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Technology > Investment Platforms

The Future of Robo-Advice

By Melanie Waddell

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While broker-dealers and asset managers will continue to adopt robo-type technology to ensure they can profitably service smaller accounts under the Department of Labor’s fiduciary rule, traditional pure-play robo-advisors will likely fade and morph into technology offerings that also offer a human touch.

So says CGI Wealth360 in its recently released report, “The Future of Automated Advice Platforms: Lessons Learned.” The report argues that the shortcomings of pure-play robos “point to a new way” that advisors, online brokerages and other financial institutions can do business under an increasingly regulated advice environment via investment programs delivered through advisor, call center and digital channels.

CGI argues this new “omni-channel” automated advice platform offers “a suite of software that can guide investment decisions and much more,” including tax-loss harvesting, rebalancing, data mining and predictive analytics, helping the “firm and advisor interact with the client through the most appropriate channel.”

Growth has leveled off in the older robo model that uses simple computer algorithms to set asset allocations based on age and risk tolerance, with robo-advisors automating the rebalancing and tax-loss harvesting process to keep an investor’s portfolio on track, CGI maintains.

Robo-advisor services are “being replaced by a broader trend, with financial advisors using computer programs to assist them in offering investment advice and overseeing client accounts.”

A relatively small segment of investors can still have their needs met by pure robos, CGI says, but most investors have broader needs, so both investors and advisors are catching on to the “significant benefits” offered by “digital advice for a digital world, but with humans firmly at the helm.”

David Lyon, founder and CEO of Oranj, a client services and prospecting platform for advisors, agrees that trying to scale the advisor business by eliminating the need for interaction with an advisor is the “greatest shortfall of robo-advisors today.”

Increased regulation, he says, will make it nearly impossible for robo-advisors to maintain the scalability of their business models as well as drive up client acquisition and service costs.

The “real opportunity” that has surfaced, Lyon argues, is for traditional advisors who already have a business model driven by a high level of service to become more efficient and scalable using digital advice platforms. That’s so because the value of traditional advisors is that they “work holistically with their clients to add alpha to their net worth, the one true controllable factor in their clients’ financial lives,” according to Lyon.

Fidelity: First Retail, Then for Advisors

RIA custodians are jumping into the robo-advisor game as well, with Fidelity being the latest with the recent release of Fidelity Go, its retail digital advice platform. Fidelity Go touts features such as portfolios constructed, monitored and rebalanced over time by investment professionals — not simply by an algorithm — available at a minimum investment of $5,000.

Launched in a pilot phase late last year, Fidelity Go offers a combination of a professionally managed portfolio, a digital dashboard, integration with Fidelity’s broader investment tools and services, as well as “an all-in cost” that Fidelity argues is “among the lowest in the industry.”

A Fidelity spokesman told me that details about the robo-service Fidelity is developing for financial advisors will be available by year-end. “The goal is to offer an advisor-centric solution that is integrated into Fidelity’s technology platform for registered investment advisors, broker-dealers and banks.”

The CGI report points to the rise in 2010 of robo-advisor offerings from financial technology firms that provide algorithm-based computer programs to capture a client’s basic details, determine an asset allocation based on age, time horizon and risk tolerance, and offer a “canned product selection based on the asset allocation, and then automate the rebalancing, tax harvesting, billing and reporting functions.”

The pitch for this type of service six years ago, the report notes, touted robo-advisors’ ability to eliminate behavioral biases and handle routine account maintenance without human interaction while significantly lowering costs to the end client.

The idea “made sense to many, and robo-advisors quickly gained market traction,” overseeing $19 billion by the end of 2014, with forecasts of hitting $2 trillion in assets by 2020, the report states. Some of the early players included Betterment and Wealthfront.

But drawbacks to the model soon became evident, CGI says, with client acquisition for robo-advisors being costly, and the lower fees that consumers expect for a robo-advisory solution making the economics difficult.

Stated bluntly: “Growth rates have dropped, and average revenue per robo-advisor client has been declining, which does not bode well for their long-term outlook.”

The Shortcomings of Robos Only

The report zeros in on the pure robo-advisor model’s shortcomings, including the simplicity of the investment portfolio along with the fact that the platforms leave “no choice for the investor” — once the allocation is determined, the investor can’t switch.

“If the portfolio is just an allocation of various passive ETFs, then it is cheaper to purchase through a self-directed account. This can be accomplished with relative ease for a fraction of robo-advisory fees,” CGI argues.

Some critics, echoed by the report, charge that the real shortcomings of the robo-advisor approach won’t be seen until it faces an extended bear market or recession, and it remains unclear how it will handle events like post-retirement drawdowns.

As to dealing with the DOL rule’s new fiduciary mandates come April 2017, software leveraging robo-advisor approaches can help broker-dealers service smaller accounts while still meeting the fiduciary rule’s no-commission and best-interest mandates, but the DOL rule’s requirements are “broad,” and technology will be “crucial to meeting all of its precepts,” CGI says.

The “right technology” can ensure proper compliance, such as by ensuring an advisor does not recommend the “wrong” investment product, and making sure that the advice given is consistent across all channels, the CGI report says. Technology also can keep track of exactly what advice is given, making it easier to “prove to regulators that the advice and the execution of that advice were in the client’s best interest.”

Automated advisory platforms also allow firms and advisors to be “significantly more cost-efficient” in their advice delivery and execution, helping to maintain profitability even if firms or individual advisors see declines in fee revenue.

In creating Oranj, Lyon says the goal was a digital advice platform “that requires an advisor, instead of taking them out of the equation.”

Over the past three years, advisors using Oranj have been able to increase new clients by nearly 50% and service approximately 28% more clients, he says.

Since “money and personal goals are emotional, working holistically with an advisor is the single greatest part of the equation to add alpha to their clients’ net worth,” Lyon adds. “If you take that away, as many robo-advisors have,” he says, “all you are left with is a shopping cart of automated investment portfolios.”

As to how broker-dealers are preparing for DOL’s fiduciary rule, Lyon says the biggest impact will be on the expense line of their financials. Compliance with the rule will add to their overall cost of business, and he says some BDs are already getting out of specific lines of business because it’s too costly to put into place “the IT controls to maintain that business line.” He warns that other changes are likely after the April compliance date takes hold.

BDs are being tasked with getting their back-office IT systems to properly “catalog, archive and encrypt” the information they’re requiring advisors to provide, likening it to the process of placing a client into a specific product or an entire investment portfolio.

However, there are additional steps and reports required to comply with the rule, complicating an already lengthy process, and as with any technology, the process is not a one-time expense but rather a recurring cost for broker-dealers.

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