This is a guest blog post by Ilkka Routsila, former Nordic Head of Accenture Strategy for Banking & Financial Services, currently in garden leave.
The concept of robo-advice – the use of automation, investment algorithms and an online interface to build and manage portfolios of exchange-traded funds (ETFs) and other instruments for investors – has gained significant attention within the wealth management industry. Is this pure hype or is there a chance robo-advisers will profoundly alter the existing business models by changing the way investors seek exposure and even how portfolio managers manage their funds and discretionary mandates? Will robo-advise do the same for production as mobile did for distribution in wealth management?
To date robo-advice has gained only a minuscule share of assets under management. However it presents investors with an interesting value proposition—with a price reduction of as much as 70 percent for some services—and its rate of growth is both rapid and accelerating: robo-advised assets only in the U.S. are projected to grow from $300 billion in 2016 to $2200 billion by the end of 2020, which would indicate an annual growth rate of 68%. The biggest robo-adviser platform Betterment surpassed already $5 bn of assets in July 2016 and the first robo-adviser in the Nordics (Evervest) is planned to be launch during 2016.
Much of the initial uptake and interest in robo-advice is coming from the “mass-affluent, delegator” market segment, which has traditionally been underserved. Discount brokers in the Nordics such as Avanza and Nordnet will likely follow their global peers like Charles Schwab (who introduced their “Intelligent Portfolios” early 2015) to use robo-advice to push further into advice delivery while leveraging their traditional direct engagement model.
Similarly, even prominent full-service advisers are looking at robo-advice as a way to serve smaller accounts and increase adviser productivity, but also to offer a cost effective way for high net worth individuals to diversify their risks through ETFs. For example, already in 2013 Goldman invested in Motif Invest, followed shortly after by Vanguard (launched Personal Services), Fidelity (partnership with Learnvest), Fidelity (acquired E-money) and BlackRock (acquired Future Advisor). Also Wells Fargo, Bank of America and Merrill Lynch have announced to launch automated investment services.
The obvious cannibalization effect of these new no-fee/ low-fee services vís a vís their traditional managed portfolios seem not to bother the high street players at all, even if they are making less money on the same assets. In a very bold recent move Vanguard even proactively transferred nearly half of their AuM in their Personal Services (0.3% management fee) from a more expensive (0,7%) portfolio, perhaps anticipating a very likely client driven segmentation that would happen anyway if they stand still, but doing it themselves they can still remain at control of the assets. What is it really that make robo-advice so compelling to justify these type of moves?
What can robo-advisors actually do right now?
In the context of the recent market moves described above, it is somewhat surprising that current robo-advice capabilities actually remain fairly basic (see illustration below). They struggle to match human advisers’ strengths such as offering complex advise and serving as an emphatic sparring partner. In general, they use simple surveys to profile clients and to assess their needs. An asset allocation is proposed, adjusted and implemented. Portfolios are monitored, rebalanced and reported on. Robo-advice streamlines the account opening process, and its ability to transfer assets is increasing. However, even if today it won’t meet the needs of investors with even moderately complex financial lives, it represents a useful basket of simple services at an attractive price – a compelling value proposition for the most of the mass affluent/ delegator segment.
What will robo-advisers be able to do in 2-3 years time?
It is clear that competition, innovation, new technology and a rapidly using user base combined with machine learning will dramatically increase robo-advice capabilities in the near future. Future versions will consider the client’s complexities by adapting questions based on earlier responses – for example, in developing a financial plan, they can assimilate multiple goals, including college savings, planned home purchases, retirement, protection needs, estate planning and the need for health care and/ or long term care coverage. In proposing investment solutions, they will be able to incorporate outside assets, handle individual securities, ladder bond portfolios, consider low tax basis holdings, and allocate around illiquid positions. They will help clients understand their portfolios by providing information and learning in the context of the financial results and market information being presented. In fact, for example Betterment is rapidly turning into one of biggest investment education platforms in the U.S.
The human element
It is important to note that there are also elements of the robo-advice experience that clients prefer over traditional models. They like the privacy offered by a digital solution and the ability to learn, and to chart their own path to the world of investments. These benefits will be expanded on in future releases. Over the next decade and beyond, emerging technologies, such as cognitive computing and natural language processing, will power major advances in robo-advice capabilities and bring the machine closer to a human adviser. There will be a rapid evolution towards an automated adviser assistant that can even provide complex advice, and that will also allow clients to interact with the assistant in a multi-step process rather than a one-time effort. This will help to serve clients even more effectively and in a more convenient way.
The growth of robo-advice matches up with industry trends indicating strong interest towards an automated investment management service comprised of ETFs. For example, a recent survey among 1500 affluent investors across age groups in the U.S. revealed that 75% would be very likely or somewhat likely to consider such a service, with 22% selecting very likely. Trends also indicate that investors are seeking more collaboration and integration with their advisers. Rather than simply being told how their money is invested and how it is performing, robo-advice gives investors an enhanced way to interact with their human advisers, offering an attractive tool for e.g. private bankers to increase engagement levels with their clients.
While robo-advice capabilities are improving dramatically, I believe personal connections will remain essential for many investors. There are parts of the client-adviser relationship—such as reassuring clients through difficult markets, persuading clients to take action and synthesizing different solutions as well as protecting wealth across generations—that should remain the province of the financial adviser for the foreseeable future.
It is therefore essential to develop a unified client-adviser experience that seamlessly brings together the best of human and robo-advice capabilities. Understanding where robo-advice can complement and enhance relationships will be key for most full-service wealth management firms.
Implications for wealth managers and the industry
Robo-advisers can and soon will have to be one of key pillars in the evolution of an affluent segment service model together with other digital capabilities such as remote collaboration, cross-selling and connecting to remote experts. Robo-advice will complement, rather than displace, financial advisers. It will also enable significant costs savings for wealth managers by not having to increase adviser staff while demand for advice is increasing rapidly. Further, for investment managers it offers a cost effective way to manage and allocate exposure through ETFs, for example, leaving more time for active management and client interaction.
Important to note is that even investment professionals still don’t quite know how to relate to robo-advisors and how they will impact the industry. By and large, they are still figuring out whether they’re competition, complementary or even relevant at all. In a recent study as much as 65% of investment professional surveyed were familiar or somewhat familiar with the concept of robo-advice. Of those who had heard of robo-advise, 23% believe it is competition to their practice, and 27% say it is irrelevant. Just 19% think digital advice can be complementary, while 30% haven’t yet made up their minds.
To implement a successful, segment specific and client relevant robo-advisor which minimizes cannibalization of existing offerings across segments, one should follow these simple steps:
- Define the right ambition level – what role the robo-adviser will have in the overall value proposition and how much will that change the existing business model
- Decide where to compete- addressing the right segments with an appropriate marketing communication will be crucial to minimize cannibalization. What qualification criteria should be used to select targeted segments and clients?
- Decide how to compete – what will be your value proposition to each segment and channel? Should one offer a stand-alone solution or offer it next to traditional advice? Should it be an entry level product for smaller investors guiding them towards full service model once their assets grow? What is the right price point for investors – free (as in the Charles Schwab model) or in the 25 to 35 basis points range (as other firms have established)? How to design the customer journey for each segment and underlying investment profile/ personas? How make sure the end-to-end process provides a smooth seamless experience in all selected channels? What technology to use? How to bring human advisers on-board in terms of capabilities and mindsets? What brand to use…?
- Identify the impact of the above decisions to your existing business model and do a gap analysis, followed by a decision whether you should build, buy or partner to close the gap
A typical caveat is to offer the same robo-adviser functionalities and experience for all segments as it will lead to rapid cannibalization of the standard portfolio programs one has been carefully building pre-digital era.
Robo-advice has already had a significant impact on the wealth management industry. Several wealth managers have already launched a robo-advice option; others have an option in development or are reviewing strategic alternatives. It will accelerate the fee compression in the industry, together with other trends such as passive investing. Wealth management firms need to keep a close eye on operating costs and on ways to automate transactions and processes that are currently performed manually.
On a more positive note, robo-advice will also give wealth managers access to a large new market of millennials who are interested in accumulating wealth, but have had only limited options in terms of investment management. As these individuals mature and build assets (through their own efforts and through inheritance from their boomer parents and grandparents) they can represent a significant growth opportunity for wealth management firms.
The most important effects on the industry however will come from capabilities which have not yet been released to the market, but which are logical extensions of robo-advice capabilities. In addition to cognitive computing, machine learning and natural language processing, these include the addition of investments other than ETFs, such as equities, fixed income and, eventually, alternative investments such as hedge funds, private equity, infrastructure and real estate.
Clearly, the question is not whether one should have a robo-advisor, but it is a question of how to use it for the benefit of your clients, advisers and portfolio managers. Some large firms will build their own offerings, while other large and mid-sized firms might buy or partner with independent robo-advisory firms. Smaller wealth managers may offer “white label” services or incorporate a branded industry solution. As James Gorman, CEO of Morgan Stanley put it: “Whether we build or buy it, we should have it.”