The Rise of the Robo-Advisers
Automated wealth investment services – "Robo-Advisers" – present a low-cost alternative to wealth investment, and are enjoying an exponential growth in market share. What exactly do Robo-Advisers do, and what can private banking learn from this new paradigm?
Meet Alex. Alex is a "millennial", a child of the 1980s, and employed in the "new economy" – an internet start-up on the cusp of an IPO, perhaps, or a transnational management consultancy. Alex is financially comfortable, but is beginning to think about how to translate this into long-term financial stability. Traditional wealth management options, such as financial advisers building an independent investment strategy would be an attractive option, if itself weren't for the fact that Alex is not a High-Net-Worth individual; Alex's capital won't extend to supporting a robust investment portfolio, at least not yet. Mutual funds are perhaps more appropriate for an investor of Alex's financial capabilities, but these come with their downsides, such as the relative lack of flexibility. Alex's options for developing an investment portfolio are limited, it seems.
Alex's dilemma typifies a growing challenge faced by the wealth management industry: how does the industry respond to the needs of a new generation of investors, financially literate, interested in building a long-term portfolio, but lacking the liquid assets needed to access most private banking services? A solution, underpinned by new technology, has begun to evolve: welcome to the world of automated investment advice and implementation platforms.
Robo Vs Human – Or Passive Vs Active Investment Strategies?
Robo-advisers – to use the suitably futuristic moniker adopted as a description for these services – are investment services driven by automated customer service and an investment strategy governed by computer algorithms. A clutch of start-ups, largely located in the United States but spreading to Europe and Asia, have emerged over the last few years. Their rhetoric is disruption: they offer, they claim, personalised portfolio services at competitive cost. The question, for clients and existing service providers alike, is whether these claims should be taken at face value; are robo-advisers poised to fundamentally reconfigure the wealth investment industry?
The Computer Never Sleeps
The first question is the most obvious. Can algorithms outperform seasoned wealth investment professionals? Adam Nash is CEO of Wealthfront, a Palo-Alto based investment start-up with more than $2.4bn of clients' assets under its management. He notes that his firm's overall investment strategy is founded on solid, historically tested principles. "Remember that Wealthfront is based on long-term, passive investment, as directed by our Chief Investment Officer, Dr. Burton Malkiel," Nash says, (Malkiel is a leading economist and the author of the highly influential investment text, A Random Walk Down Wall Street.) Nash argues that active investment strategies rarely beat the market, and that Wealthfront's technology-supported strategy looks to the long term. "Technology greatly aids in automating passive investing," he observes. "Good investing is like a marathon, not a sprint, and the computer never sleeps, so to speak. It watches your money 24/7 doing all of the little, boring things that make up good long-term investing like rebalancing, divided investment, tax-loss harvesting etc."
New Markets, New Demographics
What robo-advisers bring to the wealth management industry, one could argue, is a democratisation of the investment process. Not only is it easier to sign up for a program – Wealthfront claim to be able to open a client account "in under 10 minutes" – but the lower overheads inherent in an automated service lower the entry point for potential investors dramatically. The exponential growth of the robo-advisory services bears this out: assets under management of digital investment services have swelled from $1bn to $5.1bn between 2012 and 2014. Some projections suggest that this figure could increase to as much as $250bn in the next five years. This is not impossible, Christine Schmid, Global Head of Equity and Credit Research at Credit Suisse observes. "Projections are very difficult to do," she cautions. "But if robo-banking establishes itself, in particular, in the Asia and Pacific region, where the so-called middle class is expected to include up to 1.7 billion people by 2020 – up from 0.5bn in 2009 – then $250bn seems absolutely reachable."
Real Growth Will be Driven by Asia
The growth and distribution of private wealth will play an important role in the development of automated wealth investment services. A recent report by the Boston Consulting Group notes that of a $17.5 trillion increase in private wealth worldwide last year, 60 percent of this growth came from the Asia-Pacific region (excluding Japan). Real growth, for the next decade and beyond, is almost certain to be driven by Asia. But there is also the pertinent issue concerning the demographic most likely to adopt automated investment services. This population is likely to be technology-literate; to have reached financial maturity over the last decade, and thus alert to the impact of financial upheavals; and more likely to have been shut out of traditional wealth management services in the past, due to the combination of high access costs and management fees.
Millennials Have Learned the Lesson of Two Crashes
These are people like Alex, whom we met at the beginning of this piece. "We have found that this audience want a different type of investment service – one that is fully automated and transparent," Nash, from Wealthfront claims. This generation of investors would have had investment instincts shaped by the experience of growing up through two market crashes, and failures of regulation and investment propriety. "Millennials do not believe in the idea that their fortune will come from beating the market, They are looking for a service that is tax efficient and low cost to invest their money over the long run."
Schmid acknowledges the need to take into account the needs of a new generation of investors, like Alex. "The number of clients demanding cheap, simple banking solutions that adhere to the strictest cybersecurity rules to achieve long term investment goals is rising," she observes. Isn't this a threat to established wealth investment services? Not at all, Schmid says. "Established market participants can provide investment opportunities that new financial technology companies can't. Banks need to invest in technology and digital solutions."
An Opportunity For Clients – And Equally For Banking
Holger Spielberg, head of Digital Innovation at Credit Suisse, agrees, framing the development of automated investment services in positive terms – and not just for the banking sector. "At the end of the day, we need to look not at what it means for banking, but for the user – the recipient of financial services," he says. "We need to put them at the forefront."
Spielberg observes that the integration of technological advances, particularly in the domains of computer power, data transfer and data analytics have made this evolution in service provision inevitable. However aspects of the traditional wealth management services remain relevant, he argues, specifically human engagement. "The human element is a crucial aspect of our strategy," he notes. "What isn't changing, even with all the changes, is the intent in receiving value." And what automated service can do is to provide a personalised backbone to the existing framework. "What happens is that the customer becomes empowered; it shifts the balance to our side, and we as a bank must be much more personal as a result. Our experience, and technology, together, will allow the wealth management industry to enhance our services." Robo-advisers, indeed, are poised to change the face of wealth investment. But rather than creating a faceless and unresponsive automaton, they may very well add value and efficiency to private wealth management.