Should You Trust Your Hard Earned Investment or Pension to a Robot?

 

These robots, of course, aren’t like those you see in films. Instead they are capable of providing investment advice usually delivered by a human adviser sitting behind a desk — and for a lot less money.

So-called ‘robo-advisers’ — which assemble investment portfolios after an investor answers a series of questions regarding their expectation of a return and tolerance to risk — have been widely praised for their easy, low-cost approach to investing. These automated services have quickly amassed USD53 billion under management in just a handful of years in the US alone, according to estimates by Aite Group.

Should you consider using a robo-adviser, and could your current adviser not only be missing out on performance but significantly hurting your financial health?

The flow of funds into robo-adviser accounts is expected to accelerate because of increasing regulation in more regulated jurisdictions such as the USA, UK, Australia, and South Africa, which require all financial professionals to put their customers’ interests first.

Aite predicts that robo-advisers will collect nearly USD285 billion in the US alone by 2017, still a small portion of the USD20 trillion in US retail investors’ assets held at brokerage firms and registered investment advisory firms.

However, robo-advisers are already required to follow the highest standards of consumer protection — on every dollar or pound they manage, not just retirement money — because most of them are registered investment advisers. (Unfortunately, the same can’t be said for many, if not most ‘independent financial advisers’ providing expats with advice). That means they are required to act as fiduciaries, the legal term meaning they must put customers ahead of all else. It’s a banner the robo-advisers wave proudly.

Some have questioned whether robo-advisers can act as fiduciaries in the traditional sense, because of their inability to address subtleties that may arise in conversation with an investor.

However, being a fiduciary is not about the types of service you offer, it’s about the quality of service. “It is not unusual for clients to expressly or secretly withhold information from their advisers about other assets,” said Mercer E. Bullard, a professor at the University of Mississippi School of Law. “For example, if a 35-year-old says, ‘I’m not going to tell you what other assets I own and I want you to invest USD100,000 for my retirement,’ you can do that with disclosure that the allocation might be different if you knew all of their assets.”

The USA’s Financial Industry Regulatory Authority, or Finra issued a report just last month, providing guidance for investors and advisers using such automated services. The report suggested that investors evaluate whether a firm is gathering enough information to understand their needs and stomach for risk.

Sadly, this again something which many face to face ‘advisers’ operating in under-regulated offshore markets simply do not bother to consider, focussing instead on alternative, esoteric investments or structured notes which promise high annual returns, and paying more attention to the amount of commission an investment will pay them rather than the underlying risks and whether it is suitable for a given client.

Latest research from Cerulli Associates, comparing quarterly performance over a five-year period through the end of 2014, Cerulli data analyst Frederick Pickering found that the more personalised approach generally hurts performance.

The performance disparity is at times subtle and there are quarters when the advisers did better than robo-advisers, but the long-term performance favours sticking with robo-advisers.

The comparison of the average returns of robo-advisers and portfolios constructed by advisers, found that robo-advisers generated a 36.7% gain over the five-year period, while the customised adviser portfolios gained 33.5%. (Performance for customised adviser portfolios would be significantly reduced and the disparity greater, if using the expensive, commission paying offshore funds commonly found in many expat’s investments or pensions).

The research also included a hybrid portfolio that allowed for some tweaking of the home office portfolio, which Pickering described as “home office light,” that gained 33.7% over the study period.

“We broadly found that the home office portfolios did better,” he said.

Some of the reasons the robo-advisers performed better, according to Pickering, relate to a stronger emphasis on fundamentals such as risk-adjusted returns, consistency of investing style, and the tenure of the portfolio managers in which the home-office products are investing.

By contrast, Pickering said, the individual advisers are often influenced by factors that come with having to talk to clients face to face. In under-regulated offshore jurisdictions, upfront commissions from investment funds can also lead to a bias in advice, which are funded by a high level of ongoing charges or hidden charges which erode any investment performance.

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