By Hilary Schmidt, International Banker
For the world of wealth management, the COVID-19 pandemic proved distinctly transformative, particularly in terms of the way market participants—from simple retail investors to fund managers—approached investing amidst an often heavily restricted physical environment. And it is against this backdrop, as well as the continued focus by financial firms on digitalisation, that should see robo-advisory flourish throughout the rest of the 2020s.
The social-distancing regulations placed on individuals, households and businesses meant that face-to-face interaction took a backseat throughout the last few years while digital activity—whether through advisor-client meetings or the actual investing procedure—came to the fore. And with robo-advisory ideally set up for those who favour the online world, it should come as no surprise that this particular asset-management segment has been thriving of late and is expected to continue over the next decade.
For those unfamiliar with this automated form of portfolio management, robo-advisory represents an online investment-management service with little or no human input. Instead, robo-advisors provide digital financial advice optimised using algorithmic methodologies. The invariably complex algorithms are typically created by data scientists and quantitative financial engineers within the robo-advisor firm and are employed to determine the best portfolio allocation based on the customer’s investment risk and return preferences. They are then run using software such that the need for a human advisor is all but eliminated.
It is also worth remembering that it was in the wake of the previous major financial crisis—the 2008 Global Financial Crisis (GFC)—that robo-advisory first came to the fore, with companies such as Betterment and Wealthfront diving into algorithm-based portfolio-allocation methods as a low-cost, more convenient alternative they could offer customers compared with traditional asset-management services.
As the concept evolved over the last decade, it became clear that this form of investing was more suited to smaller and often younger retail investors who wanted a well-diversified portfolio but might not necessarily have had a lot of time, money or even experience to construct it (or use a traditional asset manager to do so). “Robo-advisors, well adapted to operating digitally, were able to cater to previously underserved customers like younger investors who are in the early stages of wealth accumulation,” Shelleen Shum, eMarketer senior forecasting director at Insider Intelligence, noted in June 2021. “Robo-advisors are also attractive because they are often quicker to adjust investment holdings in real time with the use of algorithms.”
Today, as retail investors have expedited their shifts to online wealth-management services, the robo-advisory world has expanded in scale and scope accordingly, with investment platforms across banks, fintechs (financial technology firms) and digital start-ups now offering highly tailored automated investment services. For example, in May 2020, the Singaporean banking major United Overseas Bank’s (UOB’s) asset-management unit launched its robo-advisory service, UOBAM Invest, which offers corporate customers a “customised portfolio based on your company’s investment goals, risk tolerance level and investment horizon”.
Indeed, the integration of robo-advisory into the business models of banks, asset-management firms and other financial institutions underlines how popular automated, algorithmic investment services have become. And with the ability to offer such perks to customers as tax-loss harvesting, low-cost fees and rational, efficient decision-making, this burgeoning industry is expected to see substantial growth over the next few years.
That said, not everyone is piling into robo-advisory with as much ebullience as one might expect. A recent report from wealth-management analytics firm ParameterInsights found that investors in the United States have used robo-advisory services less in 2022 than in previous years. Instead, high-net-worth investors are seemingly returning to traditional advisor channels with full-service financial planning. According to the report’s figures, the net usage of digital advisors declined from 27.7 percent in 2021 to just 20.9 percent in 2022, meaning that usage has fallen by nearly one-quarter. “Struggling self-directed investors are not only faced with friction-filled transfer costs but also ambiguity in the value proposition associated with digital advice compared to self-directed approaches,” ParameterInsights explained. “As a result, firms are losing opportunities to help myriad consumer segments that are desperately in need of advice during the market tumult.”
And in terms of investors’ assets, those earning the highest sums were most reluctant to continue using robo-advisors to manage their investments. Those earning $50,000 or less experienced a drop of three percentage points in robo-advisory usage, while those earning $50,000 to $99,999 used digital advisors 14.2 percent less. And for those earning $500,000 or more, robo-advisory use plummeted by a whopping 23.8 percentage points. “These higher-net-worth customers have been targeted by traditional advisor channels and are being enticed with full-service financial planning,” the report noted, adding that younger investors retained their digital advisors at higher rates than older investors. Women were also more likely to hold on to their robos than men.
Given this alarming decline, it should not be a shock to discover that a growing number of financial firms have been streamlining their robo-advisory operations, with major players, including Morgan Stanley and Fidelity Investments, recently consolidating their respective platforms. Morgan Stanley announced in October that it would move its Access Investing robo-advisor business under the umbrella of E*Trade from its Core Portfolios. And Fidelity also announced during the same month that it would combine its Fidelity Go and hybrid Personalized Planning and Advice robo-advisors. “At Fidelity, we are always evolving our offerings to meet customer needs,” the firm stated. “With this change, we will extend the benefits of Fidelity Go for younger and emerging investors through no advisory fee for accounts under $25K, and provide the coaching and planning of Personalized Planning and Advice at a new lower price for investors with accounts over $25K.”
And while some robo-advisors have been undoubtedly successful in generating positive earnings and delivering for their customers, others have not. In turn, this raises questions about the variance in performance across the industry, as the degree of personalisation, engagement and human involvement can dramatically distinguish one robo-advisory service from another.
“Some studies show that robo-advising improves portfolio allocations, reduces excessive consumption, and allows individuals to improve their debt management and reduce interest and fee payments on their outstanding debt accounts. Robo-advisors have the potential to level the playing field between wealthy and vulnerable households in personal finance, especially when it comes to individuals with low levels of financial literacy,” Francesco D’Acunto, associate professor of finance at Georgetown University’s McDonough School of Business, and Alberto Rossi, professor and director of the AI, Analytics, and Future of Work Initiative at McDonough School of Business, wrote in an October 5 piece for Brookings Institution. “At the same time, the positive effects are by no means unambiguous and universal. Certain robo-advisors for investment decisions have been found to stimulate too much trading on the part of the investors. Others are too expensive relative to the benefits they provide to their users. It appears that the effectiveness of different robo-advisors, similarly to that of human financial advisors, rests on the details of their implementation.”
Nonetheless, with digitalisation at the heart of the evolution of financial services over the next few years, many expect the robo-advisory industry to continue to evolve and grow significantly. Market analysis published by Grand View Research in late August, for instance, foresaw the global robo-advisory market—valued at $4.13 billion in 2021—growing at a compound annual growth rate (CAGR) of 29.7 percent from 2022 to 2030. Much of this growth will be driven by widespread digitalisation in the financial sector, the report predicted, which will “enable users with tech-enabled analytics offered by robo advisors for investment consultations”.
The report also noted that the rapid shift from traditional investment services to robo-advisory investment services was another major contributory growth factor, while the outsized impact of the COVID-19 pandemic will continue to drive expansion during the forecast period to 2030 significantly. “The pandemic has boosted the global demand for digital financing, robo advisors, financial planning solutions services, and investment management,” the report stated.