The Financial Times estimates that the market for funds advised by hybrid robo-human services will grow to $16.3 trillion worldwide in the next nine years. According to Swiss financial research company My Private Banking, pure robo-advice has jumped from $19 billion in 2015 to $43 billion in 2016. The rise of the robo-adviser appears to be unstoppable and is key to opening up wealth management to the mass market. There are a number of reasons why this is happening and why it’s happening now.
Low interest rates
With interest rates at record lows, virtually zero or negative in many parts of the world, savers are looking for places where they can get a return on their money as an alternative to putting it under their mattresses and seeing rising inflation eat away at the value of it faster than the moths.
With cheap funding available from the central banks, the high street banks, which have traditionally used savings accounts to fund their lending activities, are no longer interested in competing for consumer savings. The days are gone when the likes of ING Direct were fighting for savings at attractive rates.
The disappearance of affordable investment advice
Governments have introduced legislation, such as the UK’s Retail Distribution Review, designed to raise the quality of the advice that customers receive from their financial advisers and to make the charges paid to advisers far clearer. This well-intentioned regulation has resulted in the disappearance of affordable wealth advice for the mass market from the high street. The banks, many insurance companies, and independent financial advisers have decided that the cost involved in training staff to meet the new standards – in exchange for the significant reduction in revenue from selling investment products (as both upfront and trailing commission, largely invisible to customers, were banned and replaced with explicit upfront fees) – is simply not worth it.
The demise of the star active fund manager
In a rising market, it is relatively easy to appear to be a successful fund manager, particularly when your low-risk investment strategy is largely to shadow the indices in the markets you are focused on. Even the star performers who have been hugely successful in the past have been proven human – the challenges that Antony Bolton had with his Fidelity China Special Situations trust and Neil Woodford has with his Patient Capital Trust illustrate how difficult it is for active funds to consistently perform. Increasingly– and particularly during periods of economic uncertainty and turbulence in the markets – it has become evident that the majority of active fund managers fail to outperform passive index trackers, even more so when the charges for these funds are taken into account.
The emergence of Exchange Traded Funds
In 1993 the first Exchange Traded Fund was launched, and there are now several thousand of them. An ETF is a marketable security that tracks an index, a commodity, bonds, or a basket of securities like an index fund. Because it is traded on a market, it is priced throughout the day (unlike mutual funds). Among the reasons that ETFs are influencing the rise of robo-advisers is they generally have very low costs, they have a low entry price (buying one share is possible), and because they operate like an index it is very easy to automate management.
All robo-advisers have been built around ETFs as the core funds in the portfolios they recommend to their customers.
Increasing trust in computer-generated recommendations
With consumers increasingly trusting personalized recommendations from the likes of Netflix, Spotify, and Amazon, there is far more acceptance that artificial intelligence is reliable. This is further boosted by consumers’ considerable loss of trust in the people in the financial services industry following scandals such as the mis-selling of payment protection insurance (PPI), fixing of the LIBOR and FX markets, and the 2008 market crash.
The low cost and availability of supercomputing and the cloud
Without the dramatic drop in the cost of supercomputing and the ability to deliver it over the cloud, the sort of services that robo-advisers can offer would not be possible. The independent financial adviser used to have the advantage of having information superiority and exclusive access to financial models. This has been eliminated by the pervasiveness of information and the ability to deliver supercomputing to mobile devices. Algorithms that used to require a Cray to process can now be delivered via the cloud to a smartphone or tablet. This allows the ordinary person to use their robo-adviser to take advantage of sophisticated tools such as algorithmic trading.
The ability to process structured and unstructured data in real time
With high volatility in the markets and 24×7 newsfeeds, the ability to process both structured and unstructured data, including sentiment analysis, all in real time reduces the risk involved in investing in the market. This enables the robo-adviser firms using AI to flex their recommendations and portfolios in real time.
Who are the key players?
The market started in the U.S. with the likes of Vanguard, Betterment, BlackRock’s FutureAdvisor, Charles Schwab’s Intelligent Portfolio, and Wealthfront. In Europe, the key players are currently MoneyFarm, Nutmeg, Swanest (still in beta), and Yomoni.
With the potential size of the market, it is likely that the large U.S. players will bring their offerings to Europe and that others within Europe will enter the market. This will be thorough a combination of three ways:
- Banks and asset managers building their own robo-advisers using platforms that can manage structured and unstructured data in real time such as in-memory computing, advanced analytics tools, AI, and cognitive computing
- Partnering with an established robo-adviser platform provider. This could either be on a white-labeled basis or by leveraging the robo-adviser brand. Fidelity originally did this with Betterment until it decided to build its own solution. In the U.S., BBVA and RBC are both partnering with BlackRock’s FutureAdvisor.
- Fintechs entering the market in a similar way to Moneyfarm or Solarisbank.
A significant threat to the relationship with mass affluent and wealth management customers
The low cost to consumers of buying a funds portfolio using robo-adviser technology is significantly increasing the market size for what has traditionally been seen as wealth management. With many banks and insurance companies abandoning the provision of financial advice to the mass affluent, there’s a significant opportunity for new technology-enabled players to enter the market. This is a significant competitive threat to established players who persist in using only traditional channels. It also threatens the relationship banks have with mass affluent customers and risks relegating banks to simply providing low-margin, transactional services.
Now is the time to act.
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