This article examines whether so-called robo-advisors can live up to their promise and draws on examples from the US to highlight ways in which these business models must improve.

Robo-advice is undoubtedly one of the hottest topics of the moment, but will robo-advice lead to a revolution in the financial services industry or is little more than a gimmick? There are a variety of different models of “robo advisor” – a few weeks ago, this publication carried a report about a desire among people for a sort of “hybrid” version where some of the human element is retained (see here). We are sure that debate will continue.

This article is by Bruce Moss, strategy director at eValue, a technology provider that has worked with organisations such as HSBC and BlackRock. As always, the editors of this publication welcome responses. 

It’s just baby steps
The truth is that, while robo-advice has the potential to be a ground-breaking development, what we are seeing at the moment are its first baby steps. Furthermore, there is widespread confusion over what robo-advice is. Indeed, some of what is described as robo-advice isn’t even advice. So it is hard to argue with some critics when they say that robo-advice isn’t particularly helpful to the consumer.  
 
There are several reasons for the excitement about robo-advice. Firstly, the Financial Conduct Authority has been “promoting” robo-advice as a potential solution to the advice gap brought about by the Retail Distribution Review. This is because it is expected that robo-advice will be able to reduce the cost of delivering advice and thereby provide a partial solution to the advice gap.

A by-product of this robo publicity is the overdue realisation that technology can dramatically reduce the cost of delivering advice. Secondly, the fintech “bubble” and the proliferation of US robos is generating much hype in the UK. The US experience and the entry of big players like BlackRock, Fidelity, Invesco, Schwab, UBS and Vanguard have created a frisson amongst the UK’s financial institutions and start-up investors. 

American robo
Without any doubt, the US is the market leader in robo-advice – the origin of the name and a lot of the hype. What can be learned from the US, where some of the leading players have been operating for around 8 years?  

The first lesson is that, while there are currently no clear success stories, brand is all important. Although Betterment and Wealthfront had a 7-year start on Schwab and Vanguard, these two big brands have outstripped their more experienced peers. Schwab, in just over a year, has accumulated more than twice as much as either Betterment or Wealthfront. Even more impressively, Vanguard over the same timeframe has surged past everyone and has twice the robo funds under management of Betterment and Wealthfront combined. 

The second is that, although the regulatory environment in the US is very different to the UK, it is critical that the advice process is robust. Most of the US robos operate as Registered Investment Advisers and, as a result, have a fiduciary duty to their customers. However, most US robos have some serious deficiencies from a UK perspective: 

-- Poor risk questionnaires – too few questions to reliably determine a risk profile;
-- No test of capacity for loss;
-- No allowance for emergency funds or short-term cash requirements;
-- Debts are ignored;
-- Affordability of the investment is not determined.

For these reasons, most US robos would not meet the FCA’s suitability standard. Furthermore, there are growing concerns in the US. In May 2015, the SEC and the Financial Industry Regulatory Authority issued an Investor Alert on the risks and limitations of robo-advice and, in a paper issued this April, the Massachusetts Securities Division bluntly stated that it did not believe an algorithm alone was capable of serving as a fiduciary. 

For UK players there are lessons to be learnt from the US experience, and real improvements to be made. 

Consumer choice and the role of the advisor
Robo-advice needs to be positioned as a part of an omni-channel experience with the consumer able to move seamlessly between the self-directed purchase of financial products, robo and full advice.  Advice will also cover all the main financial needs including, investment, pre-, at- and in- retirement advice, protection and mortgages. Information entered by consumers should move with them as they move between channels and financial needs. 

The key challenge in the UK will be to engage the consumer and provide decision support. As in the US, the big brands are likely to win the most business. However, robo-advice will only be a financially successful proposition if consumers are engaged and provided with the support they need to make financial decisions. Behavioural finance and gamification techniques can be applied but these will, almost certainly, need to be supplemented with telephone support.

Monitoring of the operation of the robo system will also identify areas where consumers may be struggling. A continuous feedback loop should be established to translate MI into system improvements to increase usability for the consumer.   

As robo-advice has to meet the same suitability standards as traditional advice, the scope for streamlining the process is limited. However, there is potential to cut back on fact finding but it will be necessary to ensure that the focus on a particular area of advice is appropriate and not detrimental to the consumer’s other financial needs. For this reason, there will be cases where full advice is needed. And, of course, many consumers may just prefer advice from a human. As with “cyborg advice” (online process with human advisors), it will be important to use technology to deliver this advice as cheaply and efficiently as possible.

Looking ahead
Looking further ahead, robo-advice software will become much more sophisticated and mimic, ever more closely, human advisors. Using data on consumers’ personal circumstances, attitudes to risk and the choices made by others with similar profiles, robos will be able to make personalised recommendations just like a good human advisor using past experience of what has worked well with previous clients.

The UK’s tougher regulatory environment makes the development of robo-advice more challenging than it has been in the US, but it is also providing the imperative for the UK to innovate. Robo has the potential to make an enormous contribution to closing the advice gap and, through overcoming the challenges the UK has the opportunity to become the world leader for robo advice.