Robo-advisor

Robo-advisor (robo-adviser) is an automated, algorithm-driven wealth management service provided through Internet.
Robo-advisors can also be referred to as “robo-advisory”, “automated investment advisor”, “automated investment management”, “virtual adviser” and “digital advice platforms”.
The Sovereign Wealth Fund Institute (SWFI) defines robo-advisors as a type of financial advisor that provides web-based portfolio management with almost zero human intervention, typically using algorithms and formulas.

A robo-advisor collects information fr om clients about their future goals and financial situation through an online survey, and then uses the data to offer advice and/or automatically invests client assets. Robo-advisor represents the example of a software robot that communicates with Investors through smartphone apps or PC over the web.


History

The first robo-advisors appeared between 2006 and 2008. Major factors that helped robo-advisors rise to prominence towards 2018:
  • tremendous market penetration of smartphones, PC and Internet;
  • growing wealth of a generation of millenals who are accustomed to buying services through the Internet;
  • increase of popularity to purchase of services through the Internet among high-net-worth regulars of traditional investment firms
  • tightening of international regulations in favor of investor protection.
The initial purpose of robo-advisor was to rebalance assets within target-date funds as a way for investors to manage passive, buy-and-hold investments through a simple online interface. The technology itself was nothing new. Human wealth managers have been using automated portfolio allocation software since the early 2000s. But until 2006, they were the only ones who could buy the technology, so clients had to employ a financial advisor to benefit fr om the innovation.
The difference between robo-advisors and wealth management firms is in distribution channel. Until recently, wealth management services were sold almost exclusively by human advisors. At the same time wealth managers used specific analytical platforms to manage client's portfolios. The advent of modern robo-advisors allowed consumers to directly communicate with server that conducts the whole wealth management process through Internet. After a decade of development, robo-advisors are now capable of handling much more sophisticated tasks, such as tax-loss harvesting, investment selection and retirement planning.

The industry has experienced explosive growth, assets under management of robo-advisors hit $60 billion at year-end 2015, and is projected to be in a range of $3 to 5 trillion[1] by 2020.

Regulation

Robo-advisors hold the same legal status as human advisors. In the US, they must register with the Securities and Exchange Commission and FINRA to conduct business. In the UK, they must register the FCA, in Russia - Central Bank, etc. Robo-advisors are usually subject to the same securities laws and regulations as traditional broker-dealers.
In US the official designation is “Registered Investment Adviser,” or RIA for short. Investors can use BrokerCheck (FINRA supported) to research robo-advisors the same way they would a human advisor.
Assets managed by US-based robo-advisors are typically insured by the Securities Investor Protection Corporation (SIPC).

Regulatory initiatives

Jurisdiction Institute Initiative
Global IOSCO Regulators identified three areas wh ere additional guidance from IOSCO they count to be helpful: 
  1. Best practices for financial advisors providing advice via automated tools.
  2. Principles of designing an automated advising tool.
  3. Principles to regulate financial advisors that use automated tools.
 US FINRA FINRA focused[2] on investor protection concerns in the following areas: 
  1. provision of portfolio analisys,
  2. governance and supervision of algorithms, 
  3. supervision of portfolios and conflicts of interest,
  4. effective customer profiling,
  5. implementation of effective practices for automatic rebalancing,
  6. implementation of effective training and attestation practices for financial adisors.
US SEC The SEC and FINRA has issued a joint Investor Alert[3] advising that investors using robo advisors consider the following: the terms and conditions, tool limitations and key assumptions, dependency on client inputs, and information security controls.
US Massachusetts Securities Division In July 2016, the Massachusetts Securities Division issued regulatory guidance that requires state-registered investment advisors that use a third party robo advisor to provide asset allocation and trading functions to: 
- clearly identify the robo advisors it work with, 
- inform clients if financial advisory services could be obtained directly from the third party robo advisor, 
- inform the ways robo advisor provides value for its fees, 
- inform the services robo advisor cannot provide, 
- clarify the third party robo advisor may lim it the investment products available to the client, and 
- use understandable English to outline the robo advisor’s services.

In April 2016, the Division has stated: “robo-advisers, as currently structured, may be inherently unable to carry out the fiduciary obligations of a state-registered investment adviser.”[4]
EU EBA/EIOPA/ ESMA  European supervisory authorities (ESA) published a Discussion paper on Automation in Financial Advice. The Discussion paper has statement that “’advice’ is used in the common meaning of the word.” European regulatory framework distinguishes between multiple types of advice and guidance and imposes different standards on the providers of advice. Many of the risks identified by the ESAs come out of consumer biases, which have been identified in traditional advice models and by analogy are applied to digital advice.
Russia Central Bank
Federal law 39-FZ.
UK FCA      The Financial Advice Market Review (FAMR) has made a number of initiatives to provide greater regulatory clarity:
- setting out clear duties and scope of liabilities for different definitions of advice 
- implementation a "specialized advice unit" to facilitate the development of automated advice models.

Business Process


Robo-advisor business process contains the following sequential steps:
Client profiling, Asset allocation, Portfolio selection, Trade execution, Portfolio recalculation, Tax-loss harvesting, Portfolio reporting and Governance.

Market position

Table. Typical robo-advisor market position features.

Features Most common values
Available countries US, UK, Germany, Canada, Italy
Account minimum No minimum, €100, €250, €1000, €5000
Investment instruments ETF, ETC, Stocks, Mutual funds, Life insurance
Fees Asset management fee on invested money per annual, 
Transaction cost per transaction, 
Front fee, 
Exit fee, 
Perfomance fee.
Financial planning tools
Goal based planning, 
Expected return forecasting
Personalised Investment Portfolios Model portfolios, 
Mannually adjustable portfolios, 
Fully personalized portfolios
Rebalancing Yes / No
Investment management
Automated, 
Human managed, 
Hybrid management
Human assisted advice Personal advice on demand, 
Personal advice for customers with assets that exceeds certain level, 
Investment coaching
Mobile application user interface
iOS application, 
Android application
Promotion First €10000 are managed for free; 
Referral program with the reward for both the reffered person and referrer; 
Welcome bonus of €50-100; 
Guaranteed interest rate for first €10000; 
Free management for 3, 6 or 12 months. 

Robo-advisors are extending into newer business avenues:
- Video and voice client profiling;
- Usage of predictive analytics based on Big Data;
- Usage of self-learning algorithms;
- Quick and easy account opening process;
- Automated deposit of assets for management to accurately follow accumulation goals;
- Security protocol eliminating conflict of interest;
- Implementation of trustless business processes.

Benefits of Robo-advisor

Lower-cost in comparison to human advisors. By eliminating human labor, online platforms can offer the same service at a fraction of cost. Most robo-advisors charge an annual flat fee of 0.2% to 0.5% of a client’s total account balance. That compares with the typical rate of 1% to 2% charged by a human financial planner, and potentially more for commission-based accounts.

Available 24/7 as long as the user has an Internet connection.

Less capital to get started, as the minimum assets required by financial advisor is about $50000. Several popular robo-advisors have no account minimum at all, other require account minimum from $1 to $5000.

Better emotion management. Robo advisors emotionlessly rely on a strict process to make sure a client’s portfolio is efficient.

References

[1] (07.2006). Robo Advising Catching Up And Getting Ahead. p.4. KPMG.
[2] (03.2016). Report on Digital Investment Advice.
[3] (May 8, 2015). Investor Alert: Automated Investment Tools  SEC.
[4] (April 1, 2016). “Robo-Advisers and State Investment Adviser Registration”. Massachusetts Securities Division, Policy Statement.

Futher reading:

• Robo-Advisors and Wealth Management
• Robo-Advisory in Wealth Management
• The Future of Advisory: Exploring the Impact of Robo on Wealth Management
• Wealth management through robo advisory
• Automated Advice: A Portfolio Management Perspective on RoboAdvisors

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