Dawn of the roboadvisers

After the well-documented problems in the Australian financial planning industry in recent years, it's no wonder a new crop of startups are trying to offer a solution known as roboadvice. The companies generally allow investors to complete an online questionnaire that determines their risk profile and investible assets, before suggesting an appropriate portfolio of exchange-traded funds. But this process raises questions over whether a computer can replace the work of a human, or how the two can work together.

Roboadvice businesses have been growing fast in the US and their assets are expected to explode in coming years. A recent Wall Street Journal story estimated that pioneers of the industry, Wealthfront and Betterment, already manage around $US3 billion each, and that roboadvisers could manage $US5 trillion to $US7trn within a decade.

The companies are often seen as an appealing option for younger investors with a long-term focus who feel comfortable accessing financial services online but suspicious of the promises of active managers to outperform the market.

But for investors who are closer to retirement or retired, or for active investors who like to be in control of their portfolios, it's still worthwhile understanding this trend.

What's in a name?

The term roboadvice itself is misleading, CoreData principal Andrew Inwood says, as there are no robots and no advisers. He says the term is used to describe web-based, self-directed, technology-driven investment innovation that uses simple algorithms to allocate risk-based portfolios to investors for a low cost.

Roboadvisers already operating in Australia include Stockspot, InvestSmart, Ignition Wealth and QuietGrowth, with Clover expecting to launch in mid-2016. Of course, Eureka Report's super fund and platform brightday is also active in this space.

Comparing humans and robots

As automation eliminates jobs around the world – consider the manufacturing industry or the advent of driverless cars – the relative strengths of humans and robots could become more apparent. Robots (or algorithms) can often perform set, repetitive tasks with a low error rate, allowing them to gain scale. But humans are often better at creative problem solving and emotional labour such as showing empathy.

By contrast, there are some situations where human emotions can have an adverse impact and a dispassionate robot can make a better decision.

For self-directed investors, a roboadvice model can help with bringing some discipline to the investing process, State Street Global Advisors head of exchange traded funds in Australia Amanda Skelly points out. Most roboadvice platforms will automatically rebalance an investor's portfolio when it strays too far from the initial allocation, such as when equity markets fall and the portfolio's equity allocation shrinks as a proportion of the whole. The platform can then sell some of the now-overweight fixed interest allocation, for example, and use the proceeds to buy more equities while they are cheaper.

Skelly says this year's volatility is likely to continue into next year: “Things are going to go up and down like crazy and there's an opportunity for people to act adversely. If people do nothing when they should do something – or act too quickly and sell positions – a roboadvice platform helps remove that.”

But Skelly points out that there is as yet no replacement for a human financial adviser when it comes to supporting an investor through an emotional event such as the death of a partner. Indeed, many of the roboadvice businesses themselves emphasise that they are not offering estate planning or tax planning services, while others will direct clients to a human adviser if they need assistance with these issues.

Democratising advice

At Eureka Report, we have encouraged investors to get good financial advice – that is, from a reputable adviser who isn't aligned with one of the big four banks and who charges a fee for their services instead of taking commissions from financial products sold. The cost of good advice, as well as the much-publicised cases of inappropriate advice at big banks in the past, discourage many investors from seeking advice.

Many in the roboadvice industry see it as a way of opening up advice, at least on asset allocation, to clients with more modest investible assets who are not well served by human financial advisers. They also point out that good financial advisers should not feel threatened by the advent of roboadvice, but should instead consider using such a platform to serve lower-balance clients more efficiently, freeing them up to focus on helping clients with more complex issues.

Startup roboadviser Clover's chief executive and co-founder Harry Chemay, who previously worked as a financial planner, has found that the age range where investors often have the most complex affairs is in the 40s and 50s. Issues under consideration at that age can include educating children, saving enough for retirement and possibly setting up a self-managed super fund. Young investors often have simpler affairs. And in many cases once clients retired, he found their affairs became simpler as well, as their tax situation was less complicated and they had already set aside enough assets to live on. “Roboadvice works best for young and older clients,” Chemay says. But when life is complicated, “that's where a good adviser could show their value add”.

Staying in control

Some self-directed investors may dislike the idea of buying exchange-traded funds, which usually offer access to a basket of shares tracking a particular index. ETFs offer a low-fee way to replicate market performance but don't allow investors to separate good stocks from poor performers. If an investor prefers to select individual stocks, the idea of buying a portfolio of ETFs suggested by an algorithm is unappealing.

ETFs are also a comparatively new investment product and are not without issues of execution. During the share market correction in August this year, a range of large ETFs listed in the US fell much further than the markets they were supposed to track closely (see The great ETF debacle explained, September 16).

Other investors may be willing to use ETFs, or a portfolio of ETFs, as part of their broader asset allocation strategy. Stockspot chief executive Chris Brycki, a former UBS portfolio manager, says “a good portion” of his customers are SMSF clients. “There are a lot of SMSFs who haven't set up an SMSF because they want to be picking stocks. Often it's for other reasons like structuring or tax,” he says. “Often the first time we interact with an SMSF is when they're looking to outsource the portfolio.”

InvestSmart executive chairman, ipac co-founder and personal finance commentator Paul Clitheroe takes the unexpected view that a roboadviser can help put an investor in control, rather than taking control away. His platform offers users the ability to answer questions about their risk profile and current investments, then compare their actual asset allocation with the algorithm's suggested asset allocation. “I can see where I'm weak in my DIY super and where I'm strong,” he says, adding that the suggested portfolio can be used as a guide to tilt an existing asset allocation. “If you're underweight international investments and you want to do something about it, you can see your broker, or use Eureka, or use InvestSmart.”

Clitheroe adds that even if investors use roboadvice platforms as a free guide, the platforms will need investors to pay at some point in order to be sustainable. But consider the difference between this model and a human financial adviser. “Someone coming to play with your technology can do it for no cost,” he says. “If someone comes in for my ipac adviser, it's $300 an hour.”

Fees, fees, fees

Although roboadvice is described as a low-cost service, fees vary widely in Australia. CoreData's Inwood points out that some automated investing services in the US have driven costs down as low as 15 basis points. “In the minds of the consumer, that's essentially free,” he says. But some services in Australia charge a flat fee, which works out to a higher percentage of a smaller balance than a larger one.

For example, Ignition Wealth allows a minimum investment of $5000 but charges a monthly account fee that works out to $198 per year – some 3.96 per cent of $5000. Of course, this percentage falls as the balance invested rises. Stockspot charges a flat advice fee of $77 per year plus a percentage-based management fee that falls as assets rise (both waived for new clients investing $10,000 or less).

Equipsuper has invested in the Clover platform and plans to make an Equipsuper tool powered by Clover available to members at no cost for money already in super. “Ultimately we need to provide advice to our members and for us to provide advice to 52,000 members we need to have an automated service,” Equipsuper chief executive Danielle Press says. “There are not enough planners for me to reach out to every member.”

Competitive pressures and increases in scale could see fee structures change in future. In the meantime, as always, costs are not the only issue to consider before investing. QuietGrowth also offers the first $10,000 of investments for no fee, then charges a monthly fee on higher balances. But prospective investors may be interested to know that the QuietGrowth platform does not yet allow investors to withdraw distributions as cash. Any dividends received are automatically reinvested in the portfolio and the way clients can withdraw income is by selling some of the investments.

Personal or general advice

Many of the Australian roboadvisers' websites have similarities in the design. They offer a questionnaire that judges investors' risk tolerance before displaying a pie chart with a suggested asset allocation. But not all of them are offering the same type of advice: some offer personal advice, others general advice. Of course, personal advice exists where the person giving the advice has considered one or more of the client's objectives, financial situation and needs.

InvestSmart has a relatively short questionnaire and offers general advice. Clitheroe says that if an investor came to his other business, ipac, to seek personal advice specific to their own situation, the adviser would have to spend several hours understanding everything about them, before providing a statement of advice and charging around $4000 in fees.

Meanwhile, some roboadvisers are offering personal advice, or at least scaled personal advice, that takes into account a specific part of an investor's personal situation. Brycki's Stockspot offers personal advice: “Every year we make clients come back to the website and fill in that information and we provide a new statement of advice and new recommendations,” he says.

Ignition Wealth also offers personal advice, and features one of the more comprehensive questionnaires in the market, with questions such as “What kind of positive investment experience have you had in the past?” and separately, multiple-choice answers such as “I can handle minor losses in value in the short term (less than three years) as long as the returns achieved are moderate to good over the long term (eight to 10 years).” Ignition Wealth chief executive Mark Fordree says education is critical in helping customers understand concepts such as diversification and volatility. “There's a lot of mum and dad investors who might have $50,000 or $100,000 to invest who might not have come across these different factors through their careers,” he says.

Corporate regulator the Australian Securities and Investments Commission has established an internal taskforce to examine issues in roboadvice. Chairman Greg Medcraft told a business lunch last month that ASIC was “very supportive” of the automated provision of advice, given its potential to offer a low-cost service and reduce conflicts of interest. But he pointed out that the same laws apply for giving advice in person and digitally.

Watch this space

The automated investing industry in Australia is very new, with a number of operators only having launched in the past few months. QuietGrowth chief executive Dilip Sankarreddy draws parallels with other technological innovations – 15 years ago journalists might have been asking if a traveller should stick with a human travel agent instead of trusting a website. “Now the default way is booking on a website and you don't speak to any humans,” he says.

“There are so many roboadvisers, the algorithms they have might not be identical, some might be better quality than the rest. The best one will eventually emerge – it happened with search.”

InvestSmart's Clitheroe expects the space to expand and change quickly over the next few years. “You are looking at the steam engine version,” he says. “In two years' time this industry will be unrecognisable compared to what you see now. It's going to get buckets better.”

He's also considered the value of roboadvice over the longer term: “I'm 60 and the big challenge for me or anyone like me is, in 20 years' time, what is my confidence going to be to run my own super fund?”