‘Robo advisers’: A threat or an opportunity for ‘fintech’?
The digital transformation ripples across all areas of the financial system. In the investment portfolio management segment, algorithm based platforms are starting to challenge more traditional advisers. Are they an opportunity or a risk for the ecosystem?
Should you trust your hard-earned retirement dollars to a robot? This is the question that The New York Times asked a group of specialists to focus the debate on the so-called robo advisers, platforms that use algorithms to manage the investment portfolios of their customers.
Robo advisers offer advice and are an alternative to traditional experts. And although traditional managers don’t seem to be by any means on the brink of extinction, the companies developing automated platforms are starting to present some dizzying figures: Startups like Betterment and Wealthfront, along with offshoots from established players like Schwab, have quickly amassed $53 billion under management in just a handful of years.
For customers the process is simple: All it takes is a computer, a tablet or a smartphone, and a few minutes to fill out an online questionnaire specifying risk tolerance, goals and investment. All this information is automated to start managing the customer’s money.
Here are some of the defining features of these platform’s current models, according to Business Insider:
- Price competition. From a consumer point of view, most robo advisers do not require a minimum capital threshold, and apply low fees. Betterment, for instance, does not require a minimum capital, and applies a 0.35% commission. Charles Schwab Intelligent Portfolios requires a minimum investment of $5,000 but does not apply any commissions. These conditions seek to compete with the average minimum investment from traditional investors, which stands at about $144,000, offering an average rate of return of 1%.
- A market that is becoming more open. Although as of now robo advisers are still focusing on more affluent individuals and the typical customer of traditional financial advisers (people with investment assets in excess of $1M), the price structure of these platforms suggests that they are also aiming to cater to well-off customers (with investment assets between $10,000 and $1M).
This is a population segment that has been traditionally ignored for not being profitable enough, but robo advisor technology is helping to open the market, by reducing traditional costs.
Debate over the benefits and uses of algorithms
The U.S, newspaper also echoes some of the questions of experts are rising, regarding whether the information that robo advisers gather is thorough enough. A robo-adviser does not ask about money held outside of its service, for example, which can provide a distorted picture of a customer’s financial standing. Others argue the robo-advisers try to wiggle out of too much responsibility in their customer agreements.
“I’m not quite sure about how investors can be adequately served in many cases by just answering a few questions," says William F. Galvin, secretary of the Commonwealth of Massachusetts, who compares these advisory services to driverless car services. “You always need a human being capable of responding,” he says.
Galvin argues argue that robo-advisers should go further, evaluating assets held elsewhere before investing customers’ money. In fact, Wealthfront and Betterment already have technology in place that lets customers connect as many accounts to their services as they would like, giving the firms a bird’s-eye view of a client’s assets. But for now they do not factor that into their investment analysis.
For other experts, the lack of information is not a problem, as it already happens in the relationships of customers with traditional advisers. “It is not unusual for clients to expressly or secretly withhold information from their advisers about other assets,” said Mercer E. Bullard, a professor at the University of Mississippi School of Law.
“For example, if a 35-year-old says, ‘I’m not going to tell you what other assets I own and I want you to invest $100,000 for my retirement,’ you can do that with disclosure that the allocation might be different if you knew all of their assets.”
One point over which experts seem to agree, regardless of their stance for or against robots, is about the need for straightforward regulations, both to safeguard the interests of customers and to limit the liability of companies.
And what’s even more, they also agree in that it has to be done before the model grows even more. Aite Group, a consulting firm, predicts that robo-advisers will collect nearly $285 billion by 2017, still a small portion of the $20 trillion in retail investors’ assets held at brokerage firms and registered investment advisory firms.
According to economist José Diego Alarcón, robo advisers can provide advice for many more individuals – they never sleep – and democratize the financial system as they can engage a much broader pool of customers with varying levels of wealth across the internet.
And for customers not sure about which model to choose, there are “hybrid" formulas: Human advisers that use the portfolios handled by computers, such as Personal Capital o Vanguard Personal Advisor Services.