Journal of Financial Planning: May 2016
Over the past year, there has been a lot of talk about robo-advisers as financial advisers try to determine how to best use this technology. But before you dive in, consider your business, the environment today, and most importantly—where this technology is headed.
First, let me try to explain to those skeptics why this is not going away. When it comes to new technology, there is always a mad rush and few winners remain. Robos are no different. As a matter a fact, the concept of robos is nothing new. Today’s robo-adviser is simply the same wealth management engine that professional advisers have used with a highly simplified interface, but with very limited investment solutions. Long-term, the robo model may take a path similar to that of online trading. Clients will continue to adopt as technology improves and fees may continue to fall. Understanding how today’s robos may impact the broader wealth management business may help maintain consistent revenue.
Robos of Today
Let’s start with the robos of today. There are many flavors in the marketplace, but essentially they all offer an investment solution process: ask a few simple risk questions, run automated anti-money laundering (AML) in the background, select an investment solution, fund the account, and then invest the assets. Normally, the investment solution offered is a simple allocation model with ETFs or mutual funds. Today’s robo models are managed in many different styles that can be classified into three major categories:
Robo rebalancer: look to achieve an allocation and continually rebalance based on a theoretical formula.
Robo specialists: some are tax efficient and others act as a sub-adviser using technology to perform some level of specialized investment function.
Wealth management hybrid: a market strategist manages the strategic long-term allocation long, while the robo rebalances based on various parameters. Normally this is a sub-adviser model. This model is least utilized today.
Clients likely do not understand these differences and therefore think they are getting the same products and services as a live person. Being able to speak to these differences will go a long way toward educating your clients and maintaining business.
As various robo platforms, especially start-ups, are trying to find a place in the market, some are starting to sell their technology as a solution. However, remember that the individual financial adviser or firm would be responsible for managing risk and investments.
The real question is how can robos benefit the adviser and the firm? Advisers have many different types of clients, some small and some large. As the number of clients grows, typically advisers hire an assistant or junior adviser to manage the smaller clients while he or she manages the larger clients. This model will eventually prove dysfunctional for many reasons, but mostly because the number of advisers is shrinking, fees are shrinking, and regulation is becoming more demanding. Embracing technology is the only way to create efficiency, maintain control, and still provide a suitable level of service for clients.
Robos of today will impact wealth management. Looking at parts of the wealth management process and relationship management helps to further understand the dynamics of the technology and its future.
Allocation Models
Allocation models have long been the cornerstone of added value that advisers provided, but with innovation, allocation models are holding less value. Having a trained market strategist reviewing the market and economic data and making forward-looking changes to the allocation model is something that robos cannot efficiently do today. It is this forward-looking intelligence and thoughtful rebalancing that continues to hold some value. Artificial intelligence might someday diminish a market strategist’s value, but that is likely five to 10 years away.
The bigger threat today is social media. Much like people search the Internet before going to the doctor, clients are searching social media for ideas. There are countless social media sites on investing offering users well-thought-out research reports on securities, sectors, and economic forecasts. And for free. But it does take a tremendous amount of effort and time to go through these sites. Of course, over time, this too will become easier.
Active versus Passive
For many years the industry has been hearing the argument of active versus passive. As the argument has evolved, I think that the real answer may be that passive is not for everyone and active is not for everyone. It really depends on what the client is trying to achieve. Many of the robos today have gravitated toward passive allocation models that auto rebalance.
Although most of today’s robos have driven prices down, they also typically offer the absolute minimum. However, a few technologies have started to take hold in the industry that may actually provide greater value to clients and greater efficiency and improvements to the wealth management process.
Account Aggregation
Understanding the client and monitoring the relationship are two constantly changing parameters of the wealth management process. Account aggregation has existed for many years, but only recently has this concept gained some traction. The true value will be how each firm interprets the information and how they use this information to manage the client. This knowledge and analysis may eventually be the distinction that builds the firm’s and the adviser’s brand. For instance, the data can be used to develop insight into clients’ behavioral patterns. How do they spend money? How do they behave in an up market, in a down market, or a family event? Aggregation can also be used for risk management and compliance functions.
Much of the analytical work can be performed with technology using predictive modeling. Letting technology do most of the work not only allows for immediate analysis but also accommodates continuous client communication and response.
Alerts versus Performance Reports
As robos develop, performance reports may play a smaller role in the wealth management process. Clients may not tell you, but oftentimes they first want to know three things: how much did I give you, what did you charge me, and what is my balance. Like it or not, the client is trying to first figure out if they lost money and then do a simple performance calculation. If they did not lose money, then they are ready to hear about indices, alphas, and betas. If they did lose money, you should address that first.
With aggregation and analysis, the conversation quickly changes as the client receives continuous feedback or alerts on their total financial well-being. For instance, the analysis may show that the client does not have enough cash flow to withstand a major negative market event, not enough cash to cover expenses due to job loss, not enough insurance given their lifestyle, etc. With the ability to provide continuous and predictive feedback to the client, clients are no longer waiting until the end of the month for the backward-looking performance report.
Financial Planning
Financial planning today is a process that takes a tremendous amount of time. Tomorrow’s robos can also be developed to involve clients in the planning process. Clients can easily answer some questions online and then, if needed, finish with human interaction. This collaboration puts the client in the middle of the process. This trend will continue as systems get better and clients get more tech savvy. Add to the process account aggregation that automatically updates information, and the planning process just got much easier.
Compliance and Regulations
Regulation is something that everyone in every industry struggles with, and it is only going to get harder. Recently appointed President of the Federal Reserve Bank of Minneapolis, Neel Kashkari, announced that there isn’t enough regulation for the banks. Further regulatory mandates are not stopping anytime soon.
There is a tremendous amount of concern among compliance professionals concerning robos and account aggregation. To that I would say, if developed correctly, a robo platform can be a compliance professional’s best friend. Compliance professionals are often not technologists, so it can be hard to envision the benefits, so let’s try to quantify.
Improved “know your customer” or KYC. Today the industry generally asks a few questions and calculates risk and investments parameters. The new world—which includes clients collaborating, holistic financial planning, and account aggregation—offers transparency into the client. This information is continuously updated, reviewed, and analyzed with input directly from the client. Simply put, KYC of the future can be a very dynamic solution with financial planning being the new KYC standard.
Risk management. Dynamic updates not only improve KYC standards but continuous risk management assessment is now also possible. For example, adding a new KYC requirement is simply a blast out to clients, and responses are recorded and integrated into the wealth management and risk management process.
Record retention. Of course with more robust and automated inputs from clients, advisers, and the firm, the record retention is more efficient and effective.
Almost any level of automation is good, but it does take time to perfect. Knowing what should be automated will go a long way toward improving the risk and compliance process.
The Future
Although robos will take some time to develop, there is no doubt they will create new wealth management and compliance standards in the industry with clients being engaged in the process. Unfortunately today’s solutions largely provide an investment-only solution. Advisory platforms such as Envestnet and Genpact are trying to get to a better solution.
It might be a surprise, but the future leaders in this space may actually be the CRM platform providers such as Microsoft, Oracle, and Salesforce. These companies probably do not realize they already have the core database and automated process flow infrastructure in place today. Adding some functionality mentioned here and other inputs, such as social media data, can provide a comprehensive and interactive mobile-ready wealth management solution of the future.
Ash Bhatnagar, CFP®, is an innovation and wealth management expert with extensive background in integrating technology into business, compliance, and operations. His tenure includes major bank broker-dealers, custodians, and independent RIAs. Contact him HERE.