There has been a lot of talk about “robo advisors” in the financial services space over the past couple of years. Robo advisors are independent firms that offer online-only investment platforms for automated, algorithm-driven portfolio management services without any human interaction. It’s not the technology that’s controversial, it’s more about the robo advisors’ approach – investment advice being given without any human judgment.
One result of the widespread robo-advisor coverage is growing concern within asset management firms. Looking at this market traction, management teams are wondering if robo-advisors will grab significant market share from their traditional advisor businesses.
These concerns are largely unfounded, however, and there are three main reasons why:
They’re too small to be a real competitive threat
They’ll eventually become a source of new customers
There are legitimate questions about their long-term viability
Let’s look at each of these points in more detail.
Limited Size and Market Share
Robo-advisors clearly gained ground this past year. According to market researcher Corporate Insight, the combined assets under management for the top 11 robo-advisors was roughly $19 billion at year end. That was up from $11.5 billion in April, an impressive 65% growth rate over those nine months.
It’s true that $19 billion in AUM is an impressive tally, even more so given how quickly robo-advisors got there. But relative to the overall market, it’s a drop in the bucket. According to the professional services firm Towers Watson, AUM for North American managers totaled $42.0 trillion at 2013 year end. So while robo-advisors will win over some investors and their assets with their low-cost model, it is highly unlikely that they will pose a significant competitive threat to established asset managers any time soon.
Farm Teams for New Investors
Robo-advisors appeal to younger investors who have grown up doing everything online. Investing is just the next thing they do in that manner. Robo-advisors also bring in lower net-worth investors. That’s because they typically have lower minimum investment requirements and lower fee structures than traditional advisors.
But time goes by and things change. As younger investors grow older, and the lower net worth crowd starts to build up their portfolios, both groups will naturally start seeking advice in areas such as estate planning and retirement saving options. Since online-only platforms aren’t built for such higher-order functions, these investors will likely turn to traditional advisors for their nuanced understanding and human touch.
Beware of the Next Bear Market
Will robo-advisors survive when the bear market arrives? The answer is maybe not, because human advisors aren’t in the mix.
Think about it. The average investor isn’t known for the steely resolve it takes to not sell when share prices are in free fall. Typically, they want to get out as fast as possible, losses be damned. So they call their advisors. Those conversations invariably start out heated, but eventually the advisor’s logic defuses at least some of the investor’s emotion. The advisor talks the investor back from the ledge, and assets stay put.
How does that same scenario play out in robo-advisor environment? When panicky investors log on intending to cut their losses by dumping their holdings, there’ll be no familiar, trusted advisor in the picture. The advisor, who they maybe met after their kid’s little league game or at their favorite downtown coffee shop, won’t exist.
It’ll just be the investor in front of a screen. As he or she clicks the ’Sell’ button, maybe a dialogue box will pop up saying something like “You bought high. Are you sure you want to sell low? Press Yes or Cancel”. With no calm and steady advisor to make sure cooler heads prevail, the “Sell” button likely will be clicked more often than not. Massive fund outflows can easily follow, and that would spell big trouble for investors and robo-advisors alike.
A Net Positive for Asset Managers
The arrival of robo-advisors is a positive development in that they bring new investors into the market and give them access to investment guidance that was previously beyond their reach. Robo-advisors won’t pose a major threat to traditional advisors as long as they keep providing high-quality wealth management services. And when the inevitable happens and the next bear market arrives, it would be a shame to see robo-advisors fail. But if they do, the much larger and stronger asset managers will be there to pick up the pieces – and the robo advisors’ former investors.