Long Reads

Robo-advisory: A dependence to question

Vijay Valecha/Dubai
Filed on September 3, 2021
Industry analysts estimate that robo-advisors had $330 billion in assets under management at the end of 2019, but this number is expected to rise to $830 billion by 2024.

Can we give technology and AI the power to manage our assets and portfolio?

The pandemic has pushed companies over the technology tipping point and revolutionised businesses forever. Many surveys indicate that Covid-19 have sped the adoption of digital technologies by several years and many of these changes could be here for the long haul. Changes include increased online shopping, the introduction of digital as well as contactless payment systems, remote working, the role of technology in distance learning, telehealth, and online entertainment.

Industry analysts estimate that robo-advisors had $330 billion in assets under management (AUM) at the end of 2019, but this number is expected to rise to $830 billion by 2024, owing to the technological shift at unprecedented levels during the pandemic. Research anticipates the rate of new accounts opened during the first quarter of 2020 more than doubled compared to the fourth quarter of 2019, due to increased Generation X and millennial investors looking to participate in the market momentum. Now one would argue that robo-investing is well-suited for younger demographics who are comfortable living their lives online or for investors with lower investment amount. It is debatable whether the standard investing approach would work for high-net-worth individuals having complex requirements and demanding broader control over the portfolio allocation.

A hostile takeover by technology

Artificial intelligence is to trading what fire was to the cavemen — that’s the impact of a technology breakthrough on a staid industry. Nevertheless, can we give technology and AI the power to manage our assets and portfolio? A robot guiding you where to park your hard-earned money without knowing you inside out, what your needs and preferences are? A human touch is very well required when safeguarding your family’s long term financial security, your retirement and your children’s education. An app advising you on the best eatery joint by the corner or which movie to watch is quite different than financial planning.

Automated asset management programs arrive at the portfolio allocation decisions merely with the help of a few online questionnaires which the client can easily tweak. In fact, there are times the client believes that just because he is heavily inclined towards adventure sports, he would let that adrenaline rush reflect on his portfolio too by investing in risky bets. During such times, a financial advisor comes to the rescue by offering his knowledge and guidance to make the right asset selection that could fetch him considerable returns.

The element of personal touch

Some argue that financial advisors are expensive, on an average one to two per cent of AUM. Indeed they may be slightly steep, but will a portfolio that is “untouched by human hands” to give recommendations for long term investment planning be worthwhile?

One should do a realistic cost-benefit analysis. Experienced traders are not unknown to glitches in the investing apps demonstrated a couple of times, allowing the traders to take on excessive leverage. If amateur clients look to make a quick buck with this “advantage”, they could stand to lose a large sum, whereas it's unthinkable that a human advisor would allow a client to borrow almost hundreds of times their original deposit.

A human touch is very essential when securing one’s long-term wealth. What is the disadvantage of the lower fees? The customer never gets to talk to a person. Robots will not guide the clients especially during rough times, when the market drops by five per cent in a week, some investors panic. Just because your robo-advisor won’t start panic-selling, what’s to stop you from pulling the plug on your account? The plus side of a human advisor is that you could call them up in a panic and they would reassure you, talk you off the ledge. Sometimes markets are scary, and demand expert human advice.

No room for customisation

Robo-analysts are more often aimed for the masses. Now let’s consider investors' risk tolerance is moderate as achieved by the mundane questionnaires but can we expect the robo-analyst to understand the unique needs and preferences of the client and customise an investment plan solely for a client?

]There are a set of model portfolios that are put to work depending on the client’s risk appetite. Whereas a typical financial advisor usually sits down with the client, understands his financial goals, aspirations and conducts various meetings to thoroughly analyse the client’s risk tolerance, and offer recommendations that would be better suited for him. Investors question the cost of financial advisors, but what about the model portfolios recommended by the robo-analyst fetching average returns? The median three-year annualised return from these analysts are roughly near seven to eight per cent whereas S&P 500 returns for the same period is around 12-13 per cent, a clear indication that they lag the market. This reassures that bot analyst are suitable for passive investors looking to earn a steady return over time.

Could digital advice procure long-term benefits?

The UAE is home to a plethora of ultra-high net worth and high net worth individuals whose needs, and requirements are complex and intricate that goes beyond the traditional investing style. UAE investors usually have myriad goals stretching for multiple time horizons requiring sophisticated methods to arrive at investment recommendations.

An algorithm can be a great way to kick-start one’s investment journey and may remain a sound choice for a while — but the client may arrive at a point where he needs more than just an algorithm to figure out the optimal way to get the most value from his wealth, that’s when the role of a human advisor would unfold. They could implement an active investing strategy that can accommodate complex scenarios beyond the conventional approach.

A test during turbulent times

At the end of every commercial for a financial services firm, they repeat a disclaimer that "past results are no guarantee of future performance”. However, these automated algorithms make the mistake of assuming that a few years of past experience can predict future results. Could one predict the 2008-09 market downturn unless one is Michael Burry or the March 2020 stock market fallout when the coronavirus fears spooked investors?

The news of the majority of the world economy going into lockdown would naturally prompt these robo-advisors to offer a sell recommendation to almost all investors, but it’s a human advisor who could cope in such turbulent times since they have been through more than one up-and -down market cycle. Lastly, no trader is unfamiliar with “buy the dip” strategy and currently we all know markets are at an all-time high.

A blended approach

We as humans on more than one occasion double check the power door lock system on our automobile while leaving. If we cannot trust this simple automation, can we give AI bots to handle our hard-earned wealth? Indeed, robo-advisors have helped to increase the retail investor’s traction into the stock markets, investing at one’s fingertips; but compromising on the top-notch research and customer service provided by the financial advisor does not seem to be a viable option. Rather investors could opt for a hybrid approach — combining the desirable features from each to create an optimal portfolio.

The writer is chief investment officer of Century Financial. Views expressed are his own and do not reflect the publication’s policy.

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