As my regular conversations with wealth and investment management clients underline, the rise of automated financial advisory services – or “robo-advice” in tabloid-speak – is currently one of the banking industry’s hottest topics.
With leading players now starting to use the robo-advisory model blended with their traditional financial advisor relationship-led approach, it seems that robo-advice has a big future. However, it’s equally clear that for robo-advice solutions to become accepted as mainstream, the industry first needs to win a significant battle for hearts and minds.
In this short series of two blogs on robo-advice, I’m going to look first at the barriers it needs to overcome to reach critical mass, both among banks and consumers. Then in blog two I’ll go on to pinpoint the benefits that robo-advice delivers – and which I believe mean it will ultimately win out.
First, some context. The rise of robo-advice in wealth management suggests it could open the way for other areas of banking to be fully supported by artificial intelligence (AI), even if not actually AI-led. We already have automated decisions-in-principle for mortgages and other consumer credit agreements, as well as automated FAQ services on some banking web and mobile sites.
With services of these types there’s little or no risk to customers’ money. However, automated financial advisory services are seen as a different matter, with banks appearing more hesitant about launching them and customer adoption – at least in Europe – lagging behind the US.
Why? The reasons for caution differ between banks and customers. Among banks, the main concerns are around regulation: specifically the FCA’s recent Financial Advice Market Review (FAMR), which aims to make financial advice in the UK work more for the consumer; and the 2013 Retail Distribution Review (RDR), which placed more responsibility on FAs for ensuring investors understand the risks.
The banks’ concern is that these regulations still leave too much room for interpretation and, by extension, future possible risk. After years of compensation claims springing from issues including PPI, SME derivatives and the Plevin case, banks are understandably cautious. If the regulator does want the main high-street banks to adopt robo-advice – as the language of the FAMR suggests – then it needs to provide much clearer guidance. A further consideration for the banks is that, at a time of widespread restructuring, cost cutting and regulatory change, the idea of implementing any largely untested business model looks like a questionable use of capital.
Meanwhile, on the customer side, many UK consumers’ response to robo-advice is influenced by their engrained apathy towards long-term financial planning – another issue that the FAMR sought to address, and which contrasts starkly with the US, where financial advice is much more accepted.
There’s also a common misconception that robo-advice is purely algorithm-led. For some people this raises trust issues, especially if the advice relates to a newly-released pension pot. However, the reality is that robo-advice is often a blend of decision-tree based algorithms – asking the consumer for information such as their accepted level of risk, geographic investment preferences, age, employment status and so on, and then producing a recommendation based on the answers – combined with human interaction to build the portfolio.
Some consumers may also be concerned about being “pigeon-holed” by an algorithm that uses their age and personal circumstances to tell them what level of risk they should consider. This can be a particular worry for investors with more complex financial planning knowledge and experience, and possibly larger sums to invest. Not all investors in their 50s and 60s are looking for a passive or index-linked, lifetime-focused portfolio. And they may suspect that this is the route that a purely robo-advised portfolio would direct them down.
So these are the barriers – real or imagined – that robo-advice must overcome to become an established feature of mainstream financial services. In my next blog I’ll look at the advantages that will enable it to overcome these issues. Watch this space.