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Opportunities and challenges lie in the rise of the robo-adviser in the US


The rise of the automated investment advisory service for individual investors in the US has emerged as another pressure facing active investment managers, says Fitch Ratings in Chicago.

So called robo-advisers could be an opportunity, according to Fitch, for a growing number of wealth managers, particularly given the highly scalable nature of the business. Leading US wealth management/discount brokerage-focused firms such as Schwab and Vanguard have already established automated (or quasi-automated) investment products that make investment allocation decisions using mostly indexing and ETF products for individual investors.
Fitch found that these firms are likely to maintain advantages in further development of these services due to their historical focus on direct channel delivery capabilities, cost efficiencies and web-based platforms.
Fitch writes: “As automated offerings further proliferate, pressure may grow on higher touch advisory services to demonstrate their value proposition and bifurcate their service offerings based on investors' service needs and net worth. Firms that have a higher dependence on human advisors, particularly advisors that focus on middle-market retail investors, such as Edward Jones, Ameriprise, Raymond James, A.G. Edwards, LPL Financial, independent registered investment advisors and mid-tier wealth advisors affiliated with banking channels, could potentially feel the effects of client defections to a growing number of automated services. If investors are steered towards more commoditised investment products as a result, this could further pressure highly active or tailored investment products, particularly those that are unable to produce differentiated net returns over the long term.”
Fitch found that platforms targeting more ultra-high net worth individuals, such as Bank of America Merrill Lynch, Morgan Stanley and Northern Trust, may also feel the effects, but to lesser degrees, as the complexity of these clients' accounts require more high touch services.
“Investors with lower touch service needs and lower account balances have thus far been the primary strategic focus for automated investing services. This is likely to remain so until there is greater market adoption. Self-directed investors in lower brackets of investable assets are an underserved market that can be more efficiently serviced through automated advisory services, in our view” Fitch writes.
“Among the challenges we see with automated programs are transparency customisation and operational risk. For example, wealth managers will need to communicate investment decisions to investors; assign and maintain individual portfolios based on risk tolerances; establish how preferences can be chosen (e.g. investing socially or using dollar cost averaging); decide if overrides may be applied; and minimise the occurrence of trade errors due to automation. Additionally, how automated models perform in the face of market corrections or other risks to financial systems remains unproven.”
The advantages of the robo-adviser are largely cost based. Fitch comments: “From a cost perspective, automated investment programs appear to be more controllable and easier to maintain relative to building and maintaining a human advisor force. And while automated investing has the potential to be more manageable from a regulatory position, there will still be grounds for direct to company customer complaints or worse.”
Fitch predicts that firms with large scale and large selections of investments will be positioned to drive the lowest market price, which for some, have already reached zero fees for the service. Firms not charging advisory fees (e.g. Schwab) will instead make their incremental revenues through fees on underlying investment selections, charges on cash balances and holdings in sweep accounts.

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