Algorithm method: The machines have not risen

Robo-advice still has to live up to the hype created around it. And reactions by industry to the slow adoption have been mixed. There are those who believe the disruption is imminent, while others have started hedging their bets. And then there are a few who have thrown in the towel.

Has US-based Betterment, considered the first adopter, and the largest in the world with $13.5-billion in assets under management, seen some writing on the wall? It recently diversified its core offering by adding a human financial adviser service to its menu.

Investec is not taking any chances and in May it became the second international asset manager in less than a year to close its robo-advice shop, admitting at its recent results presentation that the appetite was just too “low”. It wrote off more than £20-million in operating losses and software costs related to the project in the last financial year.

The group said it had decided to “discontinue” Click and Invest, the lower-cost digital service it launched two years ago. The move follows UBS’s decision in August last year to shut down its own online offering. It also lasted just two years. The Swiss bank said the “near-term potential” of the scheme, designed to lure younger investors to the bank, was “limited”.

The rest of the world’s financial institutions are still buying into the future. And South Africa is no different. Data by Statista indicates that by 2022, robo-advisers will manage $177-million in South African assets, up from only $22-million this year.

This translates into a compound annual growth rate between 2018 and 2022 of 68.8%. Compared to other digital payments that are expected to grow by only 12.2%, these growth projections seem significant.

Robo-shops that have been set up in South Africa include Sygnia RoboAdvisor, Sanlam Smart Invest, OUTvest and Bizbank backed by Anchor Capital .

But what exactly is robo-advice and how does it differ from traditional platforms? James Robinson, an associate at Alexander Forbes Wealth, says robo-advisers are an online solution for investors which make use of algorithms to manage a portfolio based on a client’s personalised parameters.

“The client inputs their time horizon and risk appetite before a quick calculation gives the investor a choice of funds that suits their requirements.”

Robinson says a traditional personal financial adviser is a professional who will help manage aspects of your financial life, from investing to estate and tax planning. The more complex your financial situation, the more likely you are to approach a professional to assist with your needs.

A Research and Policy Briefs by the World Bank states that robo-advisers can provide several advantages over traditional human advisers. Robo-advisers can be conveniently accessed at any time, from anywhere with an internet connection.

Furthermore, it states, that because they save on fixed costs (such as salaries of financial advisers or maintenance of physical offices), robo-advisers can reduce minimum investment requirements and charge lower fees.

“Automated algorithms can also perform ‘tax harvesting’ more efficiently than human advisers and reduce behavioural biases (such as subjectivity, domestic bias, or limited capacity to follow multiple assets).”

But the World Bank adds that these benefits come at some cost. Client assessment through “one-size-fits-all” questionnaires might be too simple to adequately evaluate a client’s needs, it says.

“Robo-advisers also lack other aspects of a client-adviser relation, such as helping clients set financial goals and counselling during market downturns. Automation of the investment process can also lead to consumer disengagement because consumers might not make efforts to understand how the service works or continuously monitor their investments.”

It cautions that the business models of robo-advisers have not been tested, and can come under financial stress in future. They also emphasise the importance of regulating the service appropriately.

No specific regulations have been proposed in SA. However, the Financial Sector Conduct Authority (FSCA) has issued a definition of robo-advice in the latest draft of the FAIS Fit and Proper regulations. It defines robo-advice as “the furnishing of advice through an electronic medium that uses algorithms and technology without the direct involvement of a natural person”.

But no rule has been issued that prevents automated platforms from handling the entire financial advice process, from risk profiling to choosing suitable risk-weighted investments, to adjusting the investment portfolio over time. However, the regulator has offered some assurances in that it requires each robo-advice platform to appoint at least one key individual who meets the regulatory competency requirements. This person would also have to understand the algorithms, assumptions and risks incorporated in the robo-advice platform. BM