Robo-advisors could be a boon for retail investors4 min read . Updated: 02 Jun 2016, 07:06 PM IST
By using algorithms based on modern portfolio theory or the variance of it to produce the most viable and profitable investment strategy and portfolio for investors, robo-advisors are the second wave in the financial technology space
Automated portfolio management will soon become the norm in investment management industry. This is because it is a low-cost unbiased tool for investors, and can be used as a resource for traditional wealth managers to provide a broader range of financial solutions while mitigating limited servicing capacity and costs.
By using algorithms based on modern portfolio theory or the variance of it to produce the most viable and profitable investment strategy and portfolio for investors, robo-advisors are the second wave in the financial technology (fintech) space. Compared to traditional wealth managers, their competitive advantage, for most of the part, is that they cost significantly lesser and provide the same professional advice without the limitation of minimum investment amount. Hence, it becomes the most suitable alternative for less or even mass-affluent investors.
Interest in robo-advisors will continue to rise for foreseeable future, and will most likely become the preferred, if not exclusive, way to invest. As an evidence, we can look at increase in the assets under management (AUM) handled by robo-advisors globally in past 18 months. It had been anticipated that robo-advisors would put a big dent in the market share of tradition wealth managers, which is true to some extent. Robo-advisors targeted the younger less-affluent and mass-affluent markets which was underserved by traditional wealth managers. According to research and advisory firm, Aite Research, in 2012, robo-advisors managed less than $2 billion in assets. By the end of 2015, it had increased to $50 billion.
Overall, it is becoming clear that both investors and wealth managers will benefit from the growth of robo-advisors.
Investors are at ease
Millennial and generation X investors have not been well-served by wealth managers, especially because of the absence of a viable business model. Financial advice from such traditional wealth managers requires a higher minimum investment than what many small investors can afford. The only available option so far for such investors was to either do it themselves, or avail the services of distributors or independent financial advisers, or explore traditional investment instruments such as term deposits.
With the introduction of robo-advisors, investors have access to the same professional advice at a lower cost and with a more affordable minimum investment amount. Robo-advisors have brought accessibility, transparency, simplicity and unbiased opinion to the whole investment process, especially for small investors. It is more attractive to a generation that demands speed, customisation, accuracy and control from their financial advisers. With new use of data, analytics span the spectrum from institutional trading and risk management to even small notional retail wealth management.
Proliferation of data, along with new methods to capture it and virtualisation of investment advice is reshaping the investment landscape and providing robo-advisors an edge over human-based advisory. For starters, its sophisticated analytics uses advanced trading and risk management approaches such as behavioural and predictive algorithms, enabling the analysis of all transactions in real-time, deciding the best course of action on the basis market movement to maximise gains keeping tax implications and regulations in mind. The increased sophistication of data analytics is reducing the asymmetry of information between small- and large-scale financial institutions and investors. The automated nature of the tool helps in providing unbiased opinion to the investors.
Developed economies are witnessing a new business model where traditional advisers are increasingly using robo-advisors at every stage of the investment life-cycle to increase client retention and reduce operational costs. Indian wealth managers are also expected to move in the similar direction as it addresses the challenge of limited servicing capacity.
Though the desired engagement model with Indian investors is self-servicing without human intervention, robo-advisors will have to go through the maturity cycle and adopt a hybrid model, high-levels of digital enablement and self-service, along with proactive human intervention.
Robot and automatic advisory capabilities will put pressure on traditional services and fees, and will transform the delivery of advice, giving significant competition to operators in the execution-only and self-directed investment market and even traditional financial advisers. Traditional advisers would need to change their strategy and use robo advisory to bring in efficiency and increase reach. Many self-directed companies have responded with in-house and proprietary solutions, and advisers are likely to adapt with hybrid high-tech or high-touch models.
However, the success of robo-advisors depends on it tapping into existing channels and traditional advisers to benefit from vintage and expertise as well as market access. Traditional advisers can benefit by extending digital services to their existing customer base at a low cost and target a broader segment without being limited by the number of human advisers.
Robo advisory and technology is the way forward for wealth management but it has a long way to go. During this journey, various models will emerge. But we are yet to see which one will bring balance between investors and advisers, and provide substantial value to investors. However, the growth of robo-advisors will indeed result in transparency and quality service at lower cost.
Vivek Belgavi is partner, financial services-fintech and technology consulting leader, PWC.