5 Questions Most Advisors Aren’t Asking When Selecting a Robo

As debates about robo-advisors continue to rage on, it’s hard not to flash back to similar stages for innovations that transformed other industries or daily life. For example, there was a time when social media was viewed as a fad. While some of the early entrants in this space lacked longevity (MySpace comes to mind), their breakthrough innovation paved the way for other services such as Facebook and Twitter, companies that have amassed broad adoption.

Was it critical to embrace first-generation social media services? Clearly not, but these first-generation services gave consumers a taste of what’s possible in the digital world and offered various lessons for future providers to consider. And has social media replaced in-person interactions when building relationships? Generally not, especially for the more important relationships in one’s life.

Advisors and financial institutions should keep these things in mind as they monitor and research the robo space. Given the assets robo-advisors have gathered to date and the rate of growth most are experiencing, it is only prudent to be considering a robo strategy. Even if fully automated advice isn’t appropriate for your clients or your practice, technology can augment your client relationships and improve your margins. Exactly what to do inevitably will vary by firm, and it’s important not to rush to market with something that may not be right for your clients or practice. The challenge and the opportunity for advisors is to think about how to best meet the current and future investment needs of your clients and how to scale your business without decreasing client service or increasing operational risk. In our experience, here are five critical questions that advisors should consider as they develop a robo strategy.

1.  What is your value proposition?

Many firms that provide robo technology to advisors also provide investment services directly to consumers. Are your client relationships strong enough and is your value proposition differentiated enough to retain your clients over time? Advisors should be thinking about this as a general matter, but it’s even more important if you are going to steer clients to an external robo service. Which leads to the next question...

2. Who owns the client?

Some robos structure contracts such that they control the client advisory agreement and effectively own the client. At the onset, this might seem a trivial matter. After all, many advisors are seeking to use a robo to service their smallest accounts. But advisors need to consider their long term business strategy when choosing a robo. Today’s small accounts are tomorrow’s core book of business. Robos continue to evolve their services, so this is an important area to consider during the due diligence phase.

3. Are you prepared to meet the evolving needs of your clients and scale your overall practice?

A basket of mutual funds and ETFs may be fine for some clients, but clients with more complex investment needs may require a broader array of investment vehicles. Individual bonds could produce more income for a client with greater tax efficiency than a fixed income fund. There are also client customization options and tax-aware trading techniques available within separately and unified managed accounts that simply aren’t possible with mutual funds and ETFs.

Yes, higher asset levels are often required to leverage these vehicles and maintain diversification, but technology innovations are making UMAs viable in smaller and smaller accounts. Ideally, a client can seamlessly shift to a more complex portfolio as their needs evolve. If your robo solution only supports mutual funds and ETFs, what’s the process and client experience for someone who begins with the robo offering but then needs to access a broader array of investment options?  

4. Is the advice being provided consistent with your overall practice and the advice you provide to clients directly?

With the specter of new Department of Labor rules looming, advisors would be wise to carefully scrutinize how a robo will fit into their practices. Most robos don’t allow the advisor to adjust the algorithms, investment assumptions, eligible products/securities, or otherwise tailor the portfolios being generated. Differing capital market assumptions could lead to the robo tilting toward market sectors you shun. Or the robo could be buying into mutual funds or ETFs you are selling.

Perhaps these differences are OK and there is no misalignment, but consider a situation in which one client with a small account you steered to the robo has a dramatically different outcome than another client with a large account you manage directly. The accounts were opened on the same day, both clients have a similar risk and return profile, and both have a similar investment time horizon – the account size is the only real difference. Of course many factors could lead to the differing outcomes, but will you be prepared to defend to a regulator that each account was handled in the client’s best interest?

5. Can the robo technology effectively integrate with your custodian and other critical systems?

In order for an advisor to scale their operation and maximize the ROI on technology, integration is table stakes. This starts with the custodian. Many robos are bound to a single custodian or are themselves the custodian, and you should consider the implications if your primary custodian is another firm. For clients with accounts split between the robo and your primary custodian, there will be different approaches to mundane things like cash transfers as well as differing client experiences for account access and reporting. Advisors need to gain a clear understanding of the robo’s ability to integrate with other systems and best-of-breed third-party apps that advisors may incorporate into their practices.

This is especially critical for client performance reporting, particularly when a client has accounts with the robo and directly with you. You need to be able to answer the question every client asks: how am I doing? Answering this question will require some form of consolidated reporting for clients with multiple accounts. If you plan to rely on the robo to aggregate client accounts and drive client reporting, consider questions 1 and 2 again.

The robo disruption, or awakening, has accrued enough headlines to influence the strategic direction of many firms both large and small.  Before your firm considers robo technology in earnest, it’s important to take a step back and consider whether the solution will flexibly scale to augment the advice that you provide today and in the future across the continuum of clients you serve.  Asking the aforementioned questions is a good first step.  If you are interested in learning more about Vestmark’s approach to robo enablement, please visit the Vestmark website.

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