One Small Step – or is Robo-Advice a Paradigm Shift?
In 1962, Thomas Kuhn wrote The Structure of Scientific Revolution, and fathered, defined and popularized the concept of ‘paradigm shift’ arguing that scientific advancement is not evolutionary, but rather is a ‘series of peaceful interludes punctuated by intellectually violent revolutions’ when one conceptual world view is replaced by another.
A Paradigm Shift is a change from one way of thinking to another – from hunter gathering to farming; the invention of the printing press right up to the profound and transforming effect of the internet.
Evolution takes place over a very long period of time and Kuhn states that ‘awareness is prerequisite to all acceptable changes of theory’; revolution makes the existing model obsolete and that is what the next generation of robo-advisers is aiming to do in the asset management space.
In the UK the regulatory environment is adapting to facilitate the new breed of digital investment managers; the very definition of advice is being tempered to facilitate a two-tiered system with a clear distinction between personal recommendation and generic guidance.
Customer behaviours and expectations are changing and great strides in technology are driving the sector inexorably towards artificial intelligence.
Innovative, customer-focused, cost-efficient investment solutions are fast becoming the new industry norm.
‘Innovative, customer-focused, cost-efficient investment solutions are fast becoming the new industry norm’
The disruptors are challenging the status quo and turning traditional business models on their head, indicating that this could indeed represent a paradigm shift in the industry; there is a fascination in the media with the new breed of robo-advisers and VC and institutional investment has not proven difficult to come by in the States by those developing the proposition.
With so few able to access, or willing to pay for, financial advice in the UK, a key question is will innovative technology and algorithms make the human advisor obsolete, thereby truly representing a paradigm shift or will the technology be used to underpin the business model of a whole new generation of financial advisers?
Will, as originally suspected, robo-advice attract tech-savvy Millennials, or, as appears to be increasingly the case, deliver a siren call to more sophisticated baby-boomers attracted by low cost, readymade investment solutions?
With estimates for the number that have fallen into the ‘advice gap’ post-RDR ranging from ‘only’ 5m to anything up to 20m, these ‘orphaned’ clients, the auto enrolled or those that have yet to begin saving or investing should theoretically provide a happy hunting ground for the robos, but are they just too strapped with tuition fees and the cost of accommodation to even consider putting anything away?
Robo-advisers deliver an automated investment interface providing customers with easy access to financial markets at a fraction of the cost of both traditional advice and investing in actively managed mutual funds.
‘an automated investment interface providing customers with easy access to financial markets at a fraction of the cost’
The robo version of an IFA’s fact find is typically conducted via an online sign up process which gathers the individual’s personal details, gauges their financial understanding and their attitude to risk; quick and simple the process is often completed in less than ten minutes.
The results are then run through an algorithm based upon behavioural economics which assigns the user to an investment profile which aligns to a particular portfolio built up of a mix of assets weighted to their attitude to risk.
Within the current crop of advisers, portfolios are either an off-the-shelf model portfolio constructed, typically of passive exchange traded funds (ETF), around parameters of risk and return, or may be bespoke according to the individual investor.
As technology develops the advisers will be based upon genuine artificial intelligence, which is perhaps a prerequisite before the movement can genuinely be declared to have delivered a paradigm shift.
A key feature is that robo-advisers have a transparent fee structure with an annual management fee levied by the platform plus a management fee of between 0.15-0.30% payable on the ETFs they hold.
If customer demand is born of the necessity for a cost effective and accessible investment solution, technology enables many aspects of portfolio design and platform management – account creation, compliance, trade execution and reporting – to be automated, and thereby cheaper to operate and cheaper to the customer.
Most advisers include educational material on their site to ensure that their customers understand the basics of the markets in which they are invested and human contact is usually available if required; the robos concentrate on setting realistic expectations and ensuring that client remain comfortable with the level of risk they are exposed to, and understand the outcomes they are likely to achieve.
So, does robo-advice represent a paradigm shift in the wealth management business?
Well, without wishing to sit on the fence, and acknowledging that it’s not possible to be slightly pregnant, it has certainly made significant strides towards delivering a whole new way of doing things and if it cracks the challenge of engaging with a whole new generation of savers and investors, I think we’ll chalk that down as a yes.