Competition in automated advisory market leads to innovation

The use of sophisticated algorithms in wealth management is leading to improved efficiency and transparency in the financial services sector, benefitting both providers and clients. In particular, so-called robo-advisers are disrupting the industry and helping to boost financial inclusion. Primarily concentrated in developed markets such as the US and the UK, the technology is starting to make inroads in other parts of the world as traditional financial institutions and tech start-ups seek to tap the segment’s potential.

The robo-advisory model allows customers to manage their wealth or retirement plan online by completing a simple questionnaire, which is automatically analysed and matched with an appropriate portfolio that has been autonomously generated by computers programmed to gather, grade and assess the performance of a range of investment vehicles. These robots are capable of machine learning that mirrors human thought processes, and this is then applied to vast data sets. Given that there is a human programmer behind every robot, some critics of the model argue that digital interfaces mask the involvement of human labour in the processing of personal data, raising the issue of privacy. However, cognitive technology is guiding the newer generations of robots to adapt their behaviour according to each new data input, effectively allowing them to innovate without any human interference.

Automated financial services can undercut the fees charged by conventional fund-management firms, making robo-advisers an attractive alternative for cost-conscious customers. Furthermore, while a client using a trusted and experienced human fund manager will benefit from the wisdom of one professional, a customer of a robo-adviser will benefit from the combined knowledge of multiple professionals. For providers, investing in robot technology will help them save on expenses that would otherwise be spent on human capital, such as salaries, commissions and office space rentals. Furthermore, the digital nature of the model allows companies to extend their services to a broader range of clients.

Performance & Requirements

A 2019 report published by US media outlet Barron’s, in partnership with Backend Benchmarking, estimated that robo-firms had at least $440bn in assets under management globally. This was in large part due to a marked increase in the performance of five major robo-advisory firms from the US; Betterment, Personal Capital, Schwab, Vanguard and Wealthfront attracted a combined $40bn in the first half of 2019, up from $25bn throughout 2018. The US’ Fidelity Go topped the report’s performance table, with a two-year annualised return of 7.26%, an equity-only rate of 9.20% and a fixed income-only rate of 4.02%.

One of the main appeals of robo-advisory services is the low or zero account minimum requirements, in contrast to human advisers, who typically require a minimum of $50,000 in assets. According to a 2017 report by Business Insider, US firms such as Betterment, Blooom and WiseBanyan; UK companies MoneyFarm, Wealthify and Wealth Wizards; and Canada’s Wealthsimple all have a zero minimum investment limit. Of the 13 major start-up robo-advisers in North America and Europe featured in the report, five offered services to business or institutional clients in addition to retail clients, while Wealth Wizards was the only company purely focused on business-to-business customers.

Competition & Consolidation

While tech start-ups were pioneers in the market, they are now facing increasing levels of competition from legacy financial firms looking to offer similar automated services. As has been seen in the US market, tech start-ups vying with established financial services players that have adopted sophisticated technology-driven platforms to offer new services to existing customers. With $20bn each in assets, Wealthfront and Betterment were among the top-five firms covered by Backend Benchmarking’s “The Robo Report” for the third quarter of 2019. The leading market player, with $140bn in assets, was Vanguard Personal Advisor Services, a combined automation and human offering of fund giant Vanguard.

“More banks are looking to robo-advisory as a way of digitising platforms and enhancing their overall offering for retail customers,” Khalid Saad, CEO of Bahrain FinTech Bay, told OBG. “It may be harder to sell the platform to very-high-net-worth individuals used to the services provided by private banks, but I believe some of these customers may have an appetite for robo-advisory. In years to come we will see more of these transactions in both the business-to-business and business-to-consumer sectors.”

Bahrain FinTech Bay sees the nurturing of new talent and the upskilling of existing financial services workers as a vital part of its function. It has partnered with the US’ Georgetown University and the University of California, Berkeley to provide training and certification in financial technology (fintech), with an eye to creating a Bahraini centre of excellence. Bahrain, with its long history in financial services, hopes to offer foreign investors an attractive gateway into the GCC fintech market.

Given the high level of competition in the robo-advisory market, consolidation and fallouts are expected. In August 2018 US-based Hedgeable closed its advisory operations and transferred the funds to its custodian, Folio Investments. Despite its healthy portfolio, with $80m in assets under management and 1700 clients, the firm’s decision to shut down its investment services speaks to the difficulty small and mid-size companies face in acquiring assets. Hedgeable’s co-founders announced that the company will restructure its business going forwards.

On both sides of the Atlantic, robo-advisory firms are being bought by traditional financial service providers. For example, Wealthify was acquired by UK insurance company Aviva for £17m in February 2018, and in March 2019 Axos Financial completed its $3m acquisition of WiseBanyan, rebranding the robo-advisory service as Axos Invest.

Hybrid Model

As the robo-advisory market expands and companies seek to optimise their services to compete for customers, there is a noticeable shift away from the traditional, wholly automated system. Financial services firms are increasingly adopting a hybrid model, in which some advisory services are offered by humans working in tandem with artificial intelligence technology.

The transition from a pure robo-advisory model to a hybrid one can have a significant impact on tech start-ups, however. The UK’s Nutmeg, which launched in 2012, has 70,000 customers and manages £1.7bn in funds. In 2018 it adopted the hybrid model, employing human advisers for the first time. That year Nutmeg recorded losses of £18.6m, up from £12.4m in 2017, as it increased spending on staff, technology and marketing to attract new customers. Martin Stead, CEO of Nutmeg, told international press in October 2019 that the company is expected to be operationally profitable within three years.

Regulatory Sandboxes

The rise of robo-advisory services is supported by government initiatives aimed at strengthening the fintech sector. Regulatory frameworks for financial services industries around the world are being reformed to ensure that the sector remains investor-friendly in the advent of rapid disruptive innovations.

A global fintech report jointly produced by the IMF and the World Bank in June 2019 analysed 35 regulatory sandboxes, in which new technologies can be tested in a controlled environment, and found that there were significant differences in the approaches used to manage innovation and consumer protection in financial services. Specifically, there were variances in the role and objectives of the frameworks analysed. Objectives ranged from stimulating innovation and competition in the UK; to ensuring regulations are fit for purpose in Singapore; identifying gaps in market products in Malaysia; and promoting financial inclusion in Bahrain and Indonesia. Notably, the report concluded that gaps remain in the legal framework for financial activities such as robo-advisory, suggesting that further improvements to regulation are needed. It also notes the importance of developing innovation hubs and accelerators to allow and support the exchange of ideas and the flow of capital. The World Bank is helping a number of countries to develop regulatory sandboxes, including India, Jordan, Rwanda, Saudi Arabia, Sri Lanka and Vietnam, as well as assisting in the drafting of legal reforms for the fintech industry in Colombia, Kenya, Mexico, Peru and the Philippines.

The presence of regulatory sandboxes can help countries to nurture fintech innovation and thus robo-advisory services, while also acting as gateways into individual economies for international companies. “The developments that have happened in Bahrain over the last few years have been vital,” Saad told OBG. “When the Central Bank of Bahrain (CBB) launched the fintech sandbox in 2017, there was only one fintech company; now we have 35 firms from 19 countries using the regulatory sandbox.”

Wealth Tech

With large numbers of high-networth individuals, and a relatively young and techsavvy population, GCC countries are ideally placed to foster the development of robo-advisory services. Plans to establish fintech sandboxes were announced by Kuwait and Qatar in late 2018, and by the Saudi Arabian Monetary Authority in February 2019. More recently, in July 2019 the Financial Services Regulatory Authority (FSRA) of Abu Dhabi General Market (ADGM) issued a regulatory framework for robo-advisers. Richard Teng, CEO of the FSRA, announced in a press release that such services hold potential to improve investment decision-making in the wider Middle East and North Africa region.

“With this guidance, we aim to make it easier for digital investment businesses to operate in ADGM and in turn provide investors with greater access to professional tools to help them achieve their financial targets,” Teng said. The potential for continued expansion in robo-advisory services has also been identified by banks and other financial institutions in the GCC. “Personalised robo-advisory services applied to the wealth management segment are expected to grow exponentially in the coming years,” Ziad Aba Al Khail, managing director of Saudi Arabia’s joint-stock firm Aljazira Capital, told OBG. “We are expecting to see 25% of global wealth management services utilising robo-advisory by 2024.”

Islamic Finance

Robo-advisory is expanding beyond traditional markets as tech firms and startups look to tap the potential of the global Muslim population. The adoption of automated advisory services is expected to attract sharia-compliant investors, who may have a difficult time navigating the restrictions in Islamic finance.

In 2016 Wahed Invest was launched to provide Muslims living in the US with the opportunity to make sharia-compliant investments. The company expanded to the UK in 2018, and in 2019 it made inroads into the Gulf and South-east Asia. The Wahed app is now available in 130 countries, allowing anyone with at least $100 to create a portfolio that can be managed from their mobile phone. The company is a sandbox investment adviser with an office in Bahrain World Trade Centre, and was approved to join the CBB’s fintech sandbox in December 2017. In July 2019 it was one of two robo-advisory firms to be granted a licence, or FinTech ExPermit, to test computerised investment advisory services in Saudi Arabia. In October that year Wahed was granted a licence to operate in Malaysia, making it the third licensed robo-advisory firm in the country.

The other company that was granted a licence to operate robo-advisory services in Saudi Arabia in July 2019 was sharia-compliant start-up Haseed Investing Company, which has taken advantage of recent advances in the fintech ecosystem in GCC countries. In November 2018 it was one of 23 startups to complete the second 12-week accelerator programme FinTech Hive, which is run by the Dubai International Financial Centre.

Malaysian Market

Robo-advisory platforms offer a transparent and easy route to wealth management for retail customers in countries seeing growth in prosperity. One such market is Malaysia, with the Securities Commission Malaysia launching its digital investment management framework in 2017 and granting licences to three robo-advisory firms since then. The first to be granted a licence, in November 2018, was Singapore’s StashAway. Summing up the appeal of the new market, Michele Ferrario, co-founder and group CEO of StashAway, told local press, “When you think about how 43% of gross financial assets in Malaysia are in bank deposits, it is clear that current investment options are not working, making it difficult for Malaysians to build their long-term wealth through intelligent investing.”

In June 2019 the Malaysian software firm Silverlake Digital formed a joint venture with Money Design, a Japanese fintech company, to offer the robo-advisory service MYTHEO. As of the end of June 2019 Money Design’s first service THEO – established for the Japanese market – had 60,000 customers and $300m in assets under management.

Demographic Drivers

One of the main perceived strengths of robo-advisory technology is its appeal to younger generations of investors who are comfortable with mobile transactions and expect to see transparent updates on the performance of their investments. This suggests that the platform has significant potential in emerging economies with relatively youthful demographics. The potential size of the market offers signs of encouragement, with a 2019 report by US market researcher Cerulli Associates estimating that millennials in the US alone stood to inherit $68trn in assets from their parents over the next 25 years. Among this cohort, 80% are expected to choose new investment advisers.

An even more lucrative market could be found in China, where the middle class is growing at a rapid pace. According to consultancy GlobalData, 8.3m people will join China’s affluent demographic by 2023, with their estimated assets of $1.7trn providing an attractive market for robo-advisers.

Latin America & the Caribbean

Meanwhile, significant opportunities for growth are also seen in Latin America and the Caribbean, as the region is anticipated to continue its economic recovery. While the IMF forecast growth in Brazil and Mexico to fall to -9.1% and -4.7%, respectively, in 2020, largely impacted by the Covid-19 pandemic, growth in the longer term is expected to translate into greater investment activities. A report published by Kenneth Research in 2019 forecast that Latin America’s robo-advisory market will grow by a compound annual growth rate of 53.68% through to 2023 to reach $4.5bn. The main players servicing the market are US companies Betterment, Wealthfront, Personal Capital, FutureAdvisor and Charles Schwab. In September 2019 another US firm entered the Caribbean market. Guardian Asset Management launched a new robo-advisory service called Genius, the first of its kind in the region. The main focus of its investments will be in US-based exchange-traded funds.

Human Efficiency

Although artificial intelligence may offer new advantages to customers, financial experts warn that experienced human traders will continue to provide an essential service, particularly when it comes to analysing macroeconomic factors alongside microeconomic developments. “For example, here in Indonesia the government has announced a ban on the export of nickel ore from 2020,” Fransisca Wiryasaputra, equity manager at Ciptadana, an Indonesian firm offering financial services and products, told OBG. “This will have an impact on equities in the sector, which will be recorded by the robot, but a trader can analyse how long the ban may last or factor in the government’s longer-term goals.”