The need for a new generation of robo-advisors
A strong rise of robo-advisors is often predicted within the next few years. But, looking at the current situation, the offerings typically use limited possibilities to managing assets and can potentially only satisfy specific needs.
- The robo-advisor market is still at its beginning with associated weaknesses
- New generation robo-advisors shall also address needs of private banking
- With that digitalisation process, it is the investment process that is likely to be reengineered, especially at the “allocation” level
Today's robo-advisors typically offer retail clients a way to invest in a portfolio of a limited number of passive exchange-traded fund (ETFs) that are rebalanced automatically, with a certain value adding technique. That portfolio usually/necessarily being the result of a short, online questionnaire trying to identify the investor’s investment needs.
Such mandates relate to small(er) investment amounts and the offering comes either from a financial technology (fintech) company, start-up or not, using banking services, a bank alone or a bank working hand in hand with a fintech company. These are the commonly observed business models. One can also add the very large asset managers with their own extensive ETF supply that can potentially penetrate the market at "any" moment if they have not done so yet. Interestingly, they run both passive and active funds in order to mitigate risk.
Most robo-advisors appeared after the big crash in 2008 that shook global stock markets. Since March 2009, global stock markets have rallied and also managed to circumvent any bigger crash on a global scale. Hence, portfolios of (recent) robo-advisors have not yet been tested in difficult market situations and historical results are biased and therefore not necessarily a good indicator for downside protection during turmoil.
As a side note: although the classic robo-advisor is (apparently) fully digitalised, there is usually no performance of a real portfolio (historical results) visible. Even a back-tested/simulated result including management and trading fees fitted to the specific costumer characteristics is at least very often missing. These numbers are very important when evaluating a service provider. And with a total expense ratio of about 1%, the impact is definitely material when looking at a typical portfolio in Switzerland: the performance in Swiss francs needs to be optimal.
Current services are unlikely adequate for the demanding needs of private banking clients and not all solutions can practically be available for the retail segment as well. The offering needs to be much more evolved to address the objectives and constraints and for example also include other asset classes such as commodities and the optionality of short positioning and new styles (within alternative strategies). This, in return, requires (very) high-quality simulations paired with models that capture the different risk aspects of such instruments. Also, a robo-advisor can take other forms than a mandate to manage the assets.
However, the industry is evolving fast. It is likely that fintech companies with a real competitive edge, adding real value to the client’s portfolio, will first partner more extensively with the banking players in order to exploit different types of synergies. The current approach is very “linear” and IT driven. Being able to add the client competency will certainly push the industry forward. An example could be the management of diversified portfolio where individual strategies rather than asset classes are combined in an intelligent way. In this area, an advanced (new generation) investment robo-advisor could certainly help optimising a portfolio. Some distant future ideas might also include (much) less liquid instrument but that supposes a completely different approach to established allocation principles.
It is likely that robo-advisors, including or even thanks to the more advanced ones, will have the potential to cover several percentage points of the global asset managers’ assets under management. However, it is likely to take longer than some specialised analysts expect.
Note: Patrick Oberhaensli is founder and chief executive officer of EVOLIDS FINANCE LLC. The views expressed herein are strictly of the author.
Keywords: ETF, Robo-advisors, Technology
People: Alicia Garcia Herrero, Eugene Tarzimanov