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Reckoning with robo-advisors

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This fall, his upstart automated investment management firm having just secured a $64 million capital infusion, Wealthfront CEO Adam Nash outlined an ambitious plan to conquer the millennial market for financial advice, if not to alter the course of the entire advisory segment, declaring that “the future [of investment management] is automated.”

“We don’t believe we’ll kill Charles Schwab,” Nash wrote in a blog post on the Wealthfront website. “It is a great company, albeit focused on a different customer—the baby boomer. We do believe, however, that we’ll force Charles Schwab to become even better.”

A week later, Schwab CEO Walt Bettinger went out of his way at the firm’s annual IMPACT conference to assure advisors that his own company’s soon-to-be-released “robo” online advice platform poses no competitive threat to them.

Meanwhile, Swiss research company MyPrivateBanking Research recently predicted that global assets managed by so-called robo-advisors would reach $14 billion by the end of 2014 (83 percent attributable to U.S.-based firms), increasing to an estimated $255 billion within five years. Though even that figure is dwarfed by the estimated $5 trillion that conventional U.S. wealth managers currently oversee, the Swiss firm views robos as “a real threat to the business models of conventional wealth managers.”

Amid the buzz that surrounds them as VC darlings and Davids to Wall Street’s Goliath, do robo firms that deliver lower-fee, Web-based investment management services on a largely automated, passively managed platform present an immediate and genuine threat to the traditional face-to-face, brick-and-mortar model?

The answer is far from clear-cut. Indeed, it depends largely on the type of advisor, the types of client the advisor is seeking, and the advisor’s ability to evolve along with their clients’ needs and wants.

“The real threat [posed by robos] is to advisors who don’t have a clear value proposition, who aren’t very clear on who they serve and why they serve them,” says Adam Cufr, RICP, founding principal at Fourth Dimension Financial Group, a wealth management firm in Perrysburg, Ohio.

What is already abundantly clear, however, is that advisors who ignore this new breed of  Web-based advisory firms— automated investment managers, eRIAs, digital advice providers, online financial advisors, robos, call them what you like—do so at considerable risk. The rise of the robo-advisor is, at minimum, a call to action for flesh-and-blood advisors to:

1. Beef up the Web-based tools they offer clients.

2. Bolster transparency.

3. Diversify their investment approach.  

4. Justify their value proposition.

Those who don’t not only risk losing client assets to automated providers, they also may miss out on a golden opportunity to make new inroads in several market segments targeted by the robo set but hitherto largely underserved or overlooked by traditional advisors and advisory firms:

Millennials and digitally oriented do-it-yourselfers who prefer their investment assets are handled by online tools. “People who are comfortable giving their retirement accounts over to a computer,” says Scott Puritz, managing director of Rebalance IRA, a Web-based advisory firm that caters to the 45+ set, managing some $225 million in retirement plan assets using a passive, ETF-based diversification strategy. “The traditional role of the human advisor is not going away anytime soon,” he says. “But they will have to fight [with robos] for clients who are in their 20s and 30s.” Investors who are especially wary of investment-management fees—and of the firms and advisors that charge such fees. Robos typically charge fees ranging from 25 to 65 basis points, compared to the 150 to 200 or more basis points that local flesh-and-blood advisors and brick-and-mortar firms typically charge, according to Jack Waymire, founder of Paladin Research & Registry, a Roseville, California-based research firm that tracks the financial advisory community.

Investors with smaller asset portfolios (under $100,000, for example) who thus have relatively simple “auto-pilot” investment management needs

Investors who prefer that their assets be managed passively.

Know your robo

The robo population today consists of about 20 firms that provide mostly automated, Web-based services with lower minimums and lower fees compared to traditional wealth managers (see the sidebar at right for a closer look at the robo population). Other more entrenched incumbents such as Schwab, Fidelity and Vanguard are also entering the fray with robo-type platforms.

To keep fees lower, robos rely mostly on passive investment instruments such as ETFs and index funds, typically charging a few more basis points for services like automatic rebalancing and tax loss harvesting. Some robo firms, such as Betterment and Wealthfront, are fully automated, while others, such as Vanguard’s platform, blend automated investment management tools with personal financial advice.

Those in the latter category tend to charge more for their services—in the range of 55 to 65 basis points, perhaps double the going rate for fully automated portfolio management, according to Waymire. Robos are also distinguished by their dependence on digital tools to drive prospecting and sales, he adds. “Automated RIAs by and large don’t have sales departments. They have customer service and investment departments, but they don’t have a sales department because they use their websites and the Internet to do the selling.”

If you can’t beat them…

Millennials aren’t the only ones demanding more online investment tools, whether from robos or traditional advisors. Nash writes in his blog post, “We now believe almost every investor will be using some form of automated investment service in the next 5-10 years.”

Advisors who want a means to keep current clients from shifting assets to robo firms, or who want to make new inroads with the aforementioned types of clients, would be wise to consider offering robo-type online tools, Cufr asserts. “Ignoring [the robo movement] or being afraid of it is silly. Instead, it’s important to ask, ‘How does this fit into our value proposition?’”

OFAs such as Wealthfront are aiming squarely at the millennial generation, the 90 million Americans born between 1981 and 2000 who, according to Nash, collectively are projected to control some $7 trillion in liquid assets in less than five years.

One way for flesh-and-blood advisors to capture a share of that massive market is by aligning with a robo platform. Robo firms like Betterment, along with incumbents like TD Ameritrade, Fidelity, and soon, Schwab, offer “white label” automated investment management tools such as auto-rebalancing and tax loss harvesting for RIAs and other kinds of advisors to use with their clients, Cufr notes. As an advisor, having access to automated investment management tools provides a means not only to empower the digitally inclined and do-it-yourselfers among an existing client base, it can also open doors to serve younger investors—and investors of all ages, for that matter—whose smaller portfolios might not otherwise meet a firm’s minimum threshold of assets. “One of the uniform problems for many accomplished, high-AUM advisors is what to do with smaller accounts,” notes Waymire. “From the advisor’s point of view, turning to the OFA may be a very effective strategy for handling those accounts.”

Not only does that free them to focus on servicing existing higher-asset clients and prospecting for new ones, adds Cufr, “it gives the advisor an option where they might otherwise turn folks away. It’s an opportunity to marry the younger client’s money now, and to build relationships for the future.”

Meeting the robo challenge

Robos have clear limitations, Waymire’s firm, Paladin, concludes: “OFAs are not  viable alternatives for investors with larger asset amounts who require more comprehensive, complex solutions.”

But those limitations are no reason for flesh-and-blood advisors and their brick-and-mortar firms to grow complacent, particularly in light of the very real possibility that they may lose business and miss opportunities to tap new markets unless they rise to the robo-challenge by clearly demonstrating their own unique value proposition, giving clients good reason to maintain a face-to-face relationship with a local, real-life advisor. “You need to figure out where you add value that’s commensurate to the fees you charge,” explains Cufr.

Advisors “have to get good at justifying the fees they charge,” echoes Waymire, “because if you’re charging 280 basis points compared to a robo’s 40, you better have a really good explanation for what you’re recommending and why.”

Often, the key differentiator is the advisor or firm’s ability to provide a multi-dimensional, integrated plan, of which investment management is merely one part, and to work face-to-face with clients to develop, implement and update that plan. Having expertise in areas such as retirement, life insurance and long-term care planning, as well as business succession, tax and estate planning, is what will continue to separate flesh-and-blood advisors and firms from robos.

The heart of the value proposition for flesh-and-blood advisors is the ability to be a trusted resource to clients, not only in the various areas of planning, but as a source of objective information and advice, delivered with a personal touch, says Cufr. Indeed, more personal touches, be it face-to-face or via social media, email, or the telephone, “is one natural and important competitive response” to the rise of robo advisors, Puritz adds.

Another response is to lower fees and offer clients more low-cost, low-maintenance passively managed investment options, he says. “The days of saddling investors with high fees and offering conflicted advice are over.”

ETFs, index funds and other passive vehicles are gaining appeal anyway, he notes. “There’s a growing body of evidence that active management is sub-optimal,” which is prompting “an increasing acceptance of portfolio indexing” to manage investments.

“The whole premise behind higher fees is that active management will outperform the market,” adds Waymire. “But the evidence suggests that is no longer the case.” His recommendation to local advisors: “Adopt the OFA approach by offering more passively managed investments” and differentiate yourself by offering clients strategies that blend passive and active investments.

Advisors would also be wise to take a cue from robos by providing clients with access to more online information and tools, he says. “The more astute RIAs are looking to add to the face-to-face advice they provide by adapting their business practices to be more transparent and to look more like the robo model.”

That’s how to turn what is widely perceived as a threat into a genuine opportunity to grow.