What are Robo Advisers?
Robo adviser has become the catch-all phrase for any advice service that employs technology to create efficiencies in the delivery of investment advice and/or management.
I had dinner with a mate the other night who works at one of the major banks. As an industry participant, he has a keen interest in the development of robo advice, and the impact it will have on the industry.
He asked a surprising question: “So, is it a robot that actually creates the advice?”
I thought, ‘Well if he doesn’t understand robo advice, how will the rest of the world make sense of it?’
The important thing here is to understand that robo advice, while in its early adoption phase, is actually quite well established elsewhere. US robo advisers boast anything from $2 billion (Betterment) to $20 billion (Vanguard) funds under management (FUM). That’s not nothing (sic).
But just stop right there. Hold your horses! Don’t assume that robo advisers all operate a traditional FUM model – they don’t. Just like there’s a range of companies offering some level of automated investment advice, the way in which it is offered – the business models also differ.
It’s worth looking into how they provide their services, what characterises their offering, and where they fit into the spread of advice – both face-to-face and automated.
“Would you take financial advice from a robot?” – The Sydney Morning Herald, December 2015
There have been plenty of headlines about robo advice painting a picture of a ‘Brave New World’ for investing – that it will somehow be devoid of humanity, turn all of the decision-making over to technology, and should be looked upon with a level of skepticism. In some ways that’s understandable given we have ‘personified’ the process as a robot.
The reality of course is there is no robot, though there most definitely is technology made up of sophisticated programming and robust computing and security infrastructure. So perhaps a definition of robo advice is in order to help us through the spin and any associated fear:
Robo advice is any investment advice outcome achieved through using technology and automation, and removing high touch human intervention.
A robot by any other name…
Code, algorithms, programming, software – call it what you like, these are tools that provide expression for human endeavour and effort. They are created by humans and run by humans. In order to work, they need to be configured using rules. Once these rules have been set, and applied through programming, the technology produces results based on these rules; consistent, automated, dispassionate, efficient, to scale, and cost effective.
As technology provides the vehicle for delivering consistency of performance, so it must be the rules where interpretation and the analysis happen – the human bit. Portfolio managers do this work – what to look for, key indicators, “if ‘yes’ then action A, if ‘no’ then action B”, sector tilts based on market condition – all these factors are set by the portfolio managers.
Portfolio managers are the rock stars of robo advice. They are a synthesis of market analyst, professional adviser and maths super geek, and it is their skill and input that creates the rules that will ultimately shape the substance of investment advice, based on your specific portfolio, risk profile and current market conditions.
The ‘robo’ bit will then use processing power and speed to produce rules-based, data-driven advice that is consistent, evidence-based, and free of emotion – which is extremely useful when you are talking about something as emotionally charged as your money.
So can you trust a robot to handle your money? Yes, when you are confident that the horse is pulling the cart, not the other way around.
Horses for courses
Much of the discussion around robo advice has been about a low-cost model for advice when it should be about the quality of the service in relation to consumer needs.
Traditional advisers are quick to decry this ‘disruption’ as putting hands in the pockets of the their service model and compromising or threatening their very existence by building a cheaper and more cost-effective mouse trap. Yet, if the quality of the service delivers value, there’s no issue.
“Price is only ever an issue in the absence of value.” – Unknown
Thank you, Unknown. You’ve hit the nail on the head.
But I think we can all agree that maintaining the status quo may not be in the best interest of consumers.
Remember this? The status quo.
You either did your investing yourself and flew blind, or handed over your cash and put your trust in the hands of the ‘experts’. Nothing in between. As a result, the majority of consumers bypassed the advice channel altogether. In fact, the Australian Securities and Investment Commission believe that up to 80% of adult Australians are unadvised.*
80% of adult Australians are unadvised. Why?
Our industry has not been structured to bridge the gap of the cost of providing advice and the amount that consumers are willing to pay. It’s created a hole into the market that technology is perfectly placed to fill. There has been a problem in the economics of investment advice, and the industry has not been able to efficiently meet the needs of consumers to bridge any advice gap and get them engaged with the advice industry – hence robo advice.
Automation and technology is addressing this, but not at the expense of the other. It’s reaching out to a new market, previously shut out from the advice industry, and is creating a new industry segment and great opportunities for wealth creation within the mass market.
Each to his own
The various business models all co-exist as there are aspects of each that most suit consumers. Each fulfils a need along a spectrum that is choice/decision outsourcing. The more you outsource the more you pay – and so it should be – you are buying services in increasing amounts:
- Mow the lawn yourself: free and self-satisfied.
- Get a gardener to mow the lawn: one price.
- Gardener to mow the lawn and trim the hedges: high price.
Mow the lawn, trim the hedges, clean the pool … you get the point.
Every opportunity has a price, and in this case it’s about the effort required to make the most of the savings offered through automation and technology.
The only problem with going to heaven is that you have to die to get there. Same with do-it-yourself advice. You can benefit from the efficiencies and savings that go with it, but you need to be prepared to be an active participant in your investment strategy and pore through a mountain of data and views.
Robo advisers bridge the gap between DIY and outsourced. They provide guided choice – doing the data crunching and tedious process of idea discovery of the professional, then using technology to distil this down to a volume that you can handle. Guided choice.
There are plenty of advice products on the market that cater to the desired engagement you want with your investments:
High outsourcing – takes it off your hands
These are the set-and-forget consumers. They are looking to hand their investment decision across to someone else to manage. Their involvement is simply which service provider to use, and they are willing to pay handsomely for this privilege.
Funds under management works perfectly for them. It’s a low impact, ‘do it for me and send me a statement’ approach. These consumers are well suited to the no engagement managed model.
Moderate outsourcing – keeps you across what’s happening
The first iteration of robo advice; let’s call it Robo 1.0.
It has automated the sales process of funds gathering and placed it online. Once it corrals the funds, the ‘advice’ part is limited to which fund managers to use from a modest panel. It’s a fund-of-funds model – you place your money into the parent fund which invests into underlying funds (typically exchange traded funds, ETFs) on your behalf.
The Robo 1.0 funds under management model is good for those who want advice on which index funds to own and in what proportions. This is for the consumer who likes to stay across what is going in their investments. You’ll find dashboards, analytics, portfolio tools behind the paywall, and you’ll feel like you’re on top of what’s happening, though ultimately you’ll hand over your money, and let others do the executing. Robo advisers that match this preference include InvestSmart, Betterment and Wealthfront.
Low outsourcing – guiding you for ease of choice
The robo fee-for-service model provides fantastic benefits for those who like to know the details of their investments. They are less than semi-professional, but more than hobbyists – perhaps best called aficionados. Dashboards, health checks, Statements of Advice, benchmarking, all for the enthusiast who is empowered and emboldened by technology and keen to keep a watchful eye as professionals aid their choices to assess, plan and execute on their investment strategy. The robo adviser that matches this preference is OwnersAdvisory. This is Robo 2.0.
The question here is why wouldn’t you want to directly manage your investments? Is it because that until now it looked too hard, out of reach, the jurisdiction of the wealthier classes? Not anymore. If you have the drive for success, the desire for knowledge and a little time to attend to your investments, robo advice can afford you high-quality support to guide your decisions with professional-grade advice at a fraction of the traditional cost.
What’s the best approach for you?
Well, that depends. It comes down to the amount of ownership in the process you are willing to accept. In general terms, the more ownership (we’ll call that higher ownership), the less it will cost you from a fees and charges perspective. Conversely, the more of the process you outsource (lower ownership), the greater the fees and charges.
We break these service models into six categories:
Although simple to understand, the term ‘DIY’ is a little pejorative, as it implies a ‘handyman’ low level capability. It may be better to use the term ‘self-directed investors’ (SDI), because it implies a level of self-determination and accountability that goes with the empowered investor.
SDIs love the strategy and the challenge that goes with investing. There is a strong sense of satisfaction from doing it all themselves. They will more than likely operate their own trading account – a Commsec, Macquarie Online Trading, Bell Direct or NAB trade account – and will trust their knowledge, wits, feel, experience and nerve above all things when it comes to decision-making.
Robo empowered – Robo 2.0
In some ways similar to SDIs without the feeling of being alone in the market wilderness. The robo empowered model is for self-determining investors who want to do it themselves for the cost benefits or heightened sense of ownership, but understand the markets are a noisy beast, so would value a cost-effective guiding hand. We guide, you decide.
We call them ‘aficionados’ as they have enough skill, knowledge and desire to be pursue an investment strategy and realise the advantages that professional advice can offer, but up until now found it inconvenient to access or have struggled to see the value for money.
This is where platforms like OwnersAdvisory fit. Our service provides opportunities for self-directed investors to get professional-grade advice on a self-service basis, and does so for a fixed fee, providing cost controls, transparency and a high level of fee certainty within their advice.
Robo empowered advice is a great fit for this type of investor as it provides important inputs that shape strategy and inform investing decisions, while maintaining the benefits of direct ownership.
Index funds are a low-fee investment approach that tracks performance to an index. Funds or parcels of stocks inside these indexes are packaged up as a fund for investors to buy. For example, to invest in whatever makes up the All Ordinaries, there is not a lot of effort, skill or time to do this, and by default the investor gets the performance of the index (less a modest fee).
For these reasons, index funds are very popular as a halfway house between ownership and fully outsourced. Trillions of dollars are invested in them globally; it’s even quite common for superannuation funds to invest in them, as well as smaller investors because it offers broad diversification and low costs. Of course, the issue here is there are now thousands of index funds to buy, tracking many different universes. So once again, a decision – which index fund or funds suit me?
Robo managed – Robo 1.0
Companies offering in this model – InvestSmart (Australian-listed, parent Australian Wealth Investments), Stockspot (Australia, privately held), Betterment (US, privately held), Wealthfront (US, privately held), Vanguard (US, mutual), and Nutmeg (UK, privately held) to name a few – provide investment guidance of what mix of index funds suit the investors risk profile.
Over time, the advice component of a robo-managed provider largely diminishes as the auto-rebalancing takes over. So one could argue this is less about automated investment advice and more about automated investment management. Then there is the further wrinkle of non-aligned (InvestSmart) versus vertical integration (Vangaurd) – but that is a whole other debate.
The traditional advice model has been in place for generations. It’s a high-touch, people-intensive process that best suits people who want to outsource their money to a professional fund manager to manage on their behalf. Of course, there are some decisions required here, namely which strategy and which fund manager to use, but once that is done, the process is convenient and professional as it’s fully outsourced.
The satisfaction of direct ownership is lost, but the professional management is there. The payment structure in the industry is percentage fees based on the amount of money invested. There is a wide array of fees, and due to the hands-on intensive nature of the process, the levels are higher than index funds (and/or Robo 1.0 managed when full fees are accounted for).
Hedge funds use alternative investment strategies that are more complex than traditional managed funds. Hedge funds aim to achieve returns through an investment manager’s skill and by using complex strategies and tools that can be riskier than traditional managed funds. They are highly focused on human capability and need a lot of attention. They also layer onto this leverage – so in simple terms, an investor outsources both the investment management decision and the gearing decision. As such, they can often be more expensive, much more expensive.
Hedge funds are usually actively managed. Investment managers typically have wide discretion over what assets to invest in and how much to invest into any given asset or market. The expertise and experience of the investment manager is crucial to the fund’s success.
The wash up
Some people love robo advice and herald it as the dawn of a new age for investors; others view it with suspicion. The traditional advice industry has howled and berated the advent of robo, instead of embracing technology and leveraging for the benefit of consumers and themselves. Robo advisers have even turned upon each other, competing for the limited first-mover market through a good old-fashioned free market war as to who has the best mouse trap.
No wonder consumers have been confused; they’ve been getting mixed messages.
We take the middle road. Robo advice will be great for many, but not for everybody – not at this stage in its evolution. There is clearly interest and consumers are keen to jump in but they are looking for some signs from the industry that the time is right.
The time has never been more right! There is opportunity, excitement and choice. Each provider of automated advice offers their own take on what they think is the right approach – their robo flavour, if you like. And it is this energy and vibrancy that is great for consumers, as a strong, viable and competitive robo advice industry will create choice, value and range for consumers to trust.
*Based on the Investment Trends 2014 Advice & Limited Advice Report and ABS statistics
By John O’Connell and the Owners team