Robo Advisors have infiltrated the wealth management industry in an unprecedented fashion and are forecasted to grow robustly – giving traditional wealth managers a run for their money. Meghna Mukerjee speaks to some of these firms about what ‘Robo Advisors’ actually do, their advantages, and why they have hit the sweet spot, especially in the US
In spite of sci-fi films induced images of robots immediately cropping to mind at the mention of the terms ‘Robo Advisors’, in reality they have nothing to do with the pop culture influenced machines as we know them.
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Robo Advisors are online technology platforms and services that use analytical tools to create financial plans or investment portfolios for clients and enable individuals to smartly invest, with minimal human intervention.
Since the financial crisis, Robo Advisory has gained momentum, resulting in a report by MyPrivateBanking Research forecasting that in five years, Robo Advisors may be managing approximately $255 billion worldwide.
For some players, the ‘Robo Advisors’ classification is stigmatised. According to Simon Roy, president of Jemstep, the terms ‘Robo Advisors’ underestimate the real value of "algorithmically based investment guidance, aided by high quality advice".
"It is not a name we would have come up with," adds Roy.
However, others are happy to embrace the popularity of Robo Advisory, having become an industry buzz, even though the nomenclature – that can be swapped for online-only wealth management – does not adequately explain what the firms actually do.
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By GlobalDataMichael Sha, CEO and co-founder at SigFig, says: "It is the use of science and technology to improve the way assets are managed, both from an investment methodology perspective and an operational perspective – keeping portfolios balanced and healthy."
Bridging the wealth-advisory gap
Geared toward the mass affluent (households with between $250,000 and $1 million in investable assets), Robo Advisory started out to, largely, service a segment that has been deprived of traditional wealth management services as well as address a prominent wealth-advisory gap in the market.
It has been ideal for clients that do not need investment sophistication or in-depth planning, and the majority of Robo Advisors’ business still comes from clients who open accounts with $10,000-$20,000.
The business model is simple and affordable. For instance, automated investment service firm, Wealthfront, manages accounts worth $10,000 and under for free, and accounts over $10,000 are charged a flat 0.25% annual management fee.
However, the average portfolio size of Robo Advisory firms, currently, can be well north of $300,000. For Wealthfront, accounts range from $5,000 to over $10 million. Similarly, for Jemstep, the largest account is worth over $15m.
The US factor
The US has been a hub for Robo Advisory with several new start ups having mushroomed across the continent, and that number is strongly escalating.
The recent MyPrivateBanking Research report finds that by the end of 2014, Robo Advisors may be managing $14bn in assets and 83% of those assets will be concentrated in US. Even though traditional advisors still control around $5 trillion, there are several macro trends in the US that make the market lucrative for Robo Advisory.
Tom Kimberly, co-founder at Upside, says, "The first dynamic that supports the growth is a culture of innovation and risk taking, born out of Silicon Valley entrepreneurship".
The "general lack of trust for traditional Wall Street advisers, especially since the financial crisis", explains Roy, contributes to the affinity towards Robo Advisors in the US.
"The US has also benefitted from the availability of low cost technology platforms and the broad adoption of index funds and ETFs. The population is more accepting and increasingly aligned to technology offerings.
"The adoption of mobile and internet access through to account aggregation and big data analytics have all converged to create an alternative, particularly in the US," adds Roy.
Agrees Sha: "The US has always been innovative in terms of using technology as a disruptive tool. That combined with the
large market opportunity have spawned an interest in using technology to change the way wealth management and asset management work."
Need for change
However, despite the US leading the trend, the wealth-advisory gap exists in any major market, and technology can democratise access to high quality investment advice. The need is evident as online-only wealth managers are currently creating a stir in the UK wealth management market.
Set up in 2011, online discretionary wealth manager, Nutmeg, has grown aggressively, boasting over 35,000 users of its site. Online advice service, Wealth Horizon UK, came into the market earlier in 2014 and has made its presence felt.
Traditional businesses, such as Hargreaves Lansdowne, for instance, plan to launch their own online advisory service and move towards a hybrid business model.
Kimberly believes hybrid service models are the way forward. Earlier in October, Upside partnered with Ritholtz Wealth Management. Using Upside’s platform, RWM is offering its solution, Liftoff, that makes RWM’s proprietary asset allocation strategies available to emerging affluent investors.
There is also a common belief that Robo Advisors are typically suitable for Gen Y clients as opposed to more mature, traditional investors. This, however, is far from facts, most players explain.
For Wealthfront, the youngest client is 19, while the oldest is 93 years of age. For Jemstep, younger or self managed investors are a "stepping stone" towards partnering with the traditional investors who are commonly used to private banks and relationship managers.
SigFig, with a total of approximately 500,000 clients, has not faced difficulty with mature investors. "It is a misnomer that only millennials use these services. More than half of our users are over 40 years old," says Sha.
Although the jury is out on whether Robo Advisors can eventually outperform traditional relationship managers, Kimberly says digital advisor solutions will become an "increasingly common element of investment management".
"Digital advisors are not a fad, but neither are they a panacea. Like all innovative solutions, it will take time to develop and become more mainstream," he says.
