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Mark Kowalczyk Nov 13, 2017

Smart advice for smart robo advising

The term “robo advising” emerged in the banking and wealth management communities about a decade ago. And, while the term of art “robo” was new, technology simply helped streamline and deliver a time-tested method of model portfolio construction to the masses. 

Model portfolio construction ensures that representatives recommend consistent portfolios to groups of people of similar ages, risk tolerances and return objectives: This concept was not new. Consulting firms such as Charles Schwab and Morningstar had offered model portfolios through broker dealers and insurance companies for decades.

At first, the industry viewed robo advising with a cautious eye. Many bankers and broker/dealers wondered if offering an automated (and usually web-based) investment planning solution might cannibalize business from both the deposit and the wealth management sides of their banks. 

But time has proven thus far that robo investing platforms introduce a bank to individuals who might not have otherwise been candidates for a more traditional fee-based money management approach. This has allowed professional advisors the time to spend with investors who value “white glove” treatment (at a higher price), while it introduces less wealthy and experienced investors to the discipline of long-term money management through robo.

There is no doubt that robo investing is here to stay. In just seven years, approximately $100 billion of assets are being managed by some type of robo platform. Most broker dealers and banks have seen the light and are jumping aboard the Robo Express, if they have not settled in the front car of the train already. 

While it is natural to look at the beautiful technology that makes the investing process fast and painless for many new investors, the main elements of sound investment policy should rule the day. So while colorful graphics and quick response times are important, often what is lost in the decision making and evaluation is what rests behind the technology:

  • First, does this robot give customers the same security and intelligent decision making as a traditional one-on-one bank investment counselor?
  • And second: Do customers get portfolio recommendations consistent with the bank’s own investment policy guidelines?

There is no doubt banks are rapidly moving to make greater use of robo advisor systems, especially for customers with fewer dollars to invest. The systems can be quite effective in serving the needs of customers who want more control over their investment portfolios, but don’t have the time to extensively research potential investments. They also allow customers with modest investment portfolios to gain access to wealth management services previously reserved for the very wealthy who can afford personal financial planners.

The popularity of these systems is reflected in optimistic projections such as that of A.T. Kearney, which estimates that assets under management by robo advisors will grow by 68% annually to about $2 trillion by 2020.

In looking at robo advisor systems, banks must ask five major questions:

  • Does the investment policy and strategy of the robo advisor agree with my bank’s policy?  And if not, can I install my bank’s investment policy and fund selection methodology in place of the robo standard models?
  • Are the tax and fee penalty implications of transfers fully vetted prior to the system going live?
  • What are the back office and operational considerations of fully executing a robo-based recommendation?
  • What is the legal relationship between the bank and the robo platform and the robo platform and the end investor?
  • When will investors be invited to migrate to a full-service model within the bank broker/dealer?

Stellar service, consistent recommendations

The recommendations of a robo advisor should mirror those your customer would get from a staff advisor employed by your bank, at least at the asset class level.  For example, if the asset allocation recommended by the robo system differs for a particular age group than what your bank typically recommends, there is a problem.

And customers served by a robo advisor should feel that the bank takes their financial concerns just as seriously as if they were being served by a bank-employed human advisor.

It doesn’t matter whether a customer has $100,000 invested in a portfolio or $10 million: The quality of the service and appropriateness of the investment strategy should remain consistent.  A good way to make sure this happens is to take a sampling of customers directed by the robo advisor and those who work with registered advisors employed by the organization—and do so on an ongoing basis. Are the recommendations for the two groups similar? If both pools have customers with similar ages and risk tolerances, their investments should largely fall into similar portfolios.

Organizations need to review the performance of their robo advisors at least annually, if not quarterly, to make sure the recommendations fit with their expectations based on customers’ ages, risk tolerances and return parameters.

Certainly not every customer’s outcome will be identical and some customers will override the recommendation of the automated system—such as those who choose to take on more or less risk than what’s recommended. But there should be an acknowledgement built into the system to show that the customer made such a choice.

The transition proposition

Financial services organizations also need to ask who is appropriate for robo system service. Often customers just entering the investment world and don’t have a lot of funds to contribute get directed to the robo advisor. But some of these customers may need a lot of hand holding. Just when do customers need a one-on-one advisor? Bank policy should address this issue.

Even once banks decide which customers to route to the robo advisor, they need to develop a transition strategy for moving those customers to a hands-on advisor if necessary. Often the robo may well serve customers with limited assets. But as a customer’s assets grow and financial needs become more complicated, it might be necessary to transition them to a bank advisor.

Life changes may also indicate a new impetus for transition. When is that and how should banks do it? Banks need to develop clear strategies to identify customers who need transitioning—and outline a plan to guide it.

Another common assumption is that a robo advisor system will relieve the bank of customer service responsibilities at the call centers. Even with the robo advisors, customers will ask questions and need help with tax issues or account issues. They need the option to call the bank and get answers from licensed brokers.

Taxes, fees and key assets

Finally, consider the tax ramifications of the robo advisor’s recommendations—and think about the appropriateness of investment recommendations based on the tax ramifications. If a customer already has an IRA, does it make sense to recommend a fixed annuity or other tax-deferred investment that might charge up to 2 percent of the investment? Look for such scenarios when auditing robo advisor results.

Similarly, look at the fees your customers incur based on the robo advisor’s recommendations. Make sure the fees are appropriate for your customers and in line with what the bank believes they should pay. 

In the end, if banks do the proper due diligence about these systems and apply them appropriately, this technology can be a tremendous asset to the firm. And that asset, properly and professionally applied, will certainly lead to assets of another kind.

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Mark Kowalczyk is BAI's Managing Director, Business Development.  For more information on BAI's expanded capabilities within the Investment Benchmarking program, a joint service of BAI and IXI, visit BAI.org.

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