Will “robo advice” significantly change the distribution landscape in the savings industry?

Images of RoboCop may spring to mind when you hear the term ‘robo-advice’. But robo-advice is increasingly seen as the solution for wealth managers and financial advisers looking to provide a service to those clients unable to afford face-to-face advice.  Many believe it has the potential to address the advice gap that exists in many markets and could help to increase savings rates.

The reality today is more mundane. The definition of a robo adviser is (according to Investopedia) “an online wealth management service that provides automated, algorithm-based portfolio management advice without the use of human financial planners.” To date they have been confined to basic portfolio management, utilising computer models with basic online goal and risk tolerance assessment tools.

This leaves the real areas of advice unaddressed, for example, life insurance, inheritance and estate planning, the risk of infirmity and the risk of living too long. Moreover, there are very real human attributes which are crucial in developing a situation of trust, such as emotional awareness, empathy and compassion. Can robots ever be a ‘trusted adviser’?

This does not mean, however, that robo-advice will not be a disruptive influence on the market. Robo-advice has a lot to offer most notably on fee levels:

  • The cost of robo-advice and execution for a client (typically 0.25% – 1% per annum, source Citi Research) is a material discount to the current industry norm of 2%-3% per annum for face-to-face advice or active fund management.
  • Bridging the advice gap. Robo-advice is a good solution for people with smaller levels of accumulated assets, typically below the minimum threshold a financial adviser may require.
  • Appealing to Generation Y and beyond. Younger generations are more comfortable with utilising online tools, so embracing robo-advice could help endear financial services to the younger generations.
  • Real-time access. Should this be desired, one could obtain financial advice, anytime, anywhere.

Quantifying how disruptive the change is likely to be is difficult given the market is nascent (Citi Research estimates only US$14bn at the end of 2014), but if the growth estimates are remotely right this will change rapidly (Citi Research estimates it could reach US$5tn in 10 years). The growing presence in the area from established financial institutions (Blackrock, Schwab, Aberdeen and NAB in Australia have all bought businesses in the area) will contribute to this by helping address some investor concerns in committing their wealth to relatively small, unknown businesses.

Perhaps this is a partly defensive move, but there are also potential synergies through the acquirers leveraging their brands, expanding their range of products (including offering hybrid solutions), addressing a new customer segment (who may mature and require more advice long term) and driving volumes to their passive / ETF business which are often the main building blocks in the robo-adviser portfolios.

The speed with which robo-advice grows will depend on three main factors:

  1. The development of appropriate technology both in terms of the sophistication in advice as well as addressing concerns over cyber security and privacy.
  2. The extent to which regulators keep pace with the potentially rapid development. The evidence to date is encouraging. A number of regulators have established separate divisions that are engaging with the financial services industry to understand the pros and cons of digital and technological solutions. In some cases they have offered additional support, for example, the FCA’s Innovation Hub seeks to help new and established businesses introduce innovative financial products to the market.
  3. Consumers’ willingness to rely on robo-advisers. Robo-advisers will struggle to match the same level of trust as a human adviser. Nevertheless, in the same way that self-driving cars have quickly gone from a faintly ludicrous idea to a reality many would be happy to accept, it seems dangerous to assume clients won’t adapt, particularly if this transition can be eased through the use of robo-advisers with human oversight.

Technological advances are proving disruptive to every element of the traditional value chain in financial services, so why should the distribution of advice be any different? Would you ever completely entrust your life savings to a robot to invest? Probably not, but you might accept a hybrid solution, with a reduction in fees for the less complex elements in the investment decision being conducted on a more automated basis.

Robo-advice is here to stay. The challenge for the wealth management industry is to embrace the change and learn to cope with the new economic reality.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.