Investment Advisors: Rage With, Not Against, The Machine

Katrina Lamb
April 13, 2016
Financial technology is disrupting the world of traditional investment management. So-called “robo-advisors” – digital financial advice and investment platforms – have caught fire in the past couple years and could grow to as much as $490 billion in assets under management by 2020. Traditional advisors are understandably concerned about this trend and the related prospect of a race to the bottom in fees. Rather than fighting the technology, though, advisors should understand that there are ways for humans and machines to profitably co-exist. You don’t just want to survive the fintech revolution, you want to prosper in it. Getting there starts with a deep understanding of what your clients truly value in the set of services you provide to them. With that understanding you are in a better position to figure out which services are more ideally suited to personal human interaction, and which might be more efficiently “outsourced” to machines. You might be surprised by what you find out.  

Robo Rising

Robo-advisors may still account for just a small percentage of the total volume of global investment assets under professional management, but they have established themselves as the industry’s growth engines. Betterment, a leading robo-advisor, has roughly doubled in size every six months since its launch in 2010. Over the course of 2015 the firm’s assets grew from about $1 billion to $3 billion, and it recently concluded a successful round of venture financing at a valuation of $700 million. Numbers like these suggest that robo-advisors will not be going away any time soon. Moreover, the growth curve may be only just beginning to accelerate as large, diversified financial institutions like BlackRock and Invesco buy up robo-advisors and insert them into their powerful distribution channels. It is the many thousands of small- to mid-sized investment advisors (roughly speaking, those with assets under management below $1 billion) that find themselves in the cross-hairs of this disruption. If you fall into that category, what can you do to meet this challenge?  


At the heart of robo-advising is a relatively straightforward proposition powered by some complex algorithms. A user inputs answers to a few basic questions into his or her computer or smartphone, provides relevant bank account information, and gets in return a fully funded investment strategy around one or more defined goals such as wealth building, retirement or a new home purchase. The algorithms do what humans have done at least since the advent of Modern Portfolio Theory in the early 1950s: allocate funds among diverse asset classes according to investment objectives and risk tolerance, select appropriate securities for portfolio inclusion, and rebalance the portfolio to target weights at periodic intervals, usually no less than once per calendar year. Portfolio management hardly fits the image most people have of the kind of routine office work easily automatable; it is a well-remunerated profession, whose practitioners sport elite educational pedigrees and advanced technical skill sets. But the technology curve has changed, and so has the range of activities vulnerable to disruption by lines of code humming in the cloud. Portfolio management, it turns out, is one of them.  

Less Is More

Since the global stock market crash of 2008, investors have cast an increasingly critical eye on the performance of their investment advisors and fund managers. A number of studies demonstrate that the performance of active money managers, such as mutual funds that attempt to beat a defined benchmark index, generally does not justify the higher fees they typically charge. Selecting these active funds, based on various criteria of past performance, is a longstanding core service offering of traditional investment advisors. In the past, clients have been willing to pay for the value of this access to perceived top performers. But if there is no statistical justification for past performance, what’s the point of paying more for their inclusion? Robo-advisors, by contrast, tend to use low-cost, passive indexed vehicles like exchange traded funds (ETFs) to populate their portfolios. Machines using algorithms to pick cheap ETFs are likely to be a more attractive economic proposition for a client than highly paid individuals spending hours poring over expensive mutual funds. That’s why robo-advisors can charge fees of 0.35 percent or less for their services, while comparable fees for traditional advisors can easily run north of one percent.  

Cede the Battle…

Unfortunately for human advisors, the robots have the evidence on their side in this debate. Even hedge funds, supposedly run by high octane managers of unimaginable brilliance, have failed in recent years to match passive benchmarks like the S&P 500 or even low-energy balanced mutual funds. So rather than trying to defend outdated beliefs about what works on Wall Street, here is where a smart investment advisor should embrace the technology, take stock of what her clients really care about and whether she is meeting those needs and expectations, and rewire her business accordingly.  

…Win the War

As it turns out, both retail investors and their institutional counterparts care a great deal about many things requiring human involvement and cognitive thinking. A recent survey of retail investors in six countries, conducted by Salesforce Research, discovered that less than half of the respondents felt their financial advisors were proactive enough in reaching out to them. More than half, though, expressed feelings of unease about their financial situation in the current market environment and would want more hand-holding from their advisors in managing through a downturn. Another recent survey, this one conducted by the CFA Institute, noted that investors “are prepared to pay fees, even higher fees, if they feel these costs will add value or deepen existing services”. Examples of things they would pay more for include (again) risk management strategies for navigating a downturn, higher security protection against cyberfraud, and helping them better understand why their portfolios are positioned the way they are. Yes, fees definitely matter, as both these surveys clearly show. But investment advisors should not imagine that their only viable path is a race to the bottom.  

Collaborators Welcome

Embracing the machine can mean collaborating with robo-advisors. Most small- to mid-sized investment advisors probably lack either the know-how to build their own platforms organically, or the deep pockets to go shopping for a robo firm in the manner of a BlackRock or Invesco. But opportunities for collaboration abound. Robo-advisor Betterment claims to have relationships with over 200 advisors, in addition to its clientele of direct users. For example, a traditional advisor could use the robo platform for the bread and butter portfolio management services of allocation, selection and rebalancing, but augment these with a bespoke risk management strategy for helping clients manage through tough markets. Such collaboration could be valuable for the robo-advisors as well. While the objective of some start-ups in this space is to cash out through a quick sale, others are motivated more by building their own unique brand and identity over time. Partnering with traditional advisors not only gives them access to new distribution channels, but augments their existing suite of services. Financial technology poses a direct and immediate challenge to many existing institutions, attitudes and assumptions in the investment management industry. What has not changed, though, is that success in this business rests first and foremost on your ability to connect with your clients, understand what they really care about, and take care of those needs in a way that earns their trust and loyalty. For you, the fintech revolution can be an asset to your business model, not a liability. HourlyNerd White Paper: How Enterprises Can Run Like a Lean Startup

About the Author

Katrina Lamb

Katrina Lamb is a consultant with many years of experience in the financial services industry including stints in sell-side investment banking and buy-side asset management. She has worked with a variety of industry participants including investment management and advisory firms, start-ups in the financial technology space, and Big Data predictive analytics companies. Katrina also manages a large cap US equities fund. A member of the CFA Institute and CFA® charterholder, Katrina is based in the Washington, DC metro area.

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