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Mind of a robo

As with any new area of technology, understanding how digital financial advice (or robo-advice) actually operates can be tricky. Most robo-advisers use number of processes – including customer data collection and risk profiling – to generate their advice. So, how does it all work?

Author: Taylee Lewis

Publication: Adviser Innovation

Before plunging into robo-advice, advisers need to get a better understanding of how the tools function and invest, and the value they can provide to a financial advice practice. 

Robo-advice is everywhere. Its disruptive impact has been well documented and new players are rapidly entering the market. Afiniation co-founder Ian Dunbar predicts that at least 15 new robo start-ups will hit the market this year.

But while robo-advice is moving forward as a sector in its own right, advisers’ understanding of it isn’t keeping pace.

A clear definition of robo-advice is still missing. Morningstar’s global head of research, Hal Ratner, has called for an “agreed-upon industry definition” so that the industry can get a better understanding of robos.

John James, chief executive and founder of newly-launched robo firm BetaSmartz, says the current conversation is “distorted as to what real robo-advice is”.

This leaves advisers with an information gap which, in turn, limits their ability to ascertain whether integrating a robo-advice tool into their practices is right for them.

“We need to shift the conversation around robo-advice to educate consumers and advisers about what robo really is,” Mr James says. “It is not a threat to advisers; robo-advice provides tools to help advisers scale their businesses with cutting-edge technology and sophisticated investment techniques.”

Investing: how it works

Morningstar’s Mr Ratner says the most prevalent form of robo-advice is one that uses a risk tolerance questionnaire to assign an investor with a diversified portfolio. But how does this process actually work?

Capital U director Greg Einfeld says – in reference to his own company’s tool – that the investment process is extremely holistic. The robo-advice tool collects client information such as investment timeframe, goals, cash flow, income, level of risk aversion and experience in investing.

“Based on all of those things, we determine how aggressively or conservatively a client should be investing,” Mr Einfeld says. “Then we recommend a portfolio based on that. Essentially, we’re going through the same process that a human adviser would often go through themselves.”

He points out that most portfolios built using robo-advice are based on exchange-traded funds (ETF) and bank deposits. Harry Chemay, chief executive of Clover.com.au, says ETFs and robos are a perfect match.

“The ETF model helps to reduce the layers of complexity involved in investing, a side-effect of which is to reduce the cost to the end investor,” Mr Chemay says. “Investment vehicles that lower complexity and cost are to be commended.”

Ignition Wealth chief executive Mark Fordree adds that when dealing with lower net-worth clients, using a low-cost investment product makes sense. “The massive reduction in the amount of fees charged leaves the [client] with more to save and invest,” he says.

Investing: how it functions

When it comes to portfolio rebalancing, it’s still possible with a robo.

BetaSmartz’s Mr James says automated guide-paths are used to adjust a client’s risk profile over time.

“Both adviser and client are notified of a change in risk profile and the algorithms automatically rebalance to account for changes in allocation,” he says.

In the case of Capital U’s more consumer-facing tool, Mr Einfeld notes that because client data is stored on a platform, the robo is aware of any changes in circumstances. Subsequently, the robo-adviser will notify and encourage the client to obtain a new plan.

“The new plan can be generated automatically based on their new situation,” Mr Einfeld says.

A grey area: best interest duty

Most of the criticism directed towards robo-advice relates to whether it can meet client best interest requirements.

ASIC deputy chair Peter Kell, speaking before Senate Estimates in Canberra in February, confirmed that robos must comply with legislation.

“We want to make sure that some of the potential new entrants understand that. It’s not suddenly the case that new rules apply because you happen to be robo,” Mr Kell says.

Paul Derham, partner at financial services law firm Holley Nethercote, says many robo-advice firms circumvent the best interest duty by branding their advice as general. “This is a very fluid area,” he says. “It’s a very grey area.”

Mr James confirms that – at least for BetaSmartz – this is the case.

“It is up to the adviser who has integrated the tool into his/her service to build on that [general] advice,” he says. “Ultimately, the adviser has to make a decision on the final allocation of a portfolio and, in that capacity, offers personal advice to the [client].”

Moreover, Clover’s Mr Chemay says the best interest duty is something of which robos are acutely aware. His firm – which is yet to go live with its tool – has directed both time and resources towards this issue.

“We feel that the most appropriate way for a robo-adviser to meet [the best interest duty] is to allow the client to define his/her financial goal(s) and risk tolerance, and thereafter utilise our tools to make the most appropriate investment decision,” Mr Chemay says.

Opportunities: integration

Most robo business models are based on the premise that robo-advice tools work best when integrated into an advice practice.

BetterWealth chief executive Jeremy Kwong-Law says robo-advice will help rather than hinder advisers.

“We’re going to [serve] customers that advisers can’t currently serve,” says Mr Kwong-Law. “We help the adviser maintain a relationship with low-balance clients so that they can engage in more strategic advice when the client’s balance grows to a meaningful level.”

However, the true value of robo-advice, according to Mr Chemay, lies in its ability to serve new cohorts of clients.

“There’s no real way that younger Australians and people with less money can get high-quality advice, particularly from independently-minded advisers, because [the advisers] can’t provide a solution at a cost that is bearable,” he says. “[Robo-advice is] a way for… planning firms to cultivate relationships with segments of the population that might have been uneconomic to pursue from a wealth management perspective.

“We see robo-advice and human advice working together in a hybrid model as… a way to grow the market for financial advice in Australia.”

Mr James adds that a white label robo-advice tool will help advisers scale their practice and reduce costs.

“Ultimately, by automating tasks such as rebalancing, tax loss harvesting, trading and compliance reporting, robo-advice frees up advisers to spend their time having meaningful conversations with their clients about their financial plans and goals,” Mr James says.

Source: http://www.adviserinnovation.com.au/2016/04/15/mind-of-a-robo/