Robo Financial Advice

The future of Asset Management?

The widespread use of the Internet and the following on-going globalization led to an increase
in global productivity while disproportionately impacting our well-being, changing the way
the world economy works. Nevertheless, this means that people have to change too. And
human beings are not always prone to change. But we adapt if we have to. That is precisely
what happened after the Industrial Revolution when thousands of workers saw their jobs
being cut off and replaced by machines, leaving them no option, other than developing a
totally new set of skills. It happened two centuries ago and it may happen in our lifetimes,
just with different machines. "Thinking" ones.

Artificial Intelligence and Robots are not just a Hollywood reality anymore. And although
they are not as developed (yet) or as deadly as the ones in the movies, they can still steal our
jobs – one area that has been widely discussed when mentioning this possibility is the
financial sector and more specifically, banks.

Banking activity has grown exponentially since the Industrial Revolution, making investing a
more common and widespread activity, available to more people than before. This is an
ongoing process. One that led to a huge increase in asset management activities during the
20th century and made a lot of fund managers famous for achieving extraordinary returns for
their clients, like Warren Buffett or Peter Lynch.

But times have changed and in the post-2008 financial crisis era, banking is not as regarded
by the population and the top university students as before (see chart 1). Some banks have
been perceived to be involved in wrongdoing and reckless behavior to the detriment of the
taxpayers and that hurt the whole industry reputation.

Harvard Business School Graduates into banking and technology

20
ofClass

15
10
Percent

5
0
2007 2014
Investment Banking
Technology
Chart 1 - Source: Annual School reports on
Where students found employment

Moreover, the returns asset managers have been able to deliver to their clients over the past
decades and their ability to beat the market on the long run on a risk-adjusted basis, net of
fees and expenses, have been under criticism by academics, researchers and clients.

Not surprisingly, passive investment strategies became more popular over the last decades,
with Vanguard being one of the companies to propel this development since the fund was
created in 1975, providing ETFs with low expense ratios that are also available to small
investors.

This distrust in high-fee active asset management led to the development of what may be the
next financial sector disruptor, robo-advisers.
Silicon Valley is on a mission to disrupt finance with the democratization of investment
advice. And it is using data, software and algorithms to do it. The evolution of the web
from a simple source of information, to an user-generated content in a
virtual community, and lately, to a new stage of the web where all of your data is connected
and websites and apps use algorithms to find out what is relevant to you,
created a new range of tailored products and possibilities. This can range from the music that
is suggested to someone to the savings account this person should use, or right now, to the
type of asset manager this person should choose.

Lending from fintech companies has been on the rise and mostly due to this advantage that
these companies have when it comes to data regarding their clients. With ever more
connected systems like Google Wallet and Apple Pay, usually associated with our email
account, that we may use to shop online on websites like Amazon or Ebay, lending
companies can probably have an advantage over traditional lenders in terms of
accessing credit risk, based on user's routines, credit history, salary history,
average monthly expenses, products bought and other relevant information to access risk. But
it comes with the downside of loss of privacy and raises security issues.

Not surprisingly, this has raised some eyebrows among financial regulators and some
experiments referred to as “sandboxes” (basically experimental playgrounds for companies to
test financial algorithms, software and robots in a controlled environment before approving
their usage in the financial sector) have been done to assess the risk of these new products.
How to regulate this industry is a sketchy subject. Some people argue that the approach
should be the same as with the Web when it was introduced - not to overregulate it
so that it does not hamper its growth and as a consequence economic development- while
others are fearful that a not regulated enough market will pose a threat in terms of data
privacy and security for its users or clients - arguing that the impact of a hypothetical cyber-
attack can be way more devastating in that type of market.

Nonetheless, it is difficult to argue that the future for the ever more connected millennials
does not include mobile payments. Put this together with the generation’s discomfort when it
comes to asset management and you can see why Silicon Valley companies would be
interested in creating a platform where through your mobile device you could make
payments, have a personal monthly financial planner based on your budget which tells you
what you can buy or not by pointing your camera at it, decide to round all your payments to
the dollar so you can save an extra cents in each purchase you make, and invest it all in your
investing account. All a couple of touches away with your phone.

The last step of this process - investing - is the trickiest one in terms of software. You have to
create a robo-adviser that people trust their money with instead of the regular asset manager.
But that is one of the areas where fintech companies are investing the most right now.

With full transparency on fees and taxes,pioneering startups like Wealthfront or Betterment
were born focusing on lowering the cost of investing like the super-rich, according to the
belief that computers can manage money better and at a lower cost than emotional, irrational
humans that are subject to a lot of biases. A basic questionnaire—age, salary, investment aims
and the like — helps establish risk appetite. Money is then allocated to low- cost funds that
suit the investor needs and specifications, provided by third parties, many of them belonging
to low-cost funds like Vanguard and Schwab.
Robo-advisers are doubling their assets under management every few months, but their
combined assets still run to less than $20B, against $17 trillion for traditional managers.
Several banks manage over $1 trillion each. This means that for example, in Betterment’s
case, the low expense-ratio together with the only $1.4B in assets under management
(AUM) only translates to less than $10M in revenue. The market for robo- advising is clearly
one in which economies of scale play a huge role and where thriving without
increasing market share seems quite impossible. Still, the target clients are not the same as
with the regular asset managers. They are usually younger and with untailored financial
needs and some degree of financial literacy, which means the business is not viable unless
you attract a huge number of clients. A problem that Betterment and Wealthfront still face
despite increasing their client asset base $100m a month.

This makes us wonder whether these startups can take on the big financial institutions and
mutual funds. Vanguard and Schwab used their client base to shift investments to their
newly robo- advising services and Schwab quickly reached $4.1B in AUM surpassing
most of the robot- advisory startups. More recently some of the biggest financial
Institutions have been looking into some opportunities to grab a piece of the pie too. UBS
declared it is interested in offering its clients automated services. Goldman Sachs
bought Honest Dollar - a robo-advisory startup. Blackrock bought FutureAdvisor last August,
a robo adviser service with the intent of targeting millennials and clients that do not
Meet the minimum amount criteria, which RBC already declared it would use. Paypal is
currently leading a $30m funding round for the robo-adviser mobile app Acorns Grow and
more big names in the financial industry are expected to enter the robo-
Advisory market. The question here is whether this will translate into the startups being
driven out of the market due to a lack of market share or if it will lead to less pricing power
by asset managers and financial advisers (which is relatively high in this industry) which may
increase competition and lower prices for clients. Ultimately, this may lead to smaller profits
for banks and financial advisors and consequently a lot of jobs being lost. Most of them are
estimated to be in the Wealth Management and Asset Management divisions.

According to U.S. News, 58% of millennials do their own financial research, and robo-
advisors make that research accessible, opening new doors to investors of modest means and
giving them access to markets and guidance that would not be available through traditional
channels.

The millennials are less likely to believe that a professional could somehow beat the market
or protect them in volatile times. The beauty of the robo-adviser is that it doesn’t care,
it’s open for business 24/7.

For now, this type of service is not suitable for anyone with complex financial affairs who
needs help with things such as trusts, estate planning or complicated retirement decisions.
But the robot revolution is likely to become increasingly sophisticated and transform the way
we manage our money within the next few decades. Unaffordable to the masses, wealth
managers, will be substituted by instantly tailored investment portfolios on our smartphones,
suited according to our circumstances and taking into account tax affairs, debts and financial
planning.

The question now isn’t whether robo-advisors will survive in the next decade, but under what
conditions will this happen. Robo-advice changes are already taking place in the UK and in
the US and it’s a question of time until it becomes commonplace for the rest of the world.
High street banks are carefully monitoring developments, seeking the opportunity of using
robo-advice to re-enter the lower end of the investment advice market. Workers in this area
may not be driven out of work entirely, but they surely will have to learn to partner up with
their “artificially intelligent peers”.