Man versus Machine - D2C automated adviser investment platforms

17 April 2018 Marius Kilian, 2IP Independent Investment Partners

The marketing machines of the industry consistently make the promise to investors that, if entrusted with their wealth, it would secure for them a comfortable retirement . The only problem is they cannot honestly manage the evidence.

Statistics suggest that very few people will actually retire financially secure. For the most part financial advisers rely on clients to answer two questions: how much of your current salary will you need in retirement? And, what is your attitude towards risk?

Unfamiliar territory

Research shows that investors typically suggest a replacement ratio of 70%. When their real needs (how do you want to live in retirement?) were calculated, based on personal budgets (expectations versus rule of thumb percentage) the required replacement ratio was in excess of 100%. People underestimate what their real needs will be..

Financial advisers have had access to a wide array of retirement planning tools for many years, but the adoption rate as an integral part of the planning process has been disappointing. This has been in part due to the complexity of many of these tools when compared to the simple risk questionnaires.

Internationally we are seeing the proliferation of Direct-to-Client (D2C) automated adviser platforms which guide a client through processes that are both simple and intuitive. Using complex algorithms, yet applying the basic principles of modern portfolio theory, the current offerings (by enlarge) provide the investor with a well-diversified optimal portfolio at low cost.

Shortfalls in financial planning

When done correctly, investment planning should be objective, unemotional and largely rules based in order to satisfy certain minimum criteria. This is where these D2C offerings excel. The automated investment advice component is accurate and is done in milliseconds. The D2C platforms also automatically rebalance client portfolios to ensure that portfolio drift over time does not lead to inappropriate risk exposure.

These offerings are very strong at optimising portfolios, but tend to focus nearly exclusively on the client risk appetite and investment term. They tend to not give enough consideration to actual client needs over time and do not establish the need for risk with a high degree of confidence and accuracy. The D2C models tend to focus on optimising client portfolios based on predominantly risk questionnaire outcomes. They mostly fall short on basic financial planning.

The initial response to D2C offerings in the USA from the investment adviser community has been to dispel it as a serious and credible threat to their practices. This is however increasingly being viewed in the context of the natural evolution of the financial planning environment. In a highly regulated environment advisers in the UK (post RDR) have realised that the economics of servicing mass market clients is increasingly onerous and not profitable. An unintended consequence of the introduction of the Retail Distribution Review (RDR) in the UK has surprisingly been the disintermediation of investors by the advisors. The direct models will increasingly fill this advice gap.

Finding a balance

Financial advisers in the USA are realising that technology developed by the D2C fraternity can be beneficial for their practices. The simplicity of these platforms is easy to adopt and the automation of the investment portfolio is fast, effective and disciplined. The outcomes are based on modern portfolio principles that are articulated into client-level optimal strategic asset allocations. This provides the depth and integrity that will stand up to regulatory scrutiny, whilst simultaneously addressing the shortcomings previously alluded to.

Unless advisers find efficient ways to service the mass market profile clients responsibly, it will pose an unprofitable risk to their practices.

The future of financial planning will be a delicate balance between client preference and business reality. Investors that need advice the most will struggle to get access to experienced advisers, but will increasingly have access to automated online tools for guidance.

Ultimately, the evolution of the available planning tools will give investors the opportunity to make decisions based on informed consent.

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