Practice Management January 31, 2022

When Robo Advisers Struggle to Scale

While automated client service now plays a key role for many advisory firms, investors who accumulate substantial assets will always want and need a human adviser, especially when markets are volatile.
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Art by Lia Tuia


A decade ago, the debate over robo advisers and whether they would replace human advisers in the investment management industry was still raging. Reading the headlines back then, it sounded like doom and gloom for anyone who made their living giving investment advice.

Now, that debate is long gone and a new understanding has emerged: Investors—specifically high-net-worth clients—will always want and need a human adviser, especially when markets are volatile, experts say. The new question of the day is how to combine human advice with digital technologies that make the basics of investing cheap and easy. And how can companies provide human advice at scale?

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Scale and the Human Touch

Across the advisory industry, the rise of the hybrid model shows that both pure-play robo advisers and established asset managers are exploring these questions. Many pure-play robo advisers—i.e., those that do not employ large teams of human advisers in their client service models—have partnered with larger financial institutions to make customer acquisition easier and provide specific forms of advice via humans.

Scalable Capital, for instance, partnered with BlackRock in 2017 to help BlackRock’s UK workforce manage its personal investments. Similarly, a large number of big-name investment managers have started or acquired their own robo advisers. Vanguard’s Personal Advisor Services, launched in 2015, is now the largest player in the industry with $220 billion under management. New investors get to speak with a human adviser when they open an account with a minimum of $50,000.

Zaniyar Sharif, managing director at Redesigning Financial Services (RFS), says the industry is in a period of evolution.

“In recognition that they need to provide a human touch, robo advisers are experimenting with how to serve a lot of clients with a few financial advisers, for instance in call-center type models,” he says. “The market is tough. We’ve already seen some robo advisers morph into antithetical trading platforms to find alternative sources of revenue.”

A report by RFS on hybrid advisory models said the ubiquity of robo-advice offerings, together with the automation of middle and back offices, is reshaping the value proposition. The report suggests leading firms will seek to “identify and invest in other ways of differentiating themselves to stand apart from competition, in particular through deeper personalization of customer offerings.”

Partnerships Are Key

As the realities of the new market set in, experts say robo advisers need to continue to partner with other groups to make customer acquisition less costly and provide a more holistic offering, for instance through better investment content or with additional products and services, such as insurance.

David Trainer, the founder of New Constructs, which bills itself as an investment research firm specializing in unconflicted and comprehensive fundamental research, says robo advisers should be offering better equity research to help their customers invest with more intelligence and compete with professionals.

“When robo advisers got their start, we had rising markets,” Trainer says. “It was so easy to pick stocks back then that a robot could do it. In a more challenging market, I think that assumption breaks down. It’s difficult for pure robo advisers to work as well as everyone expects them to. They need more investment intelligence to do that.”

Trainer’s company—which he refers to as a “robo analyst” rather than a robo adviser—performs and provides fundamental stock research in an automated fashion, using algorithms to parse company filings and crunch data. He argues that small investors in particular have a right to more expansive and better investment research than they are getting.

“Robo advisers’ assets under management [AUM] have been stuck at certain levels,” he adds. “There is only so much of the world that is going to trust that the robot can figure it all out. Because it can lack any kind of intelligence about individual securities, a robo adviser is the perfect partner for a robo analyst. A robo analyst can help the robo adviser scale to the next level of AUM, because it can provide human-level sophisticated analytics via machine.”

Banking-as-a-Service Providers

Christine Schmid, head of strategy at additiv, an “embedded wealth” or “banking-as-a-service platform” provider in Zurich, Switzerland, echoes that sentiment. She says technology-based companies have a role to play in lowering the cost of advice, much like they helped decrease the cost of financial transactions over the past decade.

“Bigger banks have already decoupled the price of advice from investment products,” she explains. “Now it’s time for the new players in the market to bring down the price for advice through data, analytics and artificial intelligence [AI].”

According to Schmid, in the same way a third-party payment transaction provider gives a retailer access to the ability collect a bill just when a customer wants to pay it, for example during an online checkout, banking-as-a-service companies such as additiv can give an adviser’s client access to a digital wealth management solution “at just the right moment for the client.”

“What you have seen on the payment side, we are opening up on the wealth side, going beyond the traditional channels,” Schmid says.

A report by additiv says this model, enabled by tech-based wealth solutions, makes it possible for asset managers or independent financial advisers to extend their offerings. According to the report, independent financial advisers can work with firms like additiv to go further than automated investment advisers, for example by offering advisory services at scale within the context of a big company’s financial well-being platform.

The report, published in September, estimates a revenue potential of $100 billion in fees for wealth managers, based on an addressable market of $33 trillion in assets globally which are not professionally managed right now.

An End to the Pure-Play Era?

Experts agree that robo advisers have played an important part in the evolution of investment management, having first helped make investment advice more widely accessible and now enabling companies to strike the right balance between an easy digital investing experience and human advice.

Adam Dooley, founder, chairman and CEO of Belay Associates, a global investment firm focused on the financial services industry, says, nonetheless, people still want the human adviser touch.

“I’m of the view that there are no more pure-play robo adviser startups that plan to manage money or attract clients that are older than 30 or 35 years old,” he suggests. “If they’re out there, they’re not having much success, because people need the advice.”

Besides helping drive down the cost of trading, Dooley says, robots have helped the entire industry by ushering in a whole group of younger investors who were not active, teaching them the value of saving and investing, and familiarizing them with the terminology and the different options.

“Now, when a young investor approaches a human adviser, they’re more knowledgeable,” Dooley says. “Robo advisers have evolved from digital advisers to digital advice platforms. The most leading-edge firms have incorporated digital advice into their service offerings because clients want to be able to speak with their advisers and go online and do basic transactions themselves or inform themselves.”

Similarly, for independent plan advisers and smaller wealth advisers focused on strong relationships with their clients, the digital offering is a must.

“If they want to grow and bring in new clients, the user experience from a digital perspective is critical,” Dooley concludes.

The Markets January 31, 2022

Will ETFs Ever Break Into the Retirement Plan Space?

The factors that make exchange-traded funds popular with individual investors and financial advisers might be moot points in most DC plans.
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Exchange-traded funds (ETFs) have failed to gain widespread use in defined contribution (DC) plans, although they have become popular among individual investors.

Morningstar Director of Personal Finance Christine Benz has developed a series of hypothetical portfolios for savers and retirees, and explained in a recent article that while they all posted strong gains last year in absolute terms, “the ETF portfolios crushed their mutual fund counterparts.” Given such results, would retirement plan participants fare better with ETFs than with mutual funds?

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Morningstar Head of Global ETF Research Ben Johnson says the article is making single ETF and single mutual fund comparisons, so investors can’t make generalizations about ETF performance based on that. However, he says a generalization that Morningstar can see and say with a high degree of confidence is that over longer periods of time, lower fees lead to better outcomes.

“ETFs tend to have lower fees than many mutual funds, which might lead to longer-term outperformance,” Johnson says. “But that’s not unique to ETFs. There are low-cost mutual funds, especially in retirement plans.”

Kristen Carlisle, general manager of Betterment’s 401(k) business, says mutual funds have higher fees than ETFs, and many mutual funds in DC plans are actively managed and require in-depth analysis. She adds that research has shown there’s rarely a big improvement in performance from active management.

“A majority of actively managed funds lag in performance compared to passively managed funds over nearly every time period,” Carlisle says. She adds that ETFs allow for more diversification in investors’ portfolios.” ETFs allow for far more diversification than single stocks and must adhere to the same diversification requirements as mutual funds,” she explains. “Because ETFs typically aren’t over-concentrated in any specific company, sector, or country (unless specifically called out in the fund offering prospectus) you’ll be spreading your investments across multiple assets and therefore limiting your exposure to specific risks.”

A few DC plan providers offer all-ETF 401(k)s, including Betterment. Carlisle says the biggest reason ETFs typically aren’t included in employer-sponsored plans is that the market is dominated by players incentivized to offer certain funds.

“Many retirement plan providers are mutual fund companies, and plans are sold through their distribution partners,” she explains. “There are fees embedded in mutual funds that facilitate payments to every party involved in the sale. That structure has been in place nearly since the inception of 401(k)s.”

Carlisle says there are also existing technology limitations. “Most recordkeeping systems were built decades ago and are designed to handle batch trading, not intraday trading,” she says.

Johnson also cites the operational issue that has prevented widespread availability of ETFs in DC plans. “Because ETFs trade like stocks throughout the day, the mechanics of trading, clearing and allowing for investments in fractional shares is difficult to solve in traditional recordkeeping platforms,” he says.

However, Carlisle says technology is catching up and there is rising interest from younger and newer investors to include ETFs in their retirement plans.

Still, according to Johnson, there are two issues with ETF use in DC plans that will persist. “The first, more fundamental issue is that many of the benefits of ETFs go away when used in the confines of a tax-deferred retirement account,” he says. “A reason ETFs appeal to many individual investors and financial advisers is they tend to be more tax-efficient than open-ended mutual funds. But that becomes a moot point in a tax-deferred account.”

Lower fees are still a benefit of ETFs, but they might be less of a benefit inside a DC plan where many investment menus already feature low-cost index funds, Johnson adds. “So if a DC plan uses ETFs instead, it might be just getting a like-for-like swap, so there wouldn’t be a reason to move out of low-cost index funds.”

Another thing to keep in mind, according to Johnson, is that many plan sponsors are moving away from mutual funds toward collective investment trusts (CITs), which also boast lower fees. “There’s a tug of war between mutual funds and CITs, and CITs are winning,” he says.

The other issue with using ETFs in DC plans is liquidity, Johnson says. “ETFs trade like stocks so they can be exchanged all day long,” he explains. “That might be viewed unfavorably by sponsors because they don’t want to see participants day-trading their nest eggs.

“For all these reasons, we’ve long been skeptical ETFs will make it in the DC plan space,” Johnson says.

Asked about the concern over retirement plan participants day-trading with their savings, Carlisle says Betterment’s solution addresses that through goal-based investing, taking out the guesswork for participants about how to invest their funds. Betterment’s platform includes personalized investment advice for participants.

“We guide them to think about what life they want in retirement and we tell them how best to get there rather than leaving it up to them to pick their own funds, as traditional recordkeepers do,” she says. “There are arguments that ETFs are confusing and that they can be distracting because of intraday trading, but technology can eliminate those concerns.”

Johnson says, in his opinion, ETFs could have a role in smaller plans—those that might not have sufficient assets to qualify for the lowest-cost share classes of mutual funds. “And there’s no minimum investment requirements for ETFs,” he adds.

A way ETFs might find their way into the DC plan space more broadly is through target-date funds (TDFs), Johnson says, noting that at least one fund provider is offering ETFs in TDFs. He says the product was specifically designed to cater to smaller plan sponsors.

To get ETFs to break into DC plans comes down to who is asking for it and demanding it, Carlisle says. “As I said, younger and newer investors want ETFs in their retirement plans,” she says. She also says it will take “continued education for plan sponsors about the value of ETFs and how they differ from mutual funds, and about making choices that are best for employees.”

Carlisle adds that cost is another factor in favor of ETFs in DC plans. “People are paying attention to their retirement plan fees and litigation is on the rise,” she says. “This will put a spotlight on the difference between fees for ETFs and for mutual funds.”

“Plan sponsors should understand it’s important to pay attention to cost. It affects how much participants can save for the future,” Carlisle says. “We believe in ETFs because they are low cost without sacrificing performance.”

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