Robo-advisers are a great example of how automation is spreading like wildfire. But how safe and reliable are robo-advisers? Below Simon Bottle, COO of non-advised white label, FinchTech, talks to Finance Monthly about when and when not to trust a robo-adviser, giving some great context for investors.
The rise of robo-advisers should come as no surprise – the FSA created an environment for them to flourish post Retail Distribution Review (RDR) – but is robo-advice the right route to take? While these platforms are not brand new (with the introduction of bank robo and niche robo we’re in fact already in the ‘Robo 2.0’ phase) there are still concerns regarding their reliability and robustness. Investors need to assess the pros and cons carefully.
Reasons not to trust a robo-adviser
A potentially major issue with robo-advisers is their lack of uniformity. There is no standardised design or programming rulebook, which means that three different platforms might categorise the same investor with varying suitability levels: one platform’s cautious could be another’s adventurous. This could cause serious problems. If someone risk-averse is incorrectly categorised as an aggressive investor, they could lose a lot more than they can afford.
It all boils down to algorithmic definitions of risk. The FCA is paying attention, but regulation is still evolving.
Also, technology is impressive, but it is by no means fool-proof – take Long Term Capital Management (LTCM) as an example. Just two decades ago, this high-profile fund, built by economics Nobel prize winning founders and reliant on systematic and algorithmic analysis, failed amid much hype.
Financial algorithms have become more sophisticated over time but many are yet to demonstrate how well they can weather extreme and unexpected market events.
When you can trust a robo-adviser
The RDR left a gap in the financial advice market that robo-advice platforms could potentially fill. Consumers with smaller amounts, unable to afford IFA fees, now have a way to access advice and if the company that owns the robo defaults, the FSCS covers the first £50,000.
The most important question a retail investor needs to ask however, is not whether they can trust the robo, but whether they can trust themselves. If users are tempted by higher rates of return associated with a more adventurous portfolio selection, then they may be shocked when the market dips and their investment plummets with it. It’s imperative users don’t engineer responses. Their lack of experience means that often they don’t understand that the greater the risk, the more volatile the portfolio.
A ‘non-advised’ digital portfolio service that is managed by battle hardened humans, rather than a machine, presents potential investors with an alternative approach which goes some way to mitigate derailment by black swan events – however, risks are still involved. How far an investor chooses to stick their neck out is their prerogative.
Robo-advisers are advancing rapidly. A June 2017 report by FAMR states, “…there are approximately 100 ‘robo-models’ either already launched or in development across a broad spectrum of services”. As this new wave of robo-advisers gains ground, we’ll see niche platforms enter the market, that may be better suited to a retail investor’s demographic, beliefs and interests, or investment amount.
High street banks want their share of the pie too – ahead of plans to launch its very own robo-advice platform, NatWest unveiled a service earlier this year that allows its customers to access investment funds online through the bank. HSBC followed suit and now offers online investment advice for its customers with small savings pots.
However, the question remains, how do you get consumers to trust algorithms with their life savings? Even bigger ‘trusted’ players like UBS are struggling to find investors who are price sensitive enough to entrust investments to a cheaper robo (Juerg Zeltner, the head of UBS’s wealth management division exclaiming recently: “This is a big learning … the real question is how do you scale it to more?”).
The answer to this trust question has been marketing – advertise heavily and spend millions on promotion. This is fine for well-funded start-ups like Moneyfarm (who recently posted an operational loss of £6.4milliom, £2million of which went on marketing) as long as the capital investment tap isn’t turned off, but as more players, both big and small, enter the market, investment could flow away from established robo-advisers, towards new entrants instead.
Either way, increased competition will push margins down and likely make it cheaper for investors. Potentially a watershed moment worth waiting for if you’re looking for the best possible wealth management deal.