FinTech companies are disrupting the financial industry. Using new technology-driven applications to improve financial services, reduce costs, and respond more effectively to end consumers’ needs, these start-ups are seriously threatening the traditional financial institutions’ own patch. New digital technologies are indeed transforming the way investors access financial services.
Although these initiatives still remain little known by the public in general, according to a Citigroup report[i] the consumer banking revenue impact from digital disruption will increase from 1% in 2015 up to 17% in 2023. Another study by PwC[ii] estimates the percentage of business at risk in the financial industry to be between 20% and 30%, by 2020.
Private investors’ growing interest in FinTech companies (their funding has more than doubled in 2015 from $5.6bn up to $12.2bn, according to the same study by PwC[iii]) will certainly help these start-ups to gain momentum and allow their solutions to be widely adopted. This may explain why Statista forecasts[iv] show that FinTech’s worldwide transactional value is expected to show an annual average growth rate of 21% for the 2015-2020 period and reach more than $5,000bn. There is no doubt that FinTech solutions will accelerate their adoption as Millennials play a more significant role in the economy.
In previous articles for this blog, I covered two of these innovations: the crypto-currencies (and more particularly, the blockchain technology) and the crowdlending platforms. In this article, I will deal with another FinTech initiative: roboadvisors.
What is it and how it works?
According to Investopedia’s definition, “a roboadvisor is an online wealth management service that provides automated, algorithm-based portfolio management advice without the use of human financial planners”.
Based on customers’ profile (age, marital status, revenues, assets), indications about their investment objectives (prepare their retirement, build wealth, create a safety net, or finance a major purchase) and their aversion to risk, these digital advisory platforms use computers to define an investment portfolio adapted to these objectives.
Not surprisingly, these tools have been used by traditional wealth management firms for years. The difference is that new servicing firms, both non-financial (such as Telecom providers or FinTech firms with access to a large number of retailer investors and advanced technology) and financial (such as asset managers and insurers) have entered the market, eliminating the intermediaries and democratising the access to such tools.
Roboadvisors’ Pros and Cons
The main advantages of automated investment advisors are to:
- Propose lower fees (or even non-existent) than those of traditional financial advisory services firms
- Require lower minimum assets
- Offer State-of-the-art digital interfaces
- Allow higher control of the investments to customers
- Be accessible anytime/anywhere
On the down side, traditional wealth management firms highlight that automated advisors (check Prudential’s video below):
- Cannot fully understand individual investors’ needs and deliver a personalised advice
- Can be based on wrong assumptions, such as reducing the portfolio risk as investors approach retirement no matter what the market situation is at that time
- Won’t help investors decide how much they should set aside to achieve their investment goals
- Cannot take into account legacy, estate or retirement planning as well as a chartered financial advisor could do
- Won’t help investors choose the best option for tax purposes
- Cannot help investors plan their insurance needs
- Won’t prevent investors from taking bad decisions during periods of troubled markets
Facing these criticisms, robo-advisory firms explain that they are heavily investing in big data, machine learning and advanced analytics, so that their algorithmic can offer a much more tailored advice, including taxation or legacy issues.
Are traditional advisors an endangered species then?
Roboadvisory (or automated investment advice) may be the FinTech service that will register one of the sharpest growths in the next few years. Statista expects indeed this sector’s transactional value to increase by an annual average growth rate of more than 40% for the 2015 to 2020 period[v]. In 2020, more than 20 million people will be using robo-advisory services. Of course, robo-advisors will still be a tiny part of the wealth management business even then (around 2% of the global transactional value by 2020), but their share is doubling every two years. In every country, several start-ups have been launched: Betterment (United States), MoneyFarm (Italy), Advize (France), FeelCapital (Spain), Nutmeg (United Kingdom), SafeTrade (India).
However, just as the banking industry has deployed technology (such as ATMs or online banking services) to free staff in branches from administrative work so they can dedicate themselves to value-added services, technology-driven advice can help traditional advisors to widen the client base from high-net-worth individuals to mass market consumers.
Traditional advisors certainly cannot compete on fees with automated investment advisors and their potential for disintermediation. Large wealth management firms such as Goldman Sachs, Salomon Smith Barney, Vanguard, or Charles Swab, have realized the importance of this trend and are incorporating the same kind of services for their smaller clients.
Advanced data analytics and a broader set of investment products will certainly help robo-advisors to gain market share, mostly in the segment of clients with lower total assets. But most experts agree that human advisors won’t be so easily replaced by technology-enabled investment advice[vi]. A recent survey by Capital One Investing showed that, while 75% of Millennials prefer going to a website and manage their investments themselves, in times of market turmoil 77% of them would receive advice from a human advisor rather than from an app.
In the end, there will most probably be a mix of both worlds, with different levels of human-to-automated advice ratio depending on the complexity of the customers’ needs and the size of their global financial assets.
[i] “Digital Disruption: How FinTech is Forcing Banking to a Tipping Point”, March 2016 – CITI GPS https://www.citivelocity.com/citigps/ReportSeries.action?recordId=51&linkId=23256755
[iv] Statista Web Site – FinTech statistics https://www.statista.com/outlook/295/100/fintech/worldwide#
[v] Statista Web Site – Automated Investment Services statistics https://www.statista.com/outlook/337/100/automated-investment-services/worldwide#
[vi] “Why Robo-Advisors can never replace traditional financial planning”, Miranda Marquit, Investorjunkie Web Wite, Feb 2016 https://investorjunkie.com/37956/robo-advisors-traditional-financial-planning/