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Financial advice usually requires a demonstration of the adviser’s trustworthiness, experience and track record. But it may no longer be enough.
The emergence of algorithms that automatically calculate the best course of action for an investment or insurance plan threatens to unseat humans, who lack the evidence of hard data.
Robo-advisers are a category of websites that use algorithms to automate online investment decisions for far less than a human consultation. Robo-adviser sites already have US$14 billion under management, according to Swiss research agency MyPrivateBanking Research. This already sizeable asset pool is forecast to grow to US$255 billion within five years, reports the Financial Times.
Automated advisory sites such as Betterment and Wealthfront in the US or Nutmeg in the UK target the lower end of the investor market.
They charge below 1 per cent with a low minimum portfolio value. (Betterment charges US$13 a month, plus 0.15 per cent annually.)
A bad rep
The rise in robo-advisers is due to several converging trends. The global financial crisis and a string of financial planning scandals in Australia and elsewhere have eroded the public’s trust in financial advisers.
‘Active’ investing may be too difficult to do well. “An active manager will charge a higher management fee and try to beat the market through stock selection,” says Andrew Bird, CEO of Sharesight, a portfolio admin and tax reporting tool. “Lots of research shows that most managers don’t succeed.”
Instead, investors are deciding to match the market, save costs and use robo-advice to construct the portfolio, says Bird.
The most recent revelations of NAB and Commonwealth Bank employees short-changing clients to gain commissions have also reinforced concerns over independence. A report released by Roy Morgan in late May 2015 showed that 75 per cent of investment products recommended by Australia’s four main banks and AMP were from an aligned funds management group.
Australia has only one bona fide robo-adviser site – Stockspot. Founder and CEO Chris Brycki says that although Australia is a few years behind the US, the high cost of advice and the cost of investing – not to mention the attraction of unconflicted advice – will drive younger investors towards algorithm-based services.
“In the future, there will be more separation between those providing advice and investments,” says Brycki. “We don’t manufacture the products or receive any payments [in commission]. That allows us to
pick and choose the best ones.”
Brycki adds that compared with the “thousands of dollars” charged by human advisers, Stockspot charges an annual advice fee of $77. The funds management fee costs 0.5 per cent to 0.9 per cent per year.
Stockspot has only a one-year track record, for which it scored 13–14 per cent. This was in line with balanced super funds. “We tell investors to expect a bit less than that, say 6 to 9 per cent a year,”
The trend to replace advisers or consultants with algorithms is occurring in the big end of town, too.
Earlier this year, Ernst & Young Australia acquired two analytics companies – C3 Business Solutions and ISD Analytics – for undisclosed sums. The move followed a similar acquisition of Analytics Group by Deloitte Australia last year.
While neither company intends to launch its own robo-advisers just yet, analytics is a lucrative service in high demand by mid-size and enterprise companies. Deloitte has 100 dedicated staff in Australia in its business analytics division.
The big four accounting firms are using analytics to replace more conventional management consulting, according to Les Coleman, a Deloitte partner in business analytics. He gives the example of a bank reviewing its retail branch footprint: typically, it would hire a consulting team to view last year’s reports and decide which branches to close and where to open new ones.
Instead, Deloitte is creating an analytical model that the bank can use to find the best combination based on that month’s data.
“Markets are very dynamic,” says Coleman. “The ability to play various scenarios and refresh inputs is crucial these days. It’s literally changed the way [the bank’s] team goes about making decisions on branches. It gives a different view of what drives success and failure of their locations.”
Management consulting is no longer so attractive to enterprises, says Coleman. The new crop of senior executives does not comprise lifelong bankers, but former McKinsey or other consultants.
They want to own the intellectual property in the algorithm created for them and use their own staff to forecast scenarios.
Executives now have “a very clear appreciation of how our business works and they want to get value in a different way”, states Coleman. “They don’t want just an answer, they want a capability. It’s endemic in the market.”