It has been almost two decades since the first robo-advisors were introduced in wealth management services in the US, but nowadays they can be found around the globe in ever growing numbers, in a variety of capacities and at a lower cost that their human counterparts. Time to take stock with SimCorp’s experts.
It was when firms started looking at reducing the cost of onboarding pension clients and looking for ways to stand out with better user experience that robo-advisors were “born”. “In my view, robo-advice grew straight out of the very basic profiling pension and high-volume wealth management providers do when they onboard clients or review attitude to risk and investment horizon,” says Anders Kirkeby, Vice-President Enterprise Architecture at SimCorp. “The clients pick a score on 1-3 parameters and that is then used to pick the weight of different fund products in the pension portfolio. Robo-advice is effectively trying to improve upon that model. Where this gets interesting is where robo-advice starts adding so much value that the traditional pension providers may be disintermediated so a client works with a robo-advice tool and allocates funds between a set of simple ETFs. This reduces costs and could potentially be delivered straight out of a service like those of big internet companies, e.g. Alphabet .”
“However, if robo-advice is able to evolve enough it could threaten parts of the current portfolio analyst and manager tasks,” Kirkeby continues. “The focus has been on pensions because that is a high-volume game but robo-advice is also picking up pace in the lower tiers of wealth management where the personal individualised service model has proven too expensive compared to returns in recent years.”
With software in all its shapes and forms becoming increasingly embedded in today’s society, are ‘human advisors’ soon to be a thing from the past? Whereas not so long ago real people accounted for all of the financial advice, how big is their part still now? “That depends on your perspective,” Kirkeby says. “But if you look at the full chain then some clients probably use 100% robo-advice to pick a weighted allocation against a number of cherry-picked ETFs. But today the ETF funds are still managed by portfolio managers with humans in the loop for just about all decision-making.” So the level of human input is not about to be reduced to zero? “Probably not. Artificial intelligence and robo-advice will probably make for more efficient markets operating at a substantially lower cost if the right scale can be found. But the capital markets have always proven resilient when it came to being creative in thinking up new ways to seek out inefficiency in markets which could be leveraged.”
With computers by definition being sheer infallible, is it correct to think that in the near future robo-advice can prevent a global stock market crash? Or in other words: is a global financial crisis as we’ve seen in 2008 something from the past? “I don’t think there is any real correlation between those elements,” says Kirkeby. “Robo-advice will in my view not have much impact whatsoever on market stability. You could in principle imagine the opposite with pension or wealth owners acting irrationally on events using self-service tools causing herd behaviour resulting in new ‘flash crashes’. But robo-advice systems are not day-trading platforms, there are natural delays built-in. So if robo-advice is to have a positive impact on market stability it should be because it siphons capital away from active investment strategies towards index trackers, ETFs and other simpler and less volatile fund products.”
Which brings us to the obvious next question: what safeguards are built into the software to prevent any ‘computer glitches’ which could have global ramifications? “Apart from good old testing I don’t know but I can speculate,” Kirkeby explains. “I’d suggest that owners of robo-advice platforms may have simple sanity checks backed up by manual review which would slow down certain changes. This is similar to how some banks follow up on potential fraud where they prevent a transaction from a new geography until they have talked to the client to confirm that he or she is indeed attempting to use a credit card in this particular country.”
With the ever-faster pace of software development, are robo-advisors THE technical revolution the financial world had been waiting for, or is it just the first step to ever more performant systems? “I see robo-advisors in their current forms as an incremental technology. But once artificial technology takes on a bigger role it could be used to create robo-advice platforms which will erode the advantage of institutional investors over private pension and wealth investors,” says Kirkeby.
And what about safety? With ever-increasing performance in hacking by malicious companies, organizations and even countries, which steps can one take to prevent serious issues in this domain on a local, international or even global scale? “I think the most substantial risk in this space is if actors with malicious intent are able to establish a deep understanding of the inner workings of a given robo-advice platform. If these are sophisticated enough it may be possible to trade against the robo-advice platform. It will however typically require a very substantial capital base in order to have the muscle to impact the market enough to trade on the differences.”