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In the ever-changing landscape of global finance and investment management, the concept of robo-advisors has long been treated as the bogeyman. With its promise of democratizing wealth management and ending the fee-based gravy train of institutional investors, it isn’t surprising that Wall Street is not a huge fan of this concept.
That being said, however, ever since they first arrived on the scene in 2008, robo-advisories have been constantly hyped to be the next big thing, only to predictably fall short of expectations.
While assets under management at leading robo-advisory services are set to scale past $2.7 trillion this year, it still makes up a small fraction of the total global assets under management at $100 trillion across leading institutional asset managers.
All of this begs the question, are robo-advisors worth it? And Do they genuinely stand to add value to retail investors? In this article, we take a deep dive into this niche domain of investment management, trying to uncover its various nuances and intricacies.
The Cost Advantage
One of the key advantages of robo-advisors is their cost-effectiveness, with traditional institutional advisors charging high management and performance fees that often eat into an investor’s returns.
While ETFs and mutual funds charge as much as 2.5% of net asset value as annual fees, in the case of robo-advisors and automatic investments, this amount can be as low as 0.25%. This is made possible by the extensive use of automation and algorithms, which save substantially in terms of execution and administrative costs.
In addition to this, there are a handful of robo advisors that employ something known as a hurdle rate, which basically means that they won’t be charging any fees from investors unless their annual returns cross a certain benchmark. This is a great value to create value for small and medium-sized investors.
Convenience & Flexibility
Robo-advisors offer unmatched convenience and accessibility with a fully digital, and often paperless experience.
While traditional asset managers have caught up to them in this regard, most robo-advisors have a tech-first approach that leaves them further ahead when it comes to delivering perfect user experience, seamless systems, and processes.
These services are further known to offer extensive customization for investors, and not just in regards to risk tolerance and investment goals, but even moral, ethical, and religious considerations. For example, portfolio allocations can be strictly Halal for Muslim investors, similarly, for those who are environmentally conscious, a bulk of their assets can be allocated in favor of ESG stocks.
Mainstream ETFs and mutual funds have tried to replicate this, often with individual funds focused on certain themes as discussed above. However, they cannot beat the value that stands to be created by automatically creating a personalized portfolio based on each investor’s requirements.
The Limitations of Algorithms
Having scaled from $60 billion in assets under management in 2015, to $2.8 trillion today, robo-advisors seemingly have a lot going for them, in reality however, they’ve been nothing short of a bitter disappointment, as their growth dwarfs in comparison to the broader asset management industry.
This can be attributed to a slew of factors that the sector has since realized over the years. It turns out that the total absence of human interactions wasn’t all that great.
Most average people, particularly when it comes to their life savings, prefer face-time with a fellow human being, whom they can trust with their money, and hold accountable in case something goes wrong.
In addition to this, the personalizations offered by robo-advisors, while fairly sophisticated, were never on par with the level of customizations that can be offered by a human advisor. This is particularly true in the case of specialized investment requirements, such as complex tax loss harvesting, hedging against particular events, etc, when a human advisor is absolutely pertinent.
Finally, there are the gains accrued from active trading and management, that often allow funds to outperform benchmarks and indices. Robo-advisors often steer clear of this, as they lack the sophistication required for such trading practices, robbing investors of significant value in the process.
Robo-Advisors have come a long way since their inception 15 years ago, and while they are not dominating the asset management industry like people expected them to, they certainly do have a role to play, in a niche segment, offering unique, customized solutions for investors who require them.
So yes, robo-advisors are perfectly worth it, and in due course, they will improve their offerings to match human asset managers, for the time being, however, they will be restricted to the fringes of investment management.