Robo-advisers: will they step into the breach?

Robo-advisers: will they step into the breach?

According to the Financial Times about two-thirds of financial products are now sold without professional financial advice compared to a much lower 40% three years ago.

RDR has created a playing field where advisers have to charge fees – rather than getting trail commission and platform rebates – and this is at least partially responsible for people on lower incomes, or with limited assets, not being able to afford, or being reluctant to pay for, financial advice. Those with high incomes are understandably far more willing and able pay for financial advice.

The number of advisers has also reduced – from 40,000 in 2011 to 31,000 in 2013 – and many of them are specifically targeting the ‘high net worth’ consumer segment, which, coupled with some of the banks stepping back from offering investment advice, has also increased the advice gap.

The government’s Financial Advice Market Review (FAMR) is currently examining the advice gap issue. Interestingly FAMR also suggests that the Financial Conduct Authority should help firms to develop automated services and with the online channel being the most preferred route to purchase for those not using financial advice, there is a significant need to help support these consumers to make better, more informed financial decisions.

Into this market place has stepped a new breed of service: the robo-adviser. It’s a digital wealth management service, which uses algorithms to give portfolio management advice without involving human financial advisers. The consumer signs up for robo-advice online, or through an app, and then answers a series of questions designed to capture information about income, capital to invest, investment goals and attitudes to risk. Based on these responses the automated investment software selects the investments, often in low-cost exchange-traded funds (ETFs), and will also continually rebalance the portfolio. Using ETFs enables greater automation and keeps overheads low.

Robo-advisers are typically low cost with low minimum investment requirements and, as our recent research suggests, are more attractive to younger investors.

They can be attractive to those either too busy and/or averse to paying for face-to-face advice. Some hybrid services are available which also allow human interaction if required and I expect these to become increasingly prevalent as they could be used as a menu-option supplement to the existing advice channels offered by financial advisers.

The robo-advice market has made much greater inroads in the United States than in the UK and, interestingly, one of the US’s more recent entrants, Bloom, uses a flower to portray how the client’s portfolio is doing, which is rather more engaging than the usual graphs and charts prevalent elsewhere. If your investments are doing well you’ll see the flower growing, you don’t want to see it wilting!

Those averse to robo-advisers often cite a number of potential shortcomings. These range from possible failure to take account of changing personal circumstances, inability to offer tax advice and not offering guidance on managing income in retirement. Our research also suggests that some consumers distrust automated online services and this is especially of true of the older market. It is also true that human advisers are much better placed to encourage their clients to take proactive decisions in making provisions for their retirement income needs and those of their dependents. This is particularly relevant given that many financial products, for example protection policies, have to be ‘sold’ to consumers and are rarely actively sought.

Robo-advisers won’t suit everyone and there is still a challenge for the industry to convince some consumers of this as a viable alternative form of advice, but, for low cost passive financial management they’re filling a need and could go some way to help instill consumers with the confidence to make their own decisions and fill the current advice gap. If you prefer the human touch, or have complicated tax, estate planning, business or retirement circumstances, face-to-face traditional financial advice is likely to remain the choice.

I’d certainly see it as advantageous if robo-advisers flag up an automated referral process to appropriate third party advice for consumers with complex financial circumstances. While robo-advisers are still-relatively low-key in the UK consumer conscious, my view is that they have considerable potential to gain traction in the future especially amongst younger generations.