At the beginning of June, the Financial Conduct Authority (FCA) launched its Advice Unit, designed to help “robo-advisers” – firms offering automated advice through online platforms to deliver cheaper advice to consumers.
The Advice Unit was first trailed in the Financial Advice Market Review (FAMR) published in March 2016, which underscored the need to tackle the “advice gap”.
The advice gap has gained increasing attention for a number of reasons. Whilst those at the top end of the wealth spectrum can afford to pay for financial advice, the majority at the other end cannot afford (or choose not) to pay for advice. The Retail Distribution Review, which addressed issues such as charging of commission, resulted in increased charges for advice.
Recently the changes to private pensions, which came into effect in 2015, means savers have access to their pensions pots but need financial advice and guidance. According to research by Unbiased, half of those over 55 are not confident that they could draw down their pension without professional advice.
This advice can come at a significant cost. A study by Which? claims IFAs are charging as much as £3,750 in fees for pensions advice. In addition, the social, demographic and financial landscape has changed, with:
- a larger older population
- increased life expectancy
- distrust of traditional financial services
- a younger population with different attitudes to finance, work and savings
Consquently the advice gap has grown.
The FCA has been considering how robo-advice can help bridge the advice gap for a while. In 2014, in a speech on the “technology challenge,” the FCA’s then Chief Executive Martin Wheatley stated that automated advice would be a “priority” for the FCA’s Project Innovate. He asked whether automated investment advice could be used to tackle “the so-called ‘advice-gap’ between those with large investment pots… and those with small investments.”
Since Project Innovate’s launch, the FCA reports that 39 companies have sought assistance from the Innovation Hub regarding the potential implementation of robo-advisory systems and technologies in the retail investment market. The FCA’s Advice Unit, its focus on tackling the advice gap and assisting those providing automated advice, is a further step along this trajectory.
Appeal of robo-advisers
It is easy to understand the attraction of robo-advisers. They promise to offer the same pensions planning advice at a fraction of the human cost. Digitalisation and low barriers to entry have permitted swift growth in this sector and caught the eye of traditional financial institutions.
- Nutmeg is an online wealth management company that has attracted significant capital, with Schroders investing $32m into the company.
- Goldman Sachs has recently made a move into the automated advice areana by buying Honest Dollar, a start up aiming to make it simpler to set up savings accounts for retirement.
- Retirement specialist LV= also capitalised on this emerging trend when it took a majority stake in robo-advisory Wealth Wizards last year, and now offers a fully regulated automated retirement planning service, with a tailored report priced at £199.
For those savers who have been automatically enrolled on a pension, with auto escalation and defaulted age-based target-date funds, the move toward robo-advisory at retirement may not be such a great leap.
The continuing distrust in traditional financial institutions has also played into robo-adviser appeal. Today’s consumers expect transparency and low-cost products and solutions. Traditional wealth management advisers have been viewed as costly and exclusive. Robo-advisers seem to be democratising the investment and wealth management space, appealing to younger consumers and those at lower income levels.
A.T. Kearney’s 2015 Robo-Advisory Services Study suggests the predominant customer base is under 35 years old, which includes millennials – the generation that has been labelled as fiscally irresponsible. Yet research by Facebook suggests that Millennials are financially cautious, responsible, diligent in paying debts and dedicated to accumulating savings.
However, just 37% of Millennials have a financial plan. And to compound this problem 53% say they have no one to turn to for financial advice. With U.S. Millennials set to inherit an estimated $30 trillion from their parents, this advice gap offers opportunities for robo-advisers.
Its not difficult to understand why Millennials are attracted to technological solutions.
- They have grown up in a world of profound economic instability and extreme technological advances.
- They do not trust traditional financial services firms, bricks and mortar or face-to-face buying experiences.
- They are comfortable using apps to discover the best deals, with decision-making dictated by peer reviews and social media rather than traditional media advertising.
A life spent in the digital age means Millennials have very different ideas of what financial advice should look like. Whilst traditional financial services have failed to effectively engage, their custom, robo-advice technology is creating a new space in which it can be profitable to serve those with less favourable bank balances. Around two thirds of those using automated investing service Betterment are Millennials.
Robo-advisers will continue to gain further traction. A.T. Kearney’s 2015 Robo-Advisory Services Study predicts that robo-advisers will be mainstream within three to five years and that approximately $2 trillion will be managed under robo-advisers by 2020.
Risks of Robo-Advisers
Should savers, trapped in the advice gap or otherwise, entrust their future financial success to an algorithm? It should be noted that some robo-advisory firms involve human investment advisers alongside robo-advisers. Vanguard offers portfolio management software along with a Vanguard adviser to oversee and review client accounts on a regular basis. Of course, this comes with a price.
Where reliance is solely on a robo-adviser, concerns remain that robo-advisers will never be fully reliable, cannot provide comprehensive financial planning, could trigger a mis-selling scandal, and could even pose a systemic risk if their automated advice is later proved erroneous. Some have expressed concern that, with human advisers removed from the picture, robo-advice firms are incorrectly assessing customers risk tolerance because they are unable to probe or question the client.
The Financial Services Consumer Panel (FSCP) expressed concern about banks’ history of mis-selling through advisers in advance of the publication of the FAMR, stating:
The concern is that high street banks view automated advice as a route back into mainstream advice, providing a cheap, low liability way of distributing their own investment products. The history of investment mis-selling by those banks raises concerns over the potential for serious and widespread consumer detriment.
For now banks and regulators will need to closely monitor the use and role of robo-advisers, especially since it looks robo-advisers are here to stay. As technology improves and we see further leaps in artificial intelligence, it is not difficult to envisage sophisticated robo-advice: personalised, granular and complex advice which might encompass the regulated and unregulated sector, and include a range of services, from wealth management, retirement and insurance alongside a blend of personal, educational and social advice—batteries not included.
*Marvin the paranoid android – Hitchhikers Guide to the Galaxy
**ED-209 – Robocop
***Robot – Lost in Space