The message has come across, loud and clear, in the investment world:
“ Fees are eating up your returns”
And even wealthy investors are reported to be migrating towards digitally delivered investment advice. Millionaires detest suspecting that they are taken advantage of with unnecessary surcharges.
The market of so called robo-advisors, has been growing and is in a phase that we cant be addressing them all under the same rubric. Two main differentiations at least are needed:
(1) Distinguish the B2C (for consumers) from the pure B2B-institutional ones (for advisors or institutional clients),
(2) Categorize them by scope of service (from basic investing to general financial planning; from savings in early life towards retirement) and also by product universe (in-house financial products, in partnership with fund companies or open product range).
The business model of each technology platform (either standalone or launched by an incumbent) will be scrutinized closely this year; because this is the year (see The unstoppable Robo-advisor trend: Leapfrogging the incumbents) that M&A activity will increase and leapfrogging from the incumbents will take off. The devil as always, will be in the details.
So, this year, the market will shift focus from Fees, Fees, Fees to Trust, Trust, Trust.
Investors across the board, digital natives, digital immigrants and prospects, are humming:
I got it, I got it, I got it, enough about fees; now show me WHY I should trust you. Are you acting in my best interest, beyond the inexpensive service provided and the seamless onboarding. Show me that you are acting in the best interest of all your customers. I don’t want to hear, an average metric. “On average, we are acting in your best interest”. Lets start with evidence for the small investor, the one that the incumbents weren’t serving in the first place.
These are the issues at heart of the ongoing battle in the US regarding the Fiduciary standards. There is a lot of lobbying going on because the industry is evolving and brokers, independent financial advisors, and all financial service providers; are affected. There is a battle about where there are conflicts of interest in the current practices, what costs are associated with amending them and whether standalone Fintechs are the beneficiaries or not of these oversights.
The Department of Labour (DOL) has taken a “progressive” first angle towards the tech companies (i.e. the standalone robo-advisors) that help retail investors access an affordable service. Secretary Perez hinted that they maybe also assisting towards a better fiduciary standard for consumers (referring to Wealthfront). Retail investors are offered a suitable product but is it the best solution in the client’s interest? Betterment is outspoken on this front because they have no relationship with fund companies and don’t receive fees or commissions.
At the same time, the SEC and FINRA are more concerned and wary of robo-advisors and whether they should be regulated and subject to current or amended fiduciary standards. The two agencies even issued an investor alert in May last year.
In a research paper by attorney Melanie Fein commissioned by Federated Investors (currently managing $350Billion), a cautionary flag has been raised regarding robo-advisors serving close to and retirement accounts. Even though the sample used for the study is small (3 undisclosed companies), the conclusion is loud and clear: Robo-advisors do NOT live up to the DOL fiduciary standards. They are discretionary managers whose profiling technology is static and incapable of taking into account the broad financial picture and needs of the client, especially when in retirement. The service offered cannot be in the best interest of the clients needs because it is “myopic”. The shortcomings pointed out by Melanie, are more acute for retirees whose time horizon is shorter and needs different treatment from other demographic groups. Retirees are more interested in Income generation, tax-loss harvesting, and need also drawdown advice. Their profiling is subject to change and the process used by robo-advisors may not be adequate to taking into account all other non-financial parameters that affect significantly, albeit indirectly, financial needs.
2016 will be year that standalone business models will be scrutinized more closely. Trust, Trust, Trust will be what the market is looking for. From the agency and regulatory bodies, to the institutions that are in a due diligence process to determine whether they should adopt these new practices or not into their business as usual. Federated Investors, is not the only one commissioning research in this domain. Others are gathering feedback from the advisor network (e.g. SEI investments – SEI Survey Reveals Financial Advisors’ Top 2016 New Year’s Resolutions: Robo-Advisor Technology and Impending DOL Regulations Not a Primary Focus for 2016) or getting their feet wet (e.g. LPL financial: LPL Financial plans to launch robo-adviser in next two months).
In addition, with markets in volatile mode and in uncertain mode (Am I in bear mode? Globally or locally?); robo-advisors will be scrutinized on the basis of “Trust and Performance”. They will be evaluated on the basis of whether they are adhering to fiduciary standards and to performance standards.
Investors across the board, digital natives, digital immigrants and prospects, will be humming:
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Show me WHY I should trust you and WHERE is the performance.