The rise of robo-advisors has caused heartburn among the world's wealth managers and what is the best approach to adopt in facing up to this trend?

Simone Westerhuis, head of wealth management at Lesmoir Gordon & Boyle, a wealth manager/investment bank that operates out of London’s Mayfair district. The author considers the most effective way for established firms to handle the challenge of robo-advisor firms. The views of the author aren’t necessarily shared by the editors of this publication but they welcome such contributions to debate and invite responses. Email tom.burroughes@wealthbriefing.com

Over the past few years, online investment companies – also known as robo-advisors – have threatened to take the wealth management sector by storm. By providing digital financial advice based on increasingly sophisticated algorithms with minimal human intervention, these low-cost online services are tapping into a generational change. Tech-savvy millennials have demonstrated an appetite for self-directed investment, and a determination to ensure that fees eat into their investment returns as little as possible. 

Yet the ascent of robo-advisors has not been seamless. Disruptors have struggled to attain profitability, and cracks have appeared in their appeal. There is growing evidence that the future of wealth management is one where algorithms will not replace humans but rather augment them. But to realise this future, wealth managers should seize the opportunity to work alongside robo-advisors and harness their capabilities, rather than simply viewing them as a threat. Below, Simone Westerhuis, MD of LGB Investment Management, examines why co-operation, rather than competition, could be the best route forward.

The pace at which online investment companies have upended the wealth management industry has been remarkable. Just a decade ago robo-advisors barely made a dent on the sector; yet from 2015 to 2016, their worldwide users almost doubled from 2.8 million to 5.7 million, while their assets under management surged from $66 billion to $126 billion, according to figures by Statistica. Many projections indicate that this growth has little chance of abating. For example, BI Intelligence forecasts that robo-advisors will hit AuM of $1 trillion by the end of the decade, and around $4.6 trillion by 2022.

The reasons for this are not difficult to comprehend. For millennials in particular, many of whom are already accustomed to exclusively managing their finances online and through mobile apps, the trend seems only natural. Robo-advice is accessible from multiple devices, has very low minimum investment thresholds, and typically charges fees considerably lower than more traditional human advice, while often offering comparable returns on investment. 

Yet the story is not one of unmitigated success. For example, while they have grown prodigiously in users, the world’s most well-known robo-advisors - such as Betterment in the US, and Nutmeg and Moneyfarm in Europe - have had difficulty turning a profit. Meanwhile, analysists warn that many of their smaller competitors will struggle to reach a size where they can achieve economies of scale.
Then there is the critical issue of trust. It is widely acknowledged that a growing number of customers - including high net worth individuals - are becoming more comfortable letting algorithms play a part in their investment-making decisions. However deferring entirely to machines may be another matter entirely. 

According to a recent survey by the Financial Planning Association and Investopedia, investors want a ‘bionic’ financial advisor - one that pairs a low-fee, automated investing platform with patient and personalised advice. Strikingly, 40 per cent of respondents noted that they would be uncomfortable using automated investing services during periods of extreme market volatility. This reluctance could be especially prominent among individuals who have greater sums of money to invest. A recent survey of 1,000 people with more than £50,000 to invest by Minerva Lending found that just 12 per cent would trust a robo-adviser to make investment decisions on their behalf – compared with 72 per cent who would trust an independent financial advisor.

Studies such as these suggest that while robo-advisors do seem certain to remain a permanent and prominent feature of the wealth management landscape, it is far from inevitable that they will simply replace traditional advisors. Rather, a hybrid system could be the most likely outcome.

But to ensure they remain relevant, wealth managers need to recognise the extent to which their industry is changing and incorporate automated investment platforms into their business models rather than simply resisting them. 

It is beyond dispute that the wealth management profession has become more data driven over recent years, as the volume of information exceeds the processing capacity of individual fund managers and investment committees. It therefore suggests that wealth managers could be best served by utilising robo-managers in relatively commoditised sectors, and when investment amounts do not justify additional human resources. 

Wealth managers can then allocate their time and effort to uncommodified sectors, in which human insight and experience add more value. Examples of such sectors include growth company shares where there is little performance history, as well as sub-investment grade corporate debt where the ability of management to achieve different objectives is far more important than a simple analysis of balance sheet ratios.

It is also important to recognise that although robo-advisors can provide similar returns to human wealth managers in many situations, they cannot understand the more idiosyncratic aspects of their customers’ financial lives and investment goals. Human advisors are set apart by the customised advice they can provide and the adeptness at which they can react to changing circumstances in their customers’ lives. 

They will build trust with their clients through long term relationships, care and service. Therefore, while robo-advice may be best for a young investor looking to invest incrementally over time, the added service provided by humans is often vital for older investors with larger portfolios and more complex considerations such as estate and retirement planning.

The importance of the human touch has been recognised throughout, including by Betterment – the US-based robo-advisor with around $17 billion in assets. Earlier this year, the previously digital-only platform announced it would offer access to human financial advisors. It tiered its fees according to the level of service required: a 0.4 per cent fee for customers who wanted an annual call with a certified financial planner, and a 0.5 per cent fee for unlimited access to financial advisors. 

For their part, traditional wealth managers should also consider embracing the incorporation of Big Data and innovation into their business models, to understand their clients better and improve their service. Big Data and predictive analytics can not only improve efficiency in client onboarding, compliance and asset allocation strategies, but also allow for automatic adjustments of portfolios when there are changes in the environment. 

The crucial point here is that it is by no means inevitable that robo-advice will subsume the wealth management industry, but nor will it retreat from its position as an integral part of that industry. Wealth managers who choose to harness the technology and ally themselves with it - who co-operate, rather than compete - can marry the low cost, transparency, and accessibility of robo-advisors with the customisability and security assured only by a human touch.