An Insight into Robo-advising
An Insight into Robo-advising.
Technology is disrupting existing business models and creating new opportunities in the financial services industry. Focusing on one particular aspect of fin-tech, Krishnak Parekh and Nandini Basu of PGP Co2017 put together a report to understand the evolution of the robo-advising industry. Here are some key insights from the report.
Using a website or a mobile app, robo-advisers generate an investor profile capturing the investor’s risk tolerance, horizon, current wealth and financial goals. Then, they generate a suitable portfolio allocation customised for the investor and often implement it using various financial assets. Compared to fees charged by traditional investor advisers (1%-2% of money managed), robo-advisers typically charge much lower fees (typically 0.1%-0.5%). Also, traditional advisers generally work only with high net-worth individuals. Robo-advisers will accept anybody with a few thousand dollars to invest. Because of these two features, robo-advisers have the potential to democratise investment advice. Not surprisingly, younger people are much more comfortable using robo-advisers.
While robo-advisers may be a great choice for somebody with relatively simple financial needs, they typically do not offer services involving tax planning and estate planning. Further, as a joint alert by the U.S. Securities Exchange Commission (SEC) and the U.S. Financial Industry Regulatory Authority (FINRA) warns, the output of a robo-adviser is limited by the assumptions of the algorithm used and the information that the investor provides. Also, just like traditional advisers, robo-advisers may try to sell products that maximise their own commissions rather than act in their clients’ best interests. Hidden fees due to such conflicts of interest have to be taken into account to judge the cost saving offered by this new platform.
Different regulators take different approaches to the issue of potential conflict of interest. In the U.S., regulators only require that robo-advisers disclose the potential conflict. It is the investor’s responsibility to understand and act in his/ her best interest. The Securities and Exchange Board of India (SEBI) takes a more explicit approach to dealing with conflict of interest. Its Investment Advisers Regulations 2013 (IA Regulations) already provide that an investor adviser cannot accept any compensation from anybody other than the client. In proposed changes to the IA regulations, SEBI makes it explicit that robo-advisers have to comply with IA Regulations and that an adviser using an automated tool will be held responsible for the advice given.
Robo-advising is already expanding in many diverse directions. Banks and other wealth managers are buying or building robo-advising solutions to interface directly with their tech-savvy clients and as back-end support for their human financial advisers. In the U.S., robo-advisers are getting into retirement plan record keeping. Insurance companies are exploring robo-advising to provide customised offerings to their clients. Some robo-advisers are also beginning to offer tax advice. Major Chinese e-commerce (Alibaba), social (Tencent), and search (Baidu, Sina) companies offer robo-advisory services leading to an amalgamation of data on the retail, social and financial lives of investors. With improvement in data mining and predictive analytics, the opportunities to use social/ shopping/ search data of consumers to deliver better financial advice are going to increase. Integration of robo-advising into smart wallets will also allow consumers to manage their spending in a smart way, contributing to another important aspect of financial health. The possibilities are endless.