Investors trust and confidence in robo advisory companies is gaining momentum globally. Recent research and analysis of financial technologies (FinTech) companies have shown that robo consulting firms have performed well as investors worldwide have started accepting their worth. Even venture capitalists are keen to pump their money into robo advisory companies as they are confident about the growth prospects. But is it true?
In February 2016, a survey by the Chartered Financial Analyst (CFA) Institute, a global association of investment professionals, revealed that 88% of investment professionals are of the opinion that robo advisors will replace personal financial advisors in coming time. Robo advisory firm Betterment's $100 million funding in Q1 in 2016 leave little scope for doubt about the growth prospects of these companies.
The Citi GPS report of March 2016 which highlights robo advisors' growing prominence amongst younger Millennial says that Gen X investors are sure to continue for the foreseeable future as they get richer.
With the fast pace of new sign-ups, Schwab estimates robo advisors US market potential to be worth $400 billion in the coming years, says the City GPS report.
Another study by BI Intelligence predicts the global assets management by robo advisory firms will increase from present $0.1 trillion to $ 8 trillion by 2020.
Why is robo advisory getting popular?
Before we look into the causes of the rising popularity of robo advisory companies, it's important to see how robo advisors help investors choose the right product and make sound investment move.
Robo advisory companies offer an online platform to potential investors to submit all their personal details, purpose, and terms of investments, risk tolerance, expected returns, etc. and based on these features using automation and algorithms offer investment advice.
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Though wealth management software was available in 2000 yet it was used mainly by human financial advisors to minimize their workload. The financial crisis of 2008 saw the birth of robo advisors whose primary function was to rebalance investors' wealth. So the wealth management software - which was accessible to a few wealth managers ? came in the public domain as robo advisors after 2008.
Initially, consumers were apprehensive about disclosing their financial matters by registering on any online platform due to security concerns. More than that, the investors - who were familiar with face to face interaction - were unable to trust a software tool to manage their investment portfolio.
But the mindset changed within a small period when small investors saw robo advisory firms cheaper and more efficient in financial consultancy than their human counterparts.
The reason for growing popularity of robo advisors is the multiple benefits it offers to an investor. Besides the fact that it's incredibly simple to use due to automation, it charges a very small fee.
According to Citi Research, while traditional asset managers charge 1% management fee along with 0.2% to 0.4% ETF fee and other fees, robo advisory firms charge only 0.25% go 0.50% for investment management fee and 0.0 to 0.15% of ETF fee. AT present robo advisory firms largely offers their service in basic planning and investment which appeal to new and young investors.
Experts see the robo advisory's strength such as straightforward and easy to use, cheap and highly scalable, etc. the main reason for its growing popularity. Robo advisory comes as a right product for the younger generation because they have an interest in the online product and a huge market of the asset is still under-managed.
Big financial institutions like Goldman Sachs have also realized the significance of robo advisors and that's the reason they are acquiring fledgling robo advisory firms to compete with companies like Betterment, Wealthfront, and Personal Capital, which have made their presence felt in the sector in a big way. Goldman Sachs has acquired Honest Dollar, which manages saving accounts for retirement.
Present market size small but growth prospect quite strong
Looking at the current market size of robo advisory firms, it shows that their control on the mutual fund and Exchange-traded Fund (ETF) industry is very small. Globally, the mutual fund and ETF industry account for $30.4 trillion and $2.6 trillion respectively. In contrast, robo advisors presently own a small fraction of the global market, i.e., $20 billion, says Citi report.
Even in Europe and Asia, robo advisory companies are early start-ups and much behind the US. However, experts believe that robo advisory firms will widen its base in Europe and Asia slowly. Robo companies are also trying to go beyond simple portfolio rebalancing into more mature and sophisticated portfolio management so that along with young and first-time investors, it can become equally popular among experienced and big investors.
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According to a recent report, Financial Technology (fintech) firm Mesitis wants to launch a robo-advisory service targeted at high net worth individuals (HNIs).
Cyber security the biggest challenge??
Citi Research, while quoting a June 2015 report by McKinsey says that McKinsey estimated the potential value of personal financial assets that could be served by virtual advice at $13.5 trillion, split into $6.4 trillion in North America, $3.4 trillion Asia, $3.3 trillion Europe, $0.4 trillion Australia and $0.1 trillion Latin America.
This assumes that 25% of affluent households ($100k to $1 million in financial assets) and 10% of high net worth households ($1to $30 million) are prime candidates for virtual advice. Once again, this is a figure for all virtual advice, not just robo-advice, says the Citi Research report.
This suggests that FinTechs dealing in robo advisory needs to evolve further to overcome the challenges. Investors believe that robo consulting firms are susceptible to mechanical failures which may jeopardize their financial planning. Safety of their investments in cyberspace which often gets hacked make robo advisory firms less attractive to the consumers. Despite these challenges, robo advisors are a segment to keep an eye on in the near future
Alex Kong