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Analysis of Part of The Money Management Process

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    However, it is imperative to analyze which parts of the wealth management process are likely to be taken over by machine learning and which services are still better off in the hands of a professional advisor. In 2017, robo advisors managed approximately $100B which is significantly less than the $20T that are currently invested in the U.S financial market. The future of the industry depends on whether the pros of robo-advisors outweigh the cons that are keeping potential clients from switching over to firms like Wealthfront or Betterment. The following are some aspects that clients often take into account when deciding who to hire when it comes to managing their capital: Costs & Fees: The main advantage robo-advisors have over traditional financial advisors (FAs) is cost. Historically, FAs have charged 1% to 2% in management fees while robo-advisors charge significantly lower fees which range from no fee to approximately 50 basis points. The main reason for this is economies of scale, a robo-advisor can be providing services to thousands of customers at once while human advisors have to factor in the cost of labor.

    Furthermore, the lower fee makes the service accessible to a greater pool of investors which continues to put downward pressure on fees in the long term. Lastly, the competitive nature of the online advisor industry means that fees tend to be more transparent than with traditional FAs and wealth managers. Apart from the cost, robo-advisors are available to clients any time and from any location. Human Element: A survey in 2016 revealed that over 70% of investors in the United States believe that a human FA is better than a robo-advisor when it comes to keeping the client’s best interests and complete financial plan in mind. The study revealed that clients prefer face-to-face advice on how much risk they are taking as well as someone to help them understand the financial jargon and methodology behind the investment process. Of course, it is difficult to quantify the value that a human adviser can offer, but studies show that the human interaction is what persuades clients to shift their levels of risk tolerance as well as endure market volatility.

    The current consensus is that even though human advisors are better at keeping clients from buying high and selling low, robo-advisors may be better suited to young clients who don’t have a lot to lose and have a lower degree of complexity in their finances.  As soon as the client starts a business or wants to begin family planning, human FAs can guide them in the financial process because as humans, clients tend to have an instinct to make wrong decisions when it comes to money management. Exhibit #6 shows in which scenarios clients feel more comfortable hiring a human advisor for. Quality & Scope of Advice: One drawback of robo-advisors is that the quality of advice can be significantly different across different platforms. Market competition has lead robo-advisors to concentrate a larger portion of the portfolio on equities in order to drive performance up, all at expense of clients who will experience large drawdowns in the event of a market correction or crash. For example, in 2016 the returns for Schwab, Betterment, and Personal capital can be seen in exchibit #7.

    All of these outperformed a benchmark because they had a much higher concentration of equities. The challenge here is that even though returns may have been better on a risk adjusted basis, robo-advisors do not always recommend allocation percentage that are customized to the client’s risk profile according to their complete financial profile. In studiers where either portfolio management or retirement planning questionnaires were answered multiple times in a similar manner, the robo-advisors’ advice differed. In terms of the scope of advice, an issue with robo advisors is that they may not consider all the types of investments in the client’s profile such as 401ks, businesses, or spouse’s financial profile. Human advisers usually provide other types of advice such as estate planning or insurance. Furthermore, robo-advisors do not usually invest in options or derivatives to hedge against risk like an active investor would. Within a portfolio, human FAs may also include a much larger scope of asset classes including derivatives or alternative investments which may be better suited for HNW sophisticated investors. Conflicts of Interest The last factor to take into account is conflicts of interest that arise when receiving financial recommendations.

    Human FAs have received backlash after recommending products where they are paid a percentage of the assets placed in that fund or product. This leads to an advisor overweighting assets where they receive a larger fee rather than the ones that are the most appropriate for the client’s risk profile. However, while robo-advisors are less susceptible to this conflict of interest, they have not been immune to criticism regarding this matter. Schwab Intelligent Portfolios for instance holds a relatively large portion of capital in cash. This represents a conflict of interest because Schwab Bank can profit from spreads in lending rates and the bank’s rate. Furthermore, Schwab’s portfolios only hold Schwab ETFs Lam (2016), the conflict of interest arises since their ETF’s expense ratios are higher than Betterment’s or Wealthfront’s What this means for the future: In the past years, stand-alone robo advisors have decreased in popularity as they are acquired by financial institutions and other companies in order to create Hybrids. This means taking the features of robo-advisors and integrating them into a product where the client receives lower fees, part of the investment process is automated, but the option to speak to a human advisor is still available.

    An example of this is Betterment’s new call center which is divided into 3 service levels. FAs leverage the algorithms and technology to make their investment process more efficient while increasing the amount of time available to investors. Furthermore, clients have the option to receive a more personalized service based on their type of account. Future Trends in the Industry Given that this industry is changing at lightning speed, it can be difficult to predict what the future of wealth management will look like. However, there are 6 industry trends which have picked up momentum and are likely to continue into the future. Compression of Margins Margins have taken a recent hit due to changing market conditions where bonds are yielding low returns and there is growing downward pressure on equity markets. Because of this, the fees that advisors are likely to compress given that clients will be skeptical of paying over 1% for a fund that yields lower returns. Furthermore, low barriers to entry means that new competitors enter the field as fees are compressed further.

    This trend is likely to continue as clients place greater emphasis on transparency, on-demand service, and access to good advice at a relatively low price. Consolidation in the Industry Industry consolidations will take place either through mergers, partnerships, or acquisitions to improve product offerings and cost synergies. Industry experts believe that the pool of robo-advisors is likely to shrink due to consolidation as industry giants and asset managers acquire startups in the field such as Blackrock’s acquisition of FutureAdvisor. The reason for these mergers and acquisitions is a shift in the global markets including fears of a liquidity crisis, an oversupply of asset managers with few clients, downward pressure on fees due to underperformance, and market uncertainty which results in clients increasing cash positions in their portfolios. Hybrid Advisors As previously mentioned, companies are shifting away from the standalone robo-advisor model towards a platform where clients have access to automated portfolio management and investment processes as well as the option to contact a human advisor for recommendations and support.

    This means a more efficient process of serving clients as well as enhanced offerings which will be available to a larger customer base for a fraction of the cost. Artificial Intelligence and Mobile Clients have shifted from laptops and tablets to mobile phones as the preferred device for financial tasks.  A bank’s client portal and virtual interphase has become a key factor in attracting potential customers who expect to continue their relationship and communication with the bank primarily online. Because of this, artificial intelligence plays a crucial role in making their interphase and robo-advisors more human-like. In addition, AI allows robo-advisors to advance quickly through the use of self-learning algorithms and enhanced investment processes. Exhibit #8 shows the evolution of robo-advisors and where their capacities are headed. Shift Towards Structured Products Robo-advisors currently offer a set of pre-defined asset allocation templates that focus on passive investing strategies and are assigned to a client based on factors like risk tolerance, age, net worth…

    However, the industry has unlimited potential in terms of the sophistication in algorithms and technology for portfolio analysis and investment advice. The expectations are that advisors will offer defined products like indexes or exchange traded funds but will complement their strategy with structured products, offering complex hedging strategies and more advanced payout diagrams to generate alpha for investors. Acceptance of RA by new demographics Robo advisers have become more popular among younger clients for many reasons. Firstly, millennials are much more comfortable handling their finances online and have much less capital to invest in these platforms. Because of this, millennials do not have access to traditional FAs. Secondly, younger customers do not have as much investing experience and trust in new technologies to make error-free investments. Lastly, younger generations who lived through the financial crisis have a lack of trust in traditional financial services, with over 66% of clients under 40 years old firing their parent’s FAs after inheritances or a transfer of wealth.

    In addition, demand is growing for investment managers from lower net worth individuals that are drawn to the lower fees. Tech Companies & Regulation Another trend that is already visible in other segments of the financial industry like payments processing systems or credit cards is competition from non-finance corporations like Amazon, Apple or Facebook. These companies leverage their existing customer bases and advanced technology to launch financial product offerings to and expand their range of services. Lastly, the need for government regulation is a trend that is quickly developing to keep up with the robo advising industry’s rapid pace. After the financial crisis in 2008, financial regulation measures became stricter and government kept a close eye on the financial advising and robo-advising industry. Other sets of regulations similar to the Consumer Protection Act or the Dodd-Frank Reform will likely be set in place as technology keeps changing and the industry continues to evolve.

    Summary: With the rise of fintech, a wave of advances in technology and artificial intelligence have emerged to take on the intergenerational challenge that exists in the wealth management industry. Consumers are turning away from traditional investment firms as they place more faith on technology to handle their finances. Robo advisors (RAs) provide a new solution, satisfying the need for automated investment management and advice for a low account minimum and even lower fees. Lower yields and uncertainty in the equities market are also prompting clients to seek efficient and low cost passive investing strategies like the ones offered by RAs. A prominent example of a traditional bank’s recent attempt to attract younger clients is UBS. The bank’s “SmartWealth” platform hoped to fulfill millenials’ desire for a digitally enabled experience; the $1B project would position UBS as a leading firm among new demographics and secure ties with existing client’s heirs. Unfortunately, the project was discontinued less than two years after launch due to limited short-term potential. The SmartWealth platform’s positioning may not have been the most adequate, it was too expensive to compete in the robo-advising sphere and not sophisticated enough for HNW individuals.

    Furthermore, there are still questions regarding the effectiveness of robo-advisors returns and the market is still maturing when it comes to a complete acceptance of fully automated investment managers. Robo-advisors have grown in popularity due to their low costs and ease of access. But despite their advantages, widespread acceptance is still hindered by the intangible services that human advisors can provide. Because of this, a more popular investment management model has emerged known as “hybrid” which pairs robo-advisers’ sophisticated technology with human advisers’ knowledge and experience to provide a more complete offering for clients. In terms of the industry’s future, there are several trends that are gaining momentum such as compression of margins, the emergence of hybrid advisors, industry consolidation, expansion of mobile capacity and artificial intelligence and the entry of non-financial firms in to the industry as well as increasing regulation. In essence, robo-advising has a lot of potential as an affordable option that complements traditional wealth managers’ services and offers a higher level of accuracy and efficiency for new and existing clients.

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