While my previous post on innovation within the financial industry considered the vastly differing global attitudes to FinTech broadly, this post will look specifically at Robo Advisors. Customers depend on Robo Advisors for a variety of services varying from chatbots such as Bank of America’s Erica for assistance with basic questions to large digital wealth management companies such as MoneyFarm. Robo Advisors create a portfolio for their clients based on Modern Portfolio Theory and the investment aim, risk tolerance, financial capability and expected return of the client. Once this information has been provided, Robo Advisors closely monitor the portfolio to ensure it maintains optimal asset class weightings.
Advantages
The advantages associated with Robo Advisors are numerous. Robo Advisors commonly allocate assets in equities and domestic blue chips which fluctuate regularly, and government bonds which are far less volatile enabling a consistently balanced portfolio. Johnson identifies tax-loss harvesting using algorithms as another balancing strategy used by Robo Advisors who sell loss securities ‘by offsetting a capital gain liability in a similar security’.[1] In this sense, Robo Advisors possess considerable advantage as traditional brokerage firms attempting rebalancing would generate significant transaction fees due to the time-consuming nature of the methods. Arguably, Robo Advisors provide more transparent cost-structures compared to human advisors who are ‘more prone to misguided, incentive-based compensation schemes’.[2] This links to another perceived benefit of Robo Advisers: the absence of emotion which can be highly influential and potentially inefficient in human advisor relationships. Clients may be suspicious of investments banks’ ulterior motives due to their long-standing reputation for placing the relentless push for capital above the interests of clients. One of the most attractive aspects of Robo Advisors is their accessibility to retail investors who are not discriminated against based on resources. They serve as an ideal solution to inexperienced investors who lack expertise, time or those with lower portfolio values as who may primarily hold exchange-traded funds.
Disadvantages
While Robo Advisors offer a wider range of investing prospects particularly for investors lacking time for research, they are still limited to specific investment options. Many Robo Advisors do not access more than 12-25 funds and may be unable to invest in closed-end funds, individual stocks, bonds and currencies.[3] This underlines another disadvantage as Robo Advisors rarely beat the market due to their tendency to match market performance and follow an index fund investing strategy. The extent to which Robo Advisors can be described as a personalized service is dubious and has been used as a source of criticism. While investing options are determined by the individual profile of clients, in the event of uncertainty, Robo Advisors are unable to physically meet with clients, provide reassurance and diminish fears by explaining the current situation and market shifts. Consequently, there is a case for a lack of personalization which results in a reluctance to trust Robo Advisors.
Influential Factors
The likelihood of individuals trusting Robo Advisors usually depends on cultural and demographic factors which applies to the acceptance of FinTech in general. Global acceptance rates vary with Robo Advisors being popular in the United States, UK, Canada and Europe but exhibiting low levels of awareness and acceptance in India. This trend could be attributed to the stringent regulatory environment as all advisors must comply with the Securities and Exchange Board of India’s guidelines. While India has a couple of prominent Robo Advisors such as Scripbox, Goalwise and 5Paisa, tech start-ups are rising at a slow rate and the lack of knowledge contributes to a preference for traditional brokerage firms.[4] The Hofstede insights provide compelling evidence for the link between cultural dimensions and the popularity of Robo Advisors. The USA and UK are far more comfortable with uncertainty in comparison with countries such as Portugal potentially due to their high masculinity scores. These insights indicate that countries with high masculinity scores are driven by achievement and success making Robo Advisors an opportunity to compete for financial value. Elements of gender across countries evidently impacts approaches to Robo Advisors, this trend can also be applied on an individual scale. Brenner finds female investors more likely to choose human financial advisors and suggests male investors ‘due to overconfidence in their own financial skills – are less likely to seek financial advice from professionals’.[5] The shifting of responsibility from financial institutions to individual investors has been a widespread point of concern as investment decisions could be detrimental in the absence of sound financial knowledge. Naturally, those lacking sound knowledge are usually the young and inexperienced, yet Robo Advisors are most popular among ‘tech-savvy millennials’ who have insufficient funds for traditional investment advisors but still pursue diversification.
Final Thoughts
In conclusion, responses to Robo Advisors are diverse with many encouraged by the absence of conflicting interests while others are reluctant to place their trust in machines. The environment is unpredictable with Robo Advisor Moola set to close at the end of the month citing slow growth rates and high acquisition costs as the cause.[6] However, the shift towards machine-driven investing strategies has been an enormous success in other cases such as Systematica, the firm relying on quantitative, algorithmic trading. CEO Leda Braga summarises her strategy’s potential with the offer of stability as “When a trader is forced to sell at a loss, he takes that home with him… a black box doesn’t care”.[7]
[1] Jeby Johnson, ‘Robo Advisors: An Innovative Financial Technology for Investment Management’, Our Heritage Journal (2020) p.12.
[2] Lukas Brenner, ‘Robo-Advisors: A Substitute for Human Financial Advice?’, Journal of Behavioural and Experimental Finance (2020) p.1.
[3] Jeby Johnson, ‘Robo Advisors: An Innovative Financial Technology for Investment Management’, Our Heritage Journal (2020) p.14.
[4] Jeby Johnson, ‘Robo Advisors: An Innovative Financial Technology for Investment Management’, Our Heritage Journal (2020) p.15.
[5] Lukas Brenner, ‘Robo-Advisors: A Substitute for Human Financial Advice?’, Journal of Behavioural and Experimental Finance (2020) p.5.
[6] ‘Robo-advisor runs out of Moola and shuts its doors’, https://www.professionaladviser.com/news/4009086/robo-adviser-runs-moola-shuts-doors.
[7] ‘Trading Legends: Leda Braga’, Trader Life – https://traderlife.co.uk/series/trading-legends/trading-legends-leda-braga/.
Financial Institutions 1850-2020 