RoboAdvisors - Offering low fees and dynamism

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Among the trending concepts around digital transformation, robo-advisors are and remain with blockchain, big data and artificial intelligence one of the hot and unmissable topics for 2018. Either by easing access and execution for investors, by providing them with a low-cost way to combine passive and active portfolio management or by being a new smart recommendations-wise side-kick to asset managers, robo-advisors are bringing game-changing digital services to the fund industry.

Although they are not yet the next gen financial advisor, they provide however a good opportunity for introducing investment robots to the general public and to help collecting some additional AUM. Human contact and trust are fortunately still praised and valuable assets. But the beginning of the new era has already seen the launch of a bunch of financial services.

The obvious question raising here is: what is at stake? Who are the main players on the market? How can an offer be structured? Let’s find out.

Robo Advising: in the middle range of the active passive mix

Whether or not passive investment strategy is earning better net returns than active investment is a vast and delicate debate. Nevertheless, passive management has gained a lot of momentum over the past decade, being by the end of 2016 worth only 4 times less than actively managed funds (20% of total AuM) when it used to be 8.5 times thinner in 2007 (9.4% of total AuM) 1. Indeed, according to Morningstar, passive AuM globally reached 6T$ by the end of 2016 VS 24T$ for active management. Passively managed has grown by 240% when active grew “only” by 54% between 2006 and 2017. This trend is even steeper for equity funds, especially in the US and in Asia (between 40 and 45% assets in passive funds end of 2016). In Europe the growth slope in terms of proportions is less steep but passive management also gained some market shares, growing from 11% to 25.2% of total AuM. According to Moody’s2, passive management should keep rising globally, even bypassing 50% of total AuM in US equity in the next 4 to 7 years.

Even if this trend could be slowing down over the coming years, the reason relies mainly in the management fees. Given the costs and fees of active management, it has become increasingly difficult to consistently beat ones benchmark in the aftermath of the financial crisis, according to a recent S&P study3 (see also Ignoring Fees Doesn’t Beat the Market by Preston McSwain4). With more and more asset managers launching their robo-advisors based products and services, clients are starting to realize that robo-advisors can bring the dynamism of an actively managed portfolio while still keeping the costs, and thus the fees, quite low. Indeed, when actively managed portfolios charge 150 bps in average, index funds annual expenses can be as low as 3bps (State Street’s Broad Market Index (SPTM) ETF), with an average of 53 bps5.

 Source: Initio based on Researcher Cerulli Associates and S&P Market Intelligence

Source: Initio based on Researcher Cerulli Associates and S&P Market Intelligence

Robo-advised funds propose an intermediary but seducing management fees rate between 25 and 100 bps, positioning themselves as a “game changer”, starting to reshape the future of the fund industry, keeping the costs low while proposing a more dynamic and reactive allocation than pure indexing. They should benefit from the global trend towards passive management in this low fee chasing environment. This may explain why the robo-advised funds, estimated at $80 billion at the end of 2016, are projected to grow annually at a consistent rate of 37% over the following five years (x 4.8 over 5 years) to reach $385 billion, according to Researcher Cerulli Associates6. S&P Market Intelligence7 estimates it will grow from $143.94 billion in 2017 to $460.46 billion at the end of 2021 (33% annual growth over the next 4 years). Robo-advising is thus bringing a new range in the middle of the active-to-passive scale. Even though their market share in terms of AuM still remains relatively pretty low, they are at the crossing of several powerful trends, thus enabling the strong growth forecasts mentioned above over the coming years.

A market led by the US

The largest robo-advised funds are located in the US, not surprising since American companies were among the first ones to launch their offers. It’s indeed been several years Vanguard, Charles Schwab and Betterment have launched their robo-advised funds, reaching respectively the impressive AuM of 52, 42.7 and 7 $billions by the end of 2016. After having acquired FutureAdvisor in 2015, Blackrock also kept investing in robo-advising by funding the London and Munich based Scalable Capital in June 2017. Bank of America entered the dance back in February 2017 when they launched what they call “Merrill Edge Guided Investing”, a robo-human-hybrid service based on 10 portfolios and relying on 2,000 advisors network. The most recent players that have launched their automated investor services over the US were Wells Fargo and Morgan Stanley respectively in November and December 2017.

 Source: Companies websites and Moody’s Investors Service for the AuM

Source: Companies websites and Moody’s Investors Service for the AuM

2 ways to use a robo advisor

We saw on the market basically 2 ways to implement a B2C (Business-to-Client) robo-advisor:

  1. as full auto-rebalancing-robot given the risk profile (potentially with committee validation) or

  2. as an allocation-advisor for advanced investors (or portfolio managers in B2B (Business-to-Business)).

The first and seemingly dominant model is to offer a robo-advised fund, meaning that once the risk profile of the investor has been digitally assessed, an allocation is suggested and the portfolio is in “auto-pilot” mode with robotized rebalancing depending on market conditions, which are sometimes validated by an internal committee. The investors’ actions and interventions are hence very limited. These models often rely on ETFs in order to maximize diversification while keeping transactions costs quite low. This is the 100% digital robo-advisor mode. As Investify would propose, this model can also offer several options to the investor: indeed she/he can choose among several “themes” to customise her/his own portfolio with special investments, for instance “aging population”, “gold”, “dividends kings”, “gaming world”, “water”... This model is similar the one offered by Birdee from Gambit.

The second model is to offer the robo-advisor as a complementary tool for helping investors in their choice to select the best suited investments. An example of this implementation type would be the Anlage Finder proposed for free by Deutsche Bank on their Maxblue online investment platform. This is also another adaptation of Gambit’s algorithm which they package under the brand Squiree. The robo-advisor then acts as an intermediary, between the client and the financial advisor, to help on one hand the customer reach his/her objectives and on the other hand the advisor improve his/her suggestions.

Beyond B2C, this type of robo-human hybrid implementation is also possible to provide portfolio managers in their day to day work with Artificial Intelligence (AI) and machine learning based tools. This kind of digitally augmented way of working might provide some additional insights as well as help improving efficiency and risk/return ratios.

It is worth noticing that Investify is based at Belval’s Technoport (Esch-sur-Alzette, Luxembourg) and that Gambit, as a 10 years old start up created at the Liege University Management School, also has a local branch in Luxembourg. Interestingly, back in September 2017 Gambit announced that BNP Paribas Asset management acquired a majority stake in their company.

Local Players: Keytrade Bank as a trend leader in Benelux

As an example of how a robo-advised fund may be structured, let’s take a look at Keytrade’s Keyprivate service which relies on Birdee by Gambit. It was launched beginning 2016 in Belgium and in April 2017 in Luxembourg. They are the first to launch such a service in Luxembourg (while Investify is the first personalised and entirely digital asset management service, launched in December 2016).

Basically, within the app or on the website, the robot digitally assesses the investor’s risk profile and ranks him/her within 10 different types of profiles. Given this ability and willingness to take risk assertion, the robo-advisor will suggest a portfolio that will be rebalanced on a monthly basis according to given the market conditions. The robo-suggestions optimize the risk/return of the portfolio allocation choosing amongst 4 asset classes (Monetary, Equity, Bonds and Commodities) by using a range of 12 trackers structured by Amundi or BlackRock. These rebalancing proposals are then monitored and validated by an investment committee of 6 portfolio management experts. This way of diversification is optimal while maintaining transaction costs quite low. Of course track record isn’t long enough to be able to compare yet, but the investors’ net returns resulting from this strategy seem to be quite competitive.

Conclusion: a Brave New World

The shape of the financial industry has remarkably evolved over the past few years. And it will keep moving towards a more digitalized way of operating while drastically changing the costs structure, the fees models and the relationships with clients.

After the 1st wave switching to computers, then passing on to the network and communications progress through internet, now the 3rd wave of technological revolution is going to impact deeply (and thoroughly) the investment profession and beyond, our way of living and working. Human contact is still praised and valued but the job of portfolio manager will keep changing, relying more and more on surrounding robots and technology. Client relationships will also keep evolving towards more and more digital interface. In some “neobanks”, chatbots have an impressive answer rate to the customers’ queries (ex: Revolut has a 27% answer rate). Many market players have promptly understood that their interest relies in moving first to reach and propose a leading edge technology.

But some more old-fashioned players appear to be still reluctant to join a trend that might look somewhat risky, given the investment it demands though presenting both operational cost cutting and marketing benefits. Combining AI, Big Data and specific operational bots like chatbots, the results can be explosive and surprisingly reliable. When we look at what Watson by IBM is capable of, it is hard to think this is not going to inspire and shape some of our choices in the coming years. Interesting period to live in, where yesterday’s sci-fi is turning into reality. Life may be easier tapping and swiping over a smartphone rather than talking to someone, but - at the same time - would life have the same flavor without human interactions? “If knowledge can create problems, it is not through ignorance that we can solve them.” Isaac Asimov

About the Authors

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Lucas Bruni,  +20 years of diversified experience in various sectors of the Fund & Asset Management world. Luca initially spent more than 10 years on the operational side of the investment fund industry working for companies such as Templeton, Schroders and RBC Dexia – then 10 years in the advisory world focusing on several key areas such as Client management, People management, Business development / product development... 

Luca is an expert on Italian and Swiss markets and joined Initio as Senior Manager in 2017.

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Frederic Lorain. Specialized in Banking and Financial Markets, Frederic’s 3.5 years experience had him build a good knowledge of the operational issues. He worked on several development projects providing increased automation, improved risk management and more effective control over operations. He passed all three levels of the CFA Program and may be awarded the charter upon completion of the required work experience . His experience as a business owner gave him confidence in implementing functional and operational solutions.

Sources

  1. Morningstar Research, 6 March 2017 2016 Global Asset Flows Report, Alina Lamy and Timothy Strauts

  2. Moody's: Passive investing to overtake active in just four to seven years in US; global traction to pick up Global Credit Research - 02 Feb 2017

  3. SPIVA® U.S. Scorecard: Mid-Year 2017, https://www.spglobal.com/our-insights/SPIVA-US-Scorecard-Mid-Year-2017.html, Aye Soe and Ryan Poirier, September 21, 2017

  4. https://blogs.cfainstitute.org/investor/2017/08/21/ignoring-fees-doesnt-beat-the-market/

  5. MorningStar Direct Asset Flows

  6. “Retail Direct Firms and Digital Advice Providers 2015: Addressing Millennials, the Mass Market, and Robo Advice.” Cerulli Associates

  7. S&P Market Intelligence study quoted in Robo Advisors’ AUM Expected to Hit Nearly $145 Billion in 2017, September 5, 2017