Roboadvice: Different strokes

It's fashionable to be enthralled by the glamour of financial technology, or ‘fintech', and in particular, ‘roboadvice'. It's the cheap disrupter, replacing those nasty and expensive financial advisers. Easy to access via the dynamic home page, it's the investment solution for millions who would never pay to see an adviser.

The recent announcements by Macquarie, BT and National Australia Bank have taken roboadvice out of the realm of the startups struggling for resources, to the mainstream where IT budgets run into billions.

How much of it is form over substance, more about the presentation, the so-called “customer experience”, than it is about offering appropriate advice and a good investment outcome?

It will improve over time, but it's not there yet

Speculating about whether roboadvice will attract money and fill the role of financial advisers is like cogitating about driverless cars. There seems obvious potential, but neither the technology nor the public is ready. Most new technologies start that way though, with incumbents failing to see the full potential - then Amazon destroys Borders, Netflix kills Blockbuster and Kodak ignores its own invention, the digital camera.

The definition of roboadvice is evolving, covering automated financial advice with some formulaic investment solution. In most cases, it works by the customer answering questions online, usually about risk appetite, age, income and assets, and rules are applied to find the optimal allocation of investments. It aims to fill the gap between what the public is willing to pay for financial advice (not much) and what full professional services cost (a lot).

A software developer recently told me he has a list of 41 roboadvice businesses in Australia either in the market or under development. Globally, companies like Wealthfront, Betterment and Nutmeg have raised hundreds of millions of venture capital dollars, and major businesses like Charles Schwab, Vanguard and Fidelity are already in the market.

Two different business models called ‘roboadvice'

While there will be an unlimited variety of robo offerings, it's important to distinguish between the two main emerging types:

1. The ‘Business-to-Consumer' (B2C) robo, which takes the client all the way from risk profiling through an ‘algorithm' to an investment outcome, invariably leading to an asset allocation among different Exchange Traded Funds (ETFs) to reduce the cost. The robo's revenue comes from an advice or subscription fee, or a percentage of assets under management following an investment.
2. The ‘Business-to-Business' (B2B) robo, where an existing superannuation fund offers an online planning tool, a type of retirement outcomes forecaster that simulates a range of retirement incomes based on different market conditions, savings patterns and time horizons. The robo's revenue comes from a licence or usage fee paid by the superannuation fund, or the fund may take equity or own the robo.

Neither presents a serious threat to full service financial advisers at the moment. Roboadvice cannot handle complex issues like estate planning; social security impacts or selecting aged care facilities. At best, it is limited advice for the masses, the 80 per cent of people who don't see an adviser.

The B2B tools are useful for member engagement to help people think better about their future super balances. A member who believes $500,000 will fund 30 years in retirement may not bother putting more into super until they realise it will not last their life expectancy with an acceptable living standard. Further enhancements will provide ‘whole of wealth' outcomes, not limited to superannuation.

Regulator focus on the investment outcomes

It is the B2C robos that will come under greater scrutiny from regulators. They face the added complication of recommending and implementing an actual portfolio as part of a product sale, not simply hypothesising about what might happen a few decades hence. This requires a compliant auto-generated Statement of Advice and a tougher test of whether the recommendation is really right for the client, often based on flimsy profiling.

While the industry regulator, ASIC, is keen to engage with this new digital world, it will not be doing any favours to the upstarts. Louise Macaulay, ASIC's Senior Executive Leader in the financial services team, told the recent Financial Planning Association (FPA) Conference:

“Our view is that the legislation is tech neutral. The same standards will apply whether it's technology-based advice, or face to face … They (roboadvisers) need to make sure that clients understand what they are buying; and that they are not just clicking from one screen to another.”

Although the B2C roboadvisers claim to be offering personal advice, the simple questions currently generate only superficial information resulting in standardised asset allocations. Some robos ask only a few basic questions about risk appetite, time horizon and capacity for loss.

Louise Macaulay went on to say: “The sector needs to improve the compliance and record keeping. There is also the potential for large scale loss if there is a flaw in the algorithm.”

In May 2015, the United States' Securities and Exchange Commission (SEC) issued a caution about roboadvice:

“An automated investment tool may not assess all of your particular circumstances, such as your age, financial situation and needs, investment experience, other holdings, tax situation, willingness to risk losing your investment money for potentially higher investment returns, time horizon for investing, need for cash, and investment goals. Consequently, some tools may suggest investments (including asset-allocation models) that may not be right for you.”

The robo investment experience

I completed the online application process of an Australian roboadviser, expecting a growth-oriented portfolio based on my responses. It allocated for me 44 per cent into Australian government bonds, 10 per cent into gold and 11 per cent in emerging markets equities. That is 65 per cent allocated to nothing I actually want, such as Australian shares, developed country shares, corporate bonds and property. Anyone given such a portfolio should carefully scrutinise whether it is right for them - especially when government bond ETFs yield less than 2 per cent.

And the total cost on a $20,000 investment with this low cost disrupter'? It was 1.6 per cent per annum, including management fee, administration fee and investment fee, far more than the standard MySuper fund from retail and industry fund incumbents of below 1 per cent.

Gaining a consumer foothold will be tough

Most startups without links to existing clients will not succeed in their own right in gaining a strong enough investor base. The cost of acquiring customers will be too great and the competition at low or no margins will become intense from the big names. Many startups will turn into B2B players and sell out to large impatient retail or superannuation funds who want the intellectual property and a few smart resources on the team.

It's only a matter of time before more large wealth players use robo to transition customers to their more complete services. Global names like Charles Schwab have no existing Australian business to cannibalise, and a company like Blackrock can drive demand for its ETFs. Expect these companies to have sophisticated offers at price points no new startup can match.

As a result of the moves into roboadvice, consumers who currently receive no financial advice will benefit. With sophisticated graphics and informative modelling of outcomes, robo offers will increase in sophistication and attract thousands who would never visit a financial adviser. Roboadvice will gradually improve in ways we can only speculate on, much like we could not foresee the extraordinary ways other technologies have changed our lives.

And the full service, personal adviser? Many will embrace robo to service the disengaged or less wealthy, and there will always be a role for person-to-person contact. Regardless of how good the website is, it will never put an arm around the worried investor and explain market events with an intimate knowledge of the client's experience, entire background and goals.

Graham Hand is Editor of Cuffelinks.