The Impact of Robo-Advice Will Be Widespread – Here's What You Need to Do

Written by: Paul Resnik | FinaMetrica A growing number of businesses are starting to focus on robo-advisers, who provide a simple process to typically match personal goals to a low cost portfolio. Whether you think they are good or bad, there’s probably little protection from their impact. In fact, wherever you sit in the financial service supply chain, a robo will probably be “visiting” you, your clients and prospects soon. In this article we will be exploring the impact of robos on the advice industry. While there are a number of advisory firms and advisers who feel confident that their clients, centres of referral and other networks will hold firm against the impending, well-funded marketing of robos, others are building their defences. Many advisory businesses understand that they must move their client engagement to higher levels of discovery and personalisation than that of robos. Traditional businesses realise they need to add other services that clients value, for which they will be prepared to pay. They also appreciate that their investment services must become visibly more personalised to take into account their clients’ individual needs and circumstances.Some advisers have reacted by adding their own low-cost robo service options. These investment adjuncts to their main offerings are targeted at smaller clients who have less demanding investment needs. Of course some argue that this is akin to inviting the “fox into the hen house”.Yet other advisers see robos as doing nothing more than providing low-cost mid-quality investment solutions that meet clients’ simpler investment needs. They have no intention of providing a similar service.

The options for advisers

So what are the best options for advisory businesses, taking into account robo competition?Personal advice is founded on building rapport with clients by understanding them, exploring their individual circumstances and recommending investments, and other services, that suit their needs. There are any number of client propositions that a firm might adopt. Five service offerings are illustrated in the graphic below (click to enlarge). Service propositions and valueFrom left to right: Box 1 – Commodity impersonal advice and complex portfolios: Represents ‘traditional’ investment advising with an emphasis on ‘finding’ investment performance, often provided with little proven portfolio competencies and usually with limited, unstructured and often idiosyncratic client discovery processes. Box 2 – Need/capacity v ATRisk and model portfolios: Represents planning businesses giving advice utilising simple investor risk profiling. Advisers often use tests with less than 10 questions and then link scores to model portfolios. This service can be carried out by a robo who can do it quickly, and reasonably accurately, at lower investment cost for single goals. Box 3 – Life planning and model portfolios: The advisory practice typically uses goals-based planning supplemented with cash flow and sometimes Monte Carlo testing. Box 4 – Life planning and personal portfolios: Represents advisory practices which provide goals-based planning, usually supplemented with cash flow and Monte Carlo testing. They build personalised portfolios for clients using proven methodologies aiming to outperform simple model portfolios usually after analysis of tax, inheritance and control issues. Box 5- Life planning and highly personlised portfolios: Represents multi-generational family offices offering highly personalised investment solutions taking into account the individual needs of members usually after detailed analysis of tax, inheritance and control issues.

Positioning and client understanding

Wherever your business is currently positioned, you are likely to face competition from others in your space, from businesses in other segments moving into your space and new players who see the opportunity in investment advice. For example, businesses in Box 1 are the most vulnerable to robo competition. They tend to have lower levels of understanding of clients’ longer-term needs, less suitable advice and indefensible positioning against competitors offering more personal services. Advisers in this segment will likely tend to be price takers, if not historically, then in the future. They are the businesses most vulnerable to competition from robos, and the ones who will most likely benefit longer term from bringing robos into their business.On the one hand, they need to improve their portfolio offerings and on the other, such businesses need to have greater client engagement and suitability processes than the simple three to 10-question investor profilers that most robos offer. A typical robo makes a portfolio recommendation based on a scored algorithm built on as little as three necessarily simple characteristics. What’s your risk tolerance? What’s your capacity for loss? What’s your time horizon?Such a profiler takes no account of existing assets, tax position and the consequences of financial changes, estate planning or social security impacts, differences in individuals’ risk tolerance or differences in couples’ risk tolerances if the monies are held jointly.Nor do robos necessarily take into account investor anxieties when markets run or crash other than warning the adviser to increase the regularity and personalisation of communication. Robos aren’t very likely to hold clients’ hands in times of stress. Because they don’t have a detailed understanding of the investors’ goals, and have great difficulty framing investment experiences against investors’ goals, robos have been described as “fairweather advisers”.Businesses that that have already developed a simple process to discover financial needs and match those to portfolios, as in Box 2, are in direct competition with robos. They need to move to Box 3, which in turn increases competition to the incumbents.

Build closer relationships

Planning businesses have to understand their positioning and pricing in comparison to others and how they can improve their situation. The aim in moving from the bottom left red to the top right green box is for advisers to build closer relationships with their clients through superior personal service, more personalised portfolios and to differentiate what they do from robos.At each level there is a greater likelihood of attracting and retaining wealthier clients with more complex needs and generating higher fees. Robos aren’t going to go away.The technology constraints that limited their development are largely gone. The regulatory restrictions that limited their application are under review. Every business in the service supply chain needs to have a researched, costed position on their impact.With this understanding FinaMetrica is finalising its Investor Profiler suitability ‘plug-in’ for existing and aspiring robos. We expect a growing demand for quality suitability processes from automated advisers. No robo can afford the loss of confidence that accompanies legal claims from dissatisfied clients. Each plug-in is built on a:
  • Market proven 12- or 25-question psychometric risk tolerance test. We’ve been delivering these tests to the market since 1998 and have more than 850,000 on file.
  • Market proven investor profiling methodology, which brings together risk tolerance with analysing clients’ capacity for loss and time horizon issues. One of our profilers has been successfully in use with a Swiss bank for over seven years. A typical client has a $5 million pot and our tool is helping to manage this pot.
  • Market proven ability to frame investment expectations through our Risk and Return Guide . We are not aware of any successful legal claim against a FinaMetrica subscriber. Our licensees report that during 2007-09 their clients stayed the course because the risks they were taking were consistent with their risk tolerance and they understood those risks. Our licensees acknowledge our risk profiling system’s central role in this success.
  • As part of this, FinaMetrica is working collaboratively on white papers covering the regulation of robo advice, a consistent risk language to be used by the financial services supply and distribution chain, suggestions for a robust due diligence process for assessing the risk tolerance component of an investor profiler and an analysis of the several different robo models around the world. Stay tuned.