt and stay relevant?

Robo Advisors and the future of Investment Advisor

Its seems that every major industry that has stagnated over the past decades is currently undergoing tremendous disruption and transformation. Airbnb is disrupting the hospitality industry and Uber is disrupting the transportation and taxi industry. It now looks like its time for the financial industry to be disrupted with Robo Advisors. Financial professionals have always relied on the latest innovations in technology to get an advantage in the capital markets. For the last couple of years, we have seen this very technology turn full circle and begin to replace these very own professionals as well as eliminate redundancy and human errors. Flash trading and algorithms trading have redefined the roles of traditional stock traders. Now Robo Advisors are questioning the value of Investment Advisors and redefining the concept of asset allocation in the portfolio management industry.

In its simplistic form, Robo Advisors are computer programs that help investors allocate, invest and rebalance their portfolios automatically on an ongoing basis while charging management fees that are far lower compared to the traditional Investment Advisory industry. If we take the US as an example, the average retail Investment Advisor charges between 1% and 3% of assets under management to perform various tasks around structuring and occasionally rebalancing individual’s portfolios. The two leading Robo Advisory firms in the US WealthFront and Betterment charge as little as 0.25% on portfolios with assets over $10,000. Some firms such as WiseBanyan do not charge any fees at all on assets under management and instead rely on selling add-on services to generate revenue.

How do Robo Advisors work?

The underlying premise of a Robo Advisor is very simple. You pick an amount you want to invest. You pick your investment objectives and your risk profile and then computerized algorithms take over. As the markets evolve and your investment horizon advances, your capital is automatically allocated among specific trading instruments like ETFs. You can also set automatic investment plans where new capital is automatically taken from your bank account and invested in your constantly changing personal investment portfolio. Although this might sound like traditional funds of mutual funds, it is important to note that rebalancing in the fund of funds is done among the predefined funds, while Robo Advisors rebalance your portfolios based on changing markets conditions, different types of ETFs and your risk/reward preferences that can change throughout your investment horizon.

The Robo Advisort industry is fairly new. Much of its growth and popularity is attributed to two things. Technology and Fees. Millennials are highly adept at tech and spend more and more time on their mobile devices. WealthFront stated that over 90% of its clientele are under the age of 50 and over 60% of that category are under the age of 35. The dominant companies in the industry invest in their platforms, user experiences and transparency. With technology and user experience being at the centre of their services, Robo Advisory companies are able to better connect to their customers and facilitate the process of investing. Since, most of the services are digital, firms are able to keep their costs down and rely on technology instead of human capital.

By keeping basic fees very low or in some cases non-existing, the new generation of investors is more likely to invest with Robo Advisors than with traditional investment managers who typically require a substantial investment capital (sometimes a minimum of $100,000).

The Robo Advisory phenomena creates additional stress and pressure on the investment management community. As an increasing amount of people (especially young investors) take their finances in their own hands and deal with Robo Advisors charging lower management fees than traditional human Investment Advisors, we wonder what is the future looks like for an Investment Manager and/or a Portfolio Manager as a profession? If computers and algorithms are able to replicate and improve the component of asset selection, asset allocation and portfolio rebalancing, what roles will Investment Managers play going forward? Currently it is hard to know whether the field of Robo Advisors will survive in its current state in the next couple of years. According to The Economist, WealthFront has approximately $2.5 billion in assets under management, but made only around $7 million in revenu so far this year. With a payroll of +100 employees, the firm likely has expenses around $40 to $50 million. This means that to survive the company either needs to significantly grow its assets under management, increase its fees, or find alternative ways to generate revenue. Currently, WealthFront is being maintained by its investors who despite having invested nearly $100 million into the firm continue to lose money every year.

How many low cost providers can the Robo Advisory industry support? If WealthFront, the biggest Robo Advisor so far, with important venture backers cannot yet make a profit, what does it mean for young starts-ups rushing into this new field. Even if Robo Advisors end up taking a greater share of individuals’ asset allocations and portfolio rebalancing, human Investment Advisors still have an important role to play in personal finances and wealth management.

How can Investment Advisors and Portfolio Managers adapt to these challenges?

1. Focus on long-lasting relationships

Traditional Investment Advisors should focus on building long lasting and truly valuable relationships with their current and future clients. Some investment advisors only see their clients once a year to update their investment policy statements, rebalance their existing portfolios and make occasional changes for the upcoming new year. This can definitely change. If Investment Advisors consider themselves as real partners in their clients’ long-term goals and objectives, they can become more proactive and focus on constantly adding value throughout the year. If an investment advisor currently meets with her clients once a year, then setting up more frequent meeting like once a quarter would show the clients that she cares about them and their objectives.

2. Maintain a constant communication

Investment Advisors can use newsletters and quarterly reports to keep their clients educated about the latest development in their industry, changes to the tax codes, changes to the wills and estates procedure, etc,. By maintaining constant communication, Investment Advisors will become more aware of their clients’ short to medium term objectives and they can focus on providing timely information to their clients to help them make the most optimal decisions. Having the desired credentials like a Charter Financial Analyst will no longer be enough going forward to stand out from the competition and gain investors trust. Building and maintaining trust between investment advisors and their clients will take longer and will require constant presence and constant communication.

3. Client Education

What can make Investment Advisors and Portfolio Managers different from Robo Advisor in the future is emphasis on client education and helping clients see and understand the big picture. By helping clients understand complex relationships between various components of portfolio management and being able to clearly and simply communicate the intricacies of industry will help Investment Advisors add true value to their clients’ financial portfolios. In return, clients will feel like they are more engage in the process of managing their money since they will be more aware of how various investment strategies can affect their net wort, help them grow their assets and reach their financial goals.

4. Move quickly

The investment management industry is a behemoth. With over $30 trillion investment in mutual funds globally alone, it takes time for big institutions to move around and pivot. Although Robo Advisory is a relatively young trend, there are already companies like Upside who want to help investment advisors better manage their existing clients at reduced management fees. If Robo Advisors go mainstream, then traditional investment managers will need to embrace change to their existing ways of working with their clients and embrace new technologies and new services in order to stay ahead of the competition.

5. Adapt to changing demographics

Traditional financial planning usually looks at the long-term investment horizon. While older generations focused on saving for retirement and having a comfortable portfolio in 30 years, today younger generation is more preoccupied with short-term planing and shorter goals. For traditional Investment advisors to stay relevant, they need to understand the goals of the current generation (the so called millennials), who focus on technology, costs, accessibility, transparency and tend to be less patient. By understanding the demographic changes and structural changes in the employment landscapes Investment Advisors will be able to find areas where they can add value.

As stated above, the investment industry is bound to undergo tremendous change and disruption going forward. Robo Advisors are among the many important changes happening in the FinTech industry. It is imperative for young professionals getting into this field to understand that the traditional ways of working in the investment management industry are changing and that credentials like MBA and/or CFA no longer automatically convince people of your skills and experience. Only by understanding the changing behaviours and preferences of investors and by focusing on adding true value to their investors, will human investment advisors be able to prosper and build their investment practices going forward.

We hope you found this article useful and educational. We invite you to send your questions and comments using the comment section below.

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