Development of the RoboAdvisory market - too early or to late to start investment automation?
For some time we have been working at Ailleron, together with a talented team, on the RoboWealth product that constitutes a part of the FinTech/Robo trend. We are also tracking the situation in different markets related to robo-advisory solutions and we recently read a document published by Finnovate: What is and what is not “hot” in the FinTech business.
I was a little surprised to learn that the “robo-advisory” category was in the “not hot” list. Also, more or less at the same time, I received a report published by EFMA (dated February 2018) that stated that as many as 69% of banks consider digitalization of financial advice to be one of their three main strategic priorities. This discrepancy has lead me to ask the following question:
Is it too late or still too early for robo-advisory?
The answer to this question (as it often happens) is not clear and definitely depends on specific markets in question.
The aforementioned “hot or not” list referred mostly to the American market which, as we all know, is a leading market for solutions of this type. In Europe, on the other hand, I would identify the United Kingdom and Germany, where there is a large number of startups offering “robo” solutions, as the leading countries. What all those markets have in common (with regard to financial instruments) is:
· a mature capital market;
· very high liquidity of instruments;
· a broad offer of ETF’s.
In my opinion, the above characteristics of those markets are some of the key factors that determine whether and at what pace robo-advisory services can develop in specific markets. Other factors are:
· The regulatory environment - the approach of the local regulatory can significantly facilitate or hinder the development of services of this type.
· The history of the capital market - what I mean is that some markets can be more suitable for solutions of this type due to, e.g. historical events, such as very high management fees in traditional products distributed by banks, common misselling (e.g. investment/insurance policies in Poland), etc.
Why does liquidity matter?
Robo-advisory is a rather broad term, but I can identify two key areas where automation in the investment advisory process can be discussed:
· algorithms responsible for profiling of users and structuring portfolios appropriate for those profiles;
· execution and regular monitoring and rebalancing of portfolios.
In various solutions available on the market, those two areas have different weights, e.g. a platform may use strategies created by a team of analysts but the execution is, from the point of view of the customer, fully automated. It appears that mostly automation of execution influences the user experience of the end customer who can avoid the tedious work related to performance of individual transactions because the system does it for him or her. The issue of “user experience” that results from “satisfaction” with the effectiveness of the algorithms is a topic for another interesting article.
However, in order for such processes as rebalancing to be effective, adequate liquidity of individual instruments included in the strategies offered to the customer must be ensured. One can easily imagine a situation where in response to a signal given by the “robo” platform, fifty thousand users sell one instrument and buy another. When liquidity is low, such a process becomes simply ineffective. This is why “robo” solutions most of all use ETF’s and not stocks (another reason is the associated costs, but they are not discussed herein). In some cases, the problem is solved buy buying assets into own books and internal settling of transactions; however, this solution is not always and not in every country used in practice. I know banks that, in principle, do not purchase securities into their own books but still would like to automate their advisory processes.
So, is it too early or too late?
If it is “too late” then, in my opinion, it is so solely in the context of the aforementioned “primary” markets for robo solutions, especially the USA. On the other hand, from the business point of view, one could argue that it is never too late for excellent solutions, as seen in banking itself. In such markets as the US, the UK, and Germany, there are many startups and perhaps all of them are similar to each other, which leads to the impression that the market is “full.” Consequently, some time is needed for consolidation and shaping of strategies that would give those startups their separate identities. It is certainly not “too late” for banks, a huge part of which does not have such solutions at all and which do not necessarily want to acquire a startup (those banks should seriously consider, besides having their own development, purchasing a good and ready-to-use technology, such as for example RoboWealth).
In the context of less developed markets, such as the markets of Central and Eastern Europe and markets of many Asian countries (with the exception of Singapore), I am more inclined to conclude that in many cases it is still too early for robo-advisory. On the one hand, those markets (unlike the EU markets) still are not overregulated and, on the other hand, their problem is lack of development of the local market - low liquidity of many companies, no ETF’s. On the other hand, offering “robo” services based, e.g. on American ETF’s is associated with the problem of currency exchange risk whose mitigation on a larger scale (e.g. for the mass-affluent customer market) is quite a challenge (and cost). Another question is whether the markets are able to bypass a certain phase of development and go into automatic solutions right away (I mean the phase of quite common interest of retail customers in the capital market and direct investment in stocks, which ends in a big boom but an even bigger bust and many small investors leaving the market).
Many questions will most likely be answered in the next 2-3 years, but I have no doubt that we will hear a lot and frequently about robo-advisory. Although we may have a small local culmination wave behind us, the global one, in my opinion, is only emerging on the horizon. I only hope that RoboWealth will play a significant role in this wave.
General Manager @Ailleron