Robo advice—soon to be a standard offering of financial service providers? Wealth management of the future

The robo advice PROCESS

As lost customer trust, a dazzling variety of investment products and the trend towards self-service via apps are setting new standards not just in online banking and online brokerage, but also in asset management, we would like to take another look at the robo advice trend. The term is used to describe digital asset management, and current developments show that this will in future be part of the standard offering of financial service providers

Figure 1: The robo advice process

With robo advice, the customer is taken through a fully automated investment advisory process via an app or on the web page of the provider. It always starts with the entry of customer data resulting in a risk classification of the customer by means of a simple if-then logic. According to WpHG, the German Securities Trading Act, there are five risk classes which differ mainly in terms of financial instruments. In order to determine the appropriate risk class for customers, they first have to answer various questions about their investment objective and horizon, their investment experience to date regarding investment classes and their financial situation. Technically, robo advisors are designed in such a way that there are standard answers to the various questions for which an if-then logic is implemented so that the different combinations of customer answers can be aggregated into one of five risk profiles. Each risk profile is linked to a standardized investment proposal which consists of a strategic asset allocation (SAA) and of the financial instruments that turn the SAA into actual investments. These instruments range from one investment fund per risk profile to several investment funds or ETFs per asset class and even to individual securities. This process is visualized for the customer in a simulation with an SAA overview, various risk/return indicators and a simulation of the future development of the proposed investment. A purchase button concludes the selection process. What follows now depends on the provider, as the customer needs a securities account to hold the financial instruments purchased and a corresponding settlement account which is debited with the amount invested. The providers therefore either need to have their own banking structure in the background or use independent banks that are not connected to their company. If the customer has any questions during the fully automated process starting from entering their data through to opening an account, they can contact the provider by phone or via chat.

Once the investment proposal is bought and deposited into customer’s securities account, it once again depends on the provider whether there is any active support during the investment term. If the customer has bought an actively managed investment fund for example, the active monitoring and re-balancing, i.e. the recovery of the original SAA after market fluctuations, are performed on an ongoing basis within the investment fund. If the customer went for instance for an ETF provider without active re-balancing, its original selection will simply follow market movements and it is up to the customer’s own due diligence to make any adjustments.

The costs of a robo advisor vary considerably depending on the provider. Fundamentally, they consist of three components: the fund costs, the costs of the robo advisor itself and the costs of the securities account that holds the financial instruments. Fund costs generally range between 0–1% p.a. of the investment volume depending on whether ETFs or actively managed investment funds have been selected. The costs of the robo advisor are usually between 0–1% p.a. of the investment volume depending on its business model and the service offered during the investment term. The costs of the securities account can either be tied to individual transactions or charged as a fixed fee. This should however not be higher than 0.5% p.a. of the investment volume.

Overview of robo advice providers

The pioneers of robo advice are based in the US and are called Betterment (*2008, AUM of approx. USD 4 bn) and wealthfront (*2008, AUM of approx. USD 3 bn). Meanwhile, all global players in asset management have added a robo advisor to their distribution channels. Here is a list of just a few of these: Goldman Sachs and Motifinvesting, Aberdeen and Pamenion, Vanguard and Personal Advisor Service, Schroders and nutmeg, Black Rock and Personal Capital as well as Future Advisor, JPMorganChase and Betterment, Fidelity and LearnVest. In the German market, there are a number of Fintech companies such as Cashboard, easyfolio, vaamo, quiroin and scalable, but some of the large banks have also already discovered robo advice for themselves. In this context, the Commerzbank with its direct banking subsidiary comdirect and Deutsche Bank should be mentioned. Large banks are using robo advice as a tool in online brokerage in order to offer their customers a supported selection process for investment products.

A comparison of the various providers shows that they have one thing in common: in the guise of digital robo advice, investment advice becomes a convenient shopping experience via an app or a web page for which the customers do not even have to leave their own sofas. Of course, there is the danger for the customer that market risks during the investment term are not fully understood during the investment “shopping” process, but there is also the danger for asset management providers who do not offer robo advice that they might seem “past it” to customers. Especially in the younger customer segment, mobile functionalities such as online banking, online brokerage and corresponding tools like online investment finders, in other words robo advisors, are standard demands today. Moreover, the expected growth rates show considerable potential for the acquisition of new customers.

Robo advice as a digital sales instrument thus offers an attractive, growth and margin-oriented opportunity for asset managers and banks to position themselves as a modern company with a transparent cost structure and an asset management that takes note of customer demands.

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