Automated investment advice, popularly dubbed robo-advice, has the potential to drive “significant long-term change” for retail wealth manager platforms, and may likely assist wealth managers in addressing new required fiduciary standards for retirement accounts, according to Fitch Ratings.
“We believe that the wealth management divisions of large banks will increasingly adopt the technology, following similar moves from traditional investment management firms such as Vanguard, retail brokers such as Charles Schwab, and internet-based companies such as Betterment,” Fitch stated in a recent commentary penned by Senior Director Justin Fuller and Justin Patrie, a senior analyst.
Morgan Stanley also recently announced a robo-advisor platform to be rolled out in the fall, becoming “the latest bank to offer an automated advisory product,” Fitch said.
Fuller told ThinkAdvisor in an email message that he sees the robo-advice trend as a net positive for wealth managers, as the automated advice “should allow for better client interactions and better client segmentation.”
Robo-advisors are likely to continue to see double-digit growth in assets under management in coming years, albeit “from a low base of less than $100 billion in 2016.”
Fitch points to a 2016 KPMG study that estimated that robo-advisors’ AUM will top $2 trillion by the end of 2020, equating to a compound annual growth rate of 68% over the five years from 2016.
“As long as investment performance and offered services meet client expectations, robo-advisors offer substantial scalability and cost efficiency, allow for better segmentation of existing client bases, and align with the increasing popularity of passive investing strategies among retail investors,” Fitch maintained.
Firms will use robo-advisors “to target self-directed investors with lower asset balances, relationships which may have previously been uneconomical to service via human investment advisors.”
Newly launched products from large wealth managers have had “substantially lower minimum investment levels than existing products,” reflecting “improved economics.”
Fuller pointed to one example of such improved economics being that “Schwab does not have a minimum for its Schwab Intelligent Portfolios product.”
Firms have also started offering robo-advisors as part of their response to the Department of Labor’s fiduciary rule. “Robo-advisors would not be exposed to conflicts of interest, provided their trading and investment management algorithms were properly designed and defined,” the analysts wrote.
Fuller and Patrie also see robo-advisors as an increasingly relevant technology requirement for wealth managers to defend market positions. Firms launching robo-advisors “will likely cannibalize some of their existing advisory services provided to clients. However, given the rapid growth and popularity of automated advisory products, firms could risk losing clients to other firms or hamper their ability to grow market share if they do not launch their own robo-advisors.”
But the two warn that automated products “come with operational and implementation risks,” with challenges including “maintenance of portfolios within stated risk tolerances, communication with clients, ensuring suitability of investments (ie. maintaining the fiduciary standard for retirement accounts), and maintaining strict cybersecurity.”
The performance of automated asset allocation and investment strategies under market downturns and severe volatility “also remain untested,” the Fitch analysts said.
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