Robo-advisers, which use algorithms to develop tailored investment strategies that match an individual’s financial goals, risk tolerance and investing preferences, continue to disrupt the investment management industry. They’re changing how individuals and institutions approach investing, but the need for human input may cap the sector’s growth.
Robo-advisers growing rapidly but clients still need that human touch
Democratising financial markets
The appeal of robo-advisers to both providers and clients is clear. They provide a low-cost route for clients to access relatively sophisticated advice and portfolio construction. The use of passive investment vehicles and automated activities helps reduce costs and democratise markets.
Moreover, fee structures are transparent, providing investors with a clear view of the costs involved. Some robo-advisers manage small amounts of money for free, while others don’t charge a management fee at all. The best also automate operations like portfolio rebalancing, tax-loss harvesting and dividend reinvestment. In addition, they provide excellent risk management, constantly monitoring each portfolio to ensure it remains aligned with the aims and risk profile of the investor.
By lowering costs, robo-advisers should help boost the flow of customers to the sector. As artificial intelligence (AI) advances, the level of sophistication of the services robo-advisers are able to provide will only increase. That will help them make inroads into the High Net Worth Individual (HNWI) and institutional sectors.
The management consultant PwC, in its Global Asset and Wealth Management Survey, published in August 2023, forecast that assets managed by robo-advisers would reach $5.9 trillion by 2027, more than double the figure of $2.5 trillion in 2022. However, it added that in some markets adoption has been slower, ‘suggesting that more work is needed to make this model viable’. 1
Robo-advice is rapidly gaining momentum
PwC added that further AI-enabled developments, ranging from enhanced trading strategies to generative AI, would pave the way for closer analysis of unstructured data. It warned that ‘these developments represent an inflection moment for AWM [Asset and Wealth Management], creating openings for industry democratisation and growth on the one side and the serious risk of disintermediation on the other’.
In other words, as robo-advisers become increasingly sophisticated, there is a danger that clients will bypass asset managers entirely and simply use a robo-adviser to build and manage portfolios composed of exchange-traded funds (ETFs).
Limits to growth?
However, some analysts believe that the potential growth of robo-advice will be constrained by clients’ desire to talk to another human. In an article published in September, Morningstar, for example, said it had found much research showing that many investors – even if the advice is fairly straightforward – often want that human touch when it comes to making the final decision in terms of ‘Here’s how you should invest the lump sum of cash that you have’ or ‘Here’s how you should rebalance your portfolio’.
It added that while many of the providers it assessed had made ‘significant strides in terms of making digital advice incredibly comprehensive in terms of what you can get, still, there are many investors that just want to have a human proverbial or sometimes literally hold their hands when it comes to some of those tougher decisions’. 2
A risky option?
Clients may also be wary of the risks associated with using robo-advisers. An obvious one is that robo-advisers are only as good as the data that powers the algorithms they use. Consequently, there is the potential for errors and biases that could affect performance. Since the algorithms are generally based on historical data, they might fail to cope with unexpected market events and fast-changing conditions.
There is also the danger of cyber fraud. Robo-advisers store sensitive personal and financial data, making them vulnerable to hacks, which could result in identity theft and financial loss.
In conclusion, the rise of robo-advisers is bringing significant opportunities and hazards for investors and institutions alike. It’s likely the market will continue to grow strongly in the coming years, given the cost advantages to consumers. The long-term potential appears to be dependent on whether robo-advice is able to overcome the apparent need of many clients for some human reassurance.
1 https://www.pwc.com/gx/en/industries/financial-services/asset-management/publications/asset-and-wealth-management-revolution-2023.html
2 https://www.morningstar.com/financial-advice/3-best-robo-advisors-one-worst-2
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