Is robo-advising a good thing?

Are you prepared to let a robot give you investment advice, or even manage your portfolio online? These robo-advisers were greeted with some scepticism at first, but have now made their way onto the Luxembourg market and are being used by a number of reputable financial institutions. Let’s take a closer look at this new breed of bankers, who have yet to earn their spurs.

Although the internet has made it possible for anyone to invest in the stock market, the reality is that most people trading online don’t have the background needed to make the right investment decisions. Wealthier investors – without necessarily having more expertise – can lean on their bankers for advice on how best to invest their money depending on their situation and investor profile.

Robo-advisers seem to be a way of levelling the playing field, marking a new phase in the democratisation of investment, be it through an advisory contract or discretionary management. But can you really trust these algorithms to properly manage your portfolios? Perhaps this isn’t the right question to ask. Instead, we should examine their strengths and weaknesses in order to judge whether they can meet your needs.

What is robo-advising?

Simply put, it is a service provided by an automated asset management adviser. These are algorithms that provide buying and selling advice, or even perform transactions on your behalf, based on a prior analysis of your personal data and investor profile.

The main difference with traditional asset management is that the robot acts exclusively on the basis of this prior analysis, without being influenced by circumstance or emotion. For all processes where there is little added value to be gained by the investor, human involvement is limited, or may even be non-existent. An important thing to remember, however, is that these solutions are generally offered on interactive, user-friendly digital platforms with entertaining educational content designed to encourage people to invest more money.

How does it work?

The way these robo-advisers operate can vary significantly from one solution to another, particularly in terms of the degree of human intervention. In your first contact with a robo-adviser, the interface will ask you to fill in a questionnaire, which will vary in length by investment solution. The aim of this questionnaire is to determine your investor profile, i.e. your investment objectives (including your level of risk tolerance), your financial situation, and your knowledge and experience of investing. Once this profile has been created, your robo-adviser will automatically generate an asset allocation recommendation.

The securities selection process generally seeks to ensure that your portfolio is diversified (and thus efficient), and composed mostly of index funds […] that track the performance of stock market indices.

The securities selection process generally seeks to ensure that your portfolio is diversified (and thus efficient), and composed mostly of index funds, i.e. exchange-traded funds, that track the performance of stock market indices. Sometimes, the algorithm will add a small portion of stocks to your portfolio that reflects selections you have made from a pre-set list of interests.

While robo-advising is based on passive management, this feature is a way of mixing things up a bit in terms of investment approach. Still, the majority of financial advisers continue to prefer active management (i.e. where the bank’s experts decide which securities to buy or sell, with the goal of outperforming a benchmark). On the other hand, passive management is based on the idea that the market is efficient, and that all it takes to achieve the best possible long-term returns is to track it.

The advantages

The main advantage for investors is of course the relatively low cost associated with this service, making investments more cost-effective. The passive management approach means it is possible to automate certain tasks and, subsequently, to lower administrative costs. The cost side of the argument carries even more weight in periods of low interest rates and limited returns.

Lower costs also make investing more accessible. It is possible to invest on these platforms with just a few hundred euros or even less.

Lower costs also make investing more accessible. It is possible to invest on these platforms with just a few hundred euros or even less. In addition, robo-advising brings a new dimension to the client relationship, significantly transforming the way you invest:

• better access to online services, wherever you are and in some cases 24/7 – all you need is an internet connection;
• faster execution and enhanced responsiveness, as all processes that provide little added value for the investor are automated;
• no emotional interference. This point can be regarded as both an advantage and a disadvantage. Here, the advantage is that the robo-adviser follows a fixed strategy without questioning itself, sticking to the information provided and the rules of the algorithm.

The disadvantages

Many investors are still put off by the idea of no human input. The lack of emotional intelligence is seen as a risk by certain experts, who question how these robo-advisers would react in the event of sudden fluctuations on the market, especially if things go south. Market fluctuations are often the result of totally irrational behaviour, whereas an algorithm depends on rational, pre-defined rules.

For some, a second disadvantage would be the passive management approach. Many experts believe that active management allows you to generate significantly higher returns than passive management. If they are right, choosing robo-advising when you have the means to afford either would be a real missed opportunity.

Investors should also be aware of regulatory issues. These new solutions bring up a number of questions, especially with regard to the handling of personal data when it is not stored at the banking establishment itself. And of course we shouldn’t forget the risk of fraud. Could it be higher for this type of solution? How is the algorithm protected from external tampering? There is no reason to doubt the effectiveness of the protection in place, but it is still too early to measure the risk.

It’s important to realise that robo-advising applies a model portfolio approach. Basically, this assumes that anyone’s capital can be invested exactly as defined by a certain risk profile.

It’s important to realise that robo-advising applies a model portfolio approach. Basically, this assumes that anyone’s capital can be invested exactly as defined by a certain risk profile. When it comes to your hopes and preferences, robo-advising isn’t really a service, so much as a product approach. Take it or leave it, the choice is yours!

The verdict

While robo-advisers are undeniably valuable tools thanks to the high-performing technology behind them, they can in no way replace regular contact with your banker, who is able to look at the emotional side of your choices and propose a tailored active management model. Robo-advising is making investing more accessible to a growing number of investors by enabling quick and effective portfolio construction. In doing so, it offers bankers the opportunity to dedicate more time to what really matters: the client relationship.