Robo-Advisors vs. Digital-Assistants
Robo-Advisor as Game Changer?
The investment services industry has been buzzing with automation ideas for a while. There are two general types of market solutions. In the FinTech world, simple and slick ‘Robo-Advisors’ grab headlines. In the incumbent camp, functionality-rich ‘Digital-Assistants’ help banks to automate service operations. Both solutions have yet to prove their sustainability. Can either or both solutions disrupt the traditional wealth management model? The question nags at investors and financial institution leaders, cautious not to be caught up in the FinTech storm of hype which venture capitalists conjure with excess capital.
In this context, 360F gets up close with these solution providers to understand their business models and offerings to make a grounded assessment.
Simplify vs. Enhance
Robo-Advisors trumpet their successes in simplifying investment services. At the last count, among the 14 FinTech start-ups delivering Robo-Advisors in Asia, a majority touts simplified client experience, low flat fees on ETFs (0.25%–0.75% fee on AUM) and automated advice on digital content for direct to consumers.
However before a bottomless pit of fire, the same trumpet sound causes plumes of smoke to block the sunlight. Conceptually, Robo-Advisors enable direct-to-consumer models by providing the basic elements of wealth management advice. They eliminate the traditional reliance on human advisors and ultimately generate fundamental economics of scale to penetrate the underserved segments. Realistically, they are prone to underestimate the complex environment they are in. (See Table 1)
In UK where Robo-Advisors have had an early start, the regulatory watchdog notes that many appear to stray into giving advice without possessing the requisite regulatory permissions or following the appropriate regulatory procedures1. A sample of 10 UK Robo-Advisor firms reveals evidence of misleading performance calculations, questionable statements regarding fees, missing pages of key legal documents, and questionable claims. 8 out of 10 of websites use risk questionnaires as basis of recommendations but 25% of these firms do not possess the regulatory permission to give advice to retail clients.
While one camp trumpets, another camp toils. Established far before the FinTech storm, Advisor-assisted digital wealth managers (“Digital-Assistant”) have a track record of several years. Unlike Robo-Advisors which are standalone solutions for the retail client, Digital-Assistants are already integrated into the advisory processes of the financial institutions and fully governed under the latter’s compliance umbrella. Digital-Assistants thus do not independently run into unknown regulatory complexities experienced by the Robo-Advisors.
Digital-Assistants are expert tools rich in functionalities. They support elaborated analysis across an universe of standard and non-standard financial instruments, enabling the human advisor to make sound recommendations and create customized solutions ranging from pricing to lending. Digital-Assistants also offer value-added services such as data aggregation capabilities to facilitate a comprehensive view of client assets and liabilities and even expense tracking. (See Table 2)
Such services build the basis of holistic advice – the foundation of financial planning which Robo-Advisors, to date, have not addressed comprehensively. The sophisticated capabilities come at a price though. Digital- Assistants fall behind Robo-Advisors in terms of ease of use. While Robo-Advisors are simple enough to be used as a B2C tool, Digital-Assistants are far more complex such that only trained experts can understand and use. The customer journey offered by Robo-Advisors are therefore much more slick than that of Digital- Assistants.
“Robot or human: which is the best wealth manager?”
— FT, August 2016
The fundamental difference between the Robo-Advisors and the Digital-Assistants lies in their advisory concepts. Robo-Advisors declutter the customer journey to simplify advisory and reduce cost while Digital-Assistants enhance the journey to support the complexities and customization needs. Both concepts can co-exist in view of customer segmentation needs – the retail vs. the affluent & high net worth investor.
The Retail Investor
For the typical retail investor, transaction costs make or break an investment. The investor with a wealth of 100,000 USD will generate on average an investment revenue of around 2,000 USD per year. In the wealth management industry, one service hour covering all required front, middle and back office functionalities cost between 500 and 1,000 USD. Hence, a retail investor with 100,000 USD can afford to consume two to four hours of advisory per year. This amount of time is sufficient for a one-off sale, but not for tracking or manual adaptation of the investments following market or profile changes. The only way to stay in touch with the retail clients over time is to automate services to keep the transaction costs low.
Banks can support the need for low transaction cost by integrating robo-based investment advisory tools into the customer journey. Automated advisory is in fact a logical extension of the savings account. While almost everyone has a savings account, only 32% of the retail segment hold investments, contrasting the behaviour of the affluent segment where more than half invest. (See Chart 1)
To illustrate the possibility, consider OCBC’s 360 Account. It rewards customers’ commitment with OCBC. Account holders earn bonus interest by linking the account with salary deposits, bill payments, OCBC credit card spending, insurance policies or investment products purchased from OCBC, and increasing their average balance each month. The aggregation of transactions pre-disposes the bank to understand its customers’ financial profile. It also shapes up a customer journey with multiple automated touchpoints. Leveraging the data and journey, an integrated Robo-Advisor adds synergistic value by offering investments at a low cost with some customizations, e.g. five to seven Model Portfolios based on ETFs.
The Asian Affluent and High Net Worth Investor
In contrast to the retail investors, the affluent and high net worth investors need tailor-made portfolios and can afford advisory. The typical Asian affluent and private banking customers seek holistic service and solutions including lending, single equity, thematic strategies, non-liquid investment opportunities etc. They expect not only tailor-made solutions but also personal attention dedicated to service their portfolios actively.
The need for advice will be more rigorous in Asia than in other parts of the world. Digital-Assistants are strategically positioned to support this need. Backed by an annual growth potential in wealth of 10.3% until 2020 in Asia compared to the 3.6% in Europe and 4.5% in the US, the Asian market is a fertile ground for tailor-made or customizable investment solutions. Replicating one-to-one the classical Western wealth management model in Asia has yielded little, if at all, success. In Asia, the first generation holds the bulk of the wealth. Wanting direct control over their hard-earned money, this generation does not favour the discretionary mandate adopted broadly in Europe. Their next generation, i.e. the millennials who will inherit the wealth, desires control too. They want to make their own investment decisions but are open to advice. It is expected that the advisor task force will grow by 15% annually on headcount until 2020 to cope with the demand for expert advice. However a talent recruitment overdrive is expensive and incurs compliance cost exponentially. Integrating Digital-Assistants into the advisory process will support scalability, increase efficiency and control (compliance) risks.
The Asian investor segment is generally sensitive to cost, even including the affluent and high net worth investors who can afford it. Hence low transaction-cost solutions suitable for the retail segment can also appeal to the affluent and high net worth segment, as part of the latter’s portfolio mix. It is in the spirit of financial advisory to offer a modular service model and serve the customers according to their needs and affordability. (See Chart 2)
A Bold Forecast for Robo-Advisors and Digital-Assistants
Depending on customer segments, Robo-Advisors and Digital-Assistants can co-exist. However the solutions’ sustainability in the market goes beyond their positioning. To drill further into the disruption potential of Robo-Advisors and/or Digital-Assistants, 360F assesses their underlying future distribution models.
Robo-Advisors: An Unscalable Future
Robo-Advisors will enjoy initial double-digit growth rates in the retail investor segment. The growth will be based on low-cost distribution channels with significant customer base — social media, online retail platforms and partnerships with employers to name a few. The US market has proven how the Robo-Advisors benefit from such channels. Wealthfront partners with Facebook, Google and Twitter while Bettermind works with Uber. Wealth-front manages, to date, 4 bn USD AUM and Betterment 5.1 bn USD. Online-Platform Schwab Intelligent Portfolios takes the icing on the cake, managing in less than one year 5.3 bn USD.
The strategy to cooperate with partners in a digital eco-system will kick off the growth momentum but is only viable as a door-opener. To sustain the momentum, Robo-Advisors must integrate into customer financial journeys which are in first contact with customers’ funds. Accordingly, banks are attractive candidates, as illustrated in the example of OCBC’s 360 Account.
However, Robo-Advisors will not have easy access to banks’ customer base. Established banks remain reluctant to cooperate with Robo-Advisors in spite of the latter’s active sales efforts. High entry barriers exist. Regulatory complexities surrounding Robo-Advisors will require active management. Existing legacy IT systems are far from ready to support the direct channel with slick customer journeys offered by Robo-Advisors. Banks also refrain from fragmenting the IT landscape to support different customer segments. Huge investments and deep expertise are therefore needed to develop the technology for the banks, as in the case of the strategic alliance between SigFig and UBS US. Some consultancies step into the gap to support the banks to develop from scratch a new customer journey.
Robo-Advisors will have some but limited success by cooperating with players without an established core banking system. External Asset Managers (EAMs) are alternative candidates, as in the case of wealth manager Crossbridge Capital teaming up with Bambu, a Singapore-based Robo-Advisor. However, the EAMs account for only 3-5% market share in AuM. Taking an assumption that 20% of the investors in the market will use a robo-advisory solution, the total market impact will be below 1% to 2% in the long run.
In view of a distribution model which sustainability will depend on overcoming high entry barriers, 360F predicts that in a few years’ time, only a handful of Robo-Advisors will survive, where 1 or 2 will be the market makers.
Digital-Assistants: An Arduous Journey to a Bright Future
Having demonstrated their Raison d’etre in the existing banking environment, Digital-Assistants now need to prove that simplification of the customer journey (even including products) and semi-automation is possible with the core IT systems. This will require web-based technology and flexible & customer-driven development processes. Furthermore, this will also demand skills which are new to the established private banks and the current core banking system providers. Digital-Assistants thus have the opportunity to penetrate this market. 360F predicts that in 5 years’ time, every private bank and wealth management player will use Digital-Assistants enhanced by Robo-Advisors functionality.
Today, however, private banks and wealth managers underestimate the organizational challenges and adaptation needs. Giving the customer the choice of a flexible service model requires sophisticated technology, strong compliance structure, documentation & processes and universal access to investment instruments. The organization can leave no stone unturned.
In the next article, 360F will share an overview of the key killer functions a Digital-Assistant needs. Showing successful use cases today will shed light on the future of automation in the wealth management industry.