What Is a Robo Advisor?
We Answer Your Questions About "Robo-Advice".
The term ‘robo advice’ can lead to confusion about the kind of service provided by such companies. It originated in the US and has migrated over to the UK, but the two countries actually use financial terms in very different ways.
- An Investment Adviser in the US is actually what the UK would describe as an Investment Manager.
- An Investment Planner in the US would be described in the UK as a Financial Adviser, so someone that makes recommendations but doesn’t typically manage the portfolio.
In the UK, the firms referred to as 'robo-advisors' typically don’t offer advice (“investing with you”) but comprehensive, discretionary investment management (“investing for you”). They create, monitor and manage portfolios for their clients so that their clients don’t have to be involved in decisions around asset allocation and don’t have to be in charge of making changes to their portfolios based on current market movements. They focus on helping their clients with the money they are ready to invest in the capital markets, after running a suitability check to ensure they don’t take more risk than they should. They don’t offer advice on which tax-wrapper might be the most suitable to use, for example.
An advisor, on the other hand, might conduct a more comprehensive analysis of a client’s financial situation - also looking at a client’s debt and already invested amounts, for example - but will ultimately not manage their clients’ investments for them. Instead, they provide clients with a list of suitable investment options and leave the execution to the client or a recommended partner firm (such as a fund manager or a discretionary investment manager such as Scalable Capital). A few advice firms offer both advisory and discretionary investment management services but the actual activities have their separate rules and regulations as established by the Financial Conduct Authority (FCA).
Frequently asked questions:
The term “robo advisor” typically refers to investment management companies that have automated part of the investment process. These firms typically do not provide advice, though exceptions might exist. For example, at Scalable Capital, we do not provide advice but we provide a discretionary investment service - we manage your money. The more sophisticated robo advice solutions use technology not just for a smooth, mobile or web-enabled sign-up process, but also at the core of their investment methodology, giving you a better return for every unit of risk you're exposed to and ensuring your risk tolerance isn't breached.
Traditionally, retail investors had three options when they wanted to invest their savings:
- They could opt for a self-directed brokerage account and invest into individual securities (stocks and bonds) themselves.
- They could invest into funds, whether actively managed funds or passive index funds / Exchange-Traded Funds (ETFs).
- They could pay an independent financial advisor (IFA).
A fourth option, delegating the allocation decisions to a private wealth manager or a private bank, wasn't available to them unless they could invest upwards of £1,000,000 or even more, as some private banks have increased their minimums to £5,000,000 in recent years.
Investing at one's own discretion is time-intensive and investors typically find it impossible to attain information that the market has not already priced into current securities prices. Many investors also feel they lack the professional experience and the specific financial education to make the right decisions.
When they invest into actively managed funds to get access to a diversified portfolio managed by a professional, investors are often disappointed by the high fees of such funds that make it rare for them to outperform the benchmark they've set for themselves. The FCA's Asset Management Market Study that was published in November 2016 summarized that "overall, our evidence suggests that actively managed investments do not outperform their benchmark after costs. Funds which are available to retail investors underperform their benchmarks after costs".
Investing into passive index-trackers seems to be a good solution and indeed ETFs have been able to attract a significant share of global assets over the last 2 decades. However, the investor still needs to decide on the crucial question of how much to invest into each ETF - should they invest 40% into equities and 60% into bonds? What about commodities? And what geographical regions - maybe they should have a larger focus on their home market, but what impact would that have on a potential lack of diversification that would expose them to unnecessary risks while leading to impaired returns?
IFAs would be a way to delegate those decisions to someone else, but they are not accessible for everyone and many investors shy away from fixed hourly fees.
Robo advisors offer a solution for investors that can solve all their issues. They offer an easy, more accessible and intelligent solution to the problems faced by most retail investors. The Financial Times therefore predicted a “fight for survival” of traditional wealth managers in an article from May 2016.
- Low Cost: Robo advisors typically invest in passive index funds (read more about these securities in our article 'What Is an ETF?'), which have much lower fees than actively managed funds. Many robo advisors, including Scalable Capital, do not charge performance fees and all management fees are disclosed clearly upfront.
- Focus on risks: When investing personally, most people tend to focus on returns rather than risks. However, modern capital markets research has shown that risks can be much more reliably predicted. Since periods of low risk in a particular asset class often go hand-in-hand with better performance, and periods of high risk typically lead to negative performance, a focus on managing risks can also help improve the return an investor achieves for every unit of risk he or she is willing to accept.
- Unemotional: Many investors act emotionally when attempting to manage their own money, and end up buying too late and selling too early. Many robo advisors offer an unemotional, technology-driven wealth management service based on their clients' individual risk profiles. We recommend investors comparing different providers to pay particular attention to a provider's investment process, though, as there are substantial differences in how investment portfolios are set up and managed.
- Transparent: Many robo advisors offer online platforms and mobile apps that investors can use to access their account information, asset allocation, performance and transactions that were carried out for them.
As mentioned before, DIY investors typically struggle with portfolio allocation and end up in suboptimal portfolios leading to higher than expected drawdowns (often leading them to exit their investments altogether) and to lower returns than they could have earned for the risk they were exposed to. They also lack the tools to systematically monitor the risk in their portfolio and make the right adjustments to bring it back in line if required.
- Time-constrained investors who do not want to invest their money themselves: Analysing company reports, economic data, past performances of different asset classes and ETF fee structures can be extremely time consuming. Robo Advisors use technology to find appropriate investment solutions and are a great tool for anyone looking to be invested in the capital markets, but does not want to be in charge of the investment decision.
- Investors with a longer investment horizon: Investing into the capital markets requires a longer time horizon, ideally 10 years or more. That's what historical data suggests as a time period that is long enough for investors to recover from losses during a crisis. Longer time periods also mean that investors increasingly benefit from the positive impact of compound returns (you might want to read our article explaining this effect: "Compound Returns – Investing with the Most Powerful Force in the Universe"). Therefore, investors looking to place their money with a Robo Advisor should typically be looking to invest their assets for a minimum of several years.
Whether a robo advisor is the right solution for you depends on the way that they are set-up and your personal circumstances. We suggest you consider the following criteria:
- Minimum Investment Amount: Different offerings require different minimum investment amounts. But it is not just about finding the easiest (lowest) starting point, but also evaluating to what extent a higher initial required investment may come with a more sophisticated service.
- Investment Technology: There is a wide range of how much technology different robo advisors are able to employ. Some are called robo advisors simply for the fact that they have a digital offering, like a mobile app. Scalable Capital, on the other hand, has developed a proprietary investment technology that enables continuous risk monitoring and dynamically adjusts portfolios to ensure they stay in line with a client's risk tolerance. To learn more, take at look at our risk management section on the website.
- Fees: Most robo advisors will charge a fixed fee that includes the set-up fees, transaction costs or withdrawals. After all, transparency is one of their key focus areas so most of them won't try to hide any fees from you. However, there are providers that charge performance fees, which might sound like a great incentive for them to deliver good returns, but remember that a 10% performance fee in a year of 6% performance implies an additional cost of 0.6%. In a bad year, however, you won't get compensated for this fee. This also means that performance fees incentivise a manager to take higher risks, as they get rewarded for higher returns, but don't get punished for lower returns. At Scalable Capital, we prefer a clear fixed fee for our service. Remember, though, that all providers invest into funds that have a separate fee - in our case, this amounts to an average of 0.25% p.a. Read more in our section on "Clarity on Costs".
The money you invest with a robo advisor is typically sitting in an account with an independent custodian bank, which holds your cash as well as your assets for you at any stage during the investment process. You can learn more about this very important topic in our "Security" section.
Robo advisory does not mean that there is no one to talk to when you need help. It simply means that many aspects around the investment process are automated to save you time and money. All investment and portfolio allocation decisions, however, are monitored by a team of investment professionals. At Scalable Capital you can reach the team easily via the online chat function, by email at email@example.com or simply by calling through to the office to ask any question about your investment. We also offer webinars and organise investment summits frequently, for which you can register on our "Events" section.
The degree of sophistication of a robo advisor's technology varies significantly. Some merely use technology in the client communication, for example, to make the sign-up process easier and paperless, but only peripherally or not at all in the portfolio optimisation process.
We believe that Scalable Capital has one of the most sophisticated technologies in the market, using a proprietary algorithm that simulates market risk and automatically adjusts client portfolios when needed. The benefit for the client being a better understanding of risk, better risk-adjusted returns and more peace of mind. Our technology enables us to keep your portfolio risk constant, even as market environments change. This is not something traditional providers or other robo advisors typically provide, as it requires a sophisticated technology.
Every single client portfolio is monitored and adjusted individually. Our algorithm makes use of data about current and historical returns of different ETFs to generate thousands of scenarios for the likely future development of each client portfolio, keeping in mind the characteristics of each ETF such as volatility and correlations with other ETFs. You can read more about this in our "Better Risk Management" section, as well as in our section on "Evidence-Based Investing". Scalable Capital employs a team of dozens of software engineers and experts with PhDs in financial econometrics to ensure its technology is delivering the best outcome for its clients.
Yes, absolutely. Robo advisors typically ask you to complete a questionnaire regarding your investment goals and horizon, as well as your risk preferences and experience, and then tailor your portfolio according to these specifications. However, if you feel like your situation is unique it may be worth consulting with a Financial Advisor. At the same time, offerings vary between different investment services, so it is worth checking thoroughly and making sure your individual circumstances are taken into account as far as possible.
The mobile apps and websites robo advisors have built are typically user-friendly, intuitive and accessible. If you are comfortable navigating a website there is no reason why a digital investment manager, as robo advisors are often called, would be too complex a service for you to use. If you like to use mobile apps to stay up-to-date, you can use a robo advisor's app to check the performance of your portfolio at any time of the day and wherever you are. Again, depending on the provider of your choice, the features of the mobile app will differ.
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