Panel highlights challenges of robo-intelligence in asset management

Robo-advice – computer driven investment advice powered by algorithms – has the potential to bring about a number of positive changes at asset managers, but equally there are challenges that must be overcome beforehand.
The technology has generated interest at asset managers. Some see it as a guidance tool which can enable them to educate prospective clients about their fund products without worrying about breaching the investment advice provisions contained in the EU’s Markets in Financial Instruments Directive II (MiFID II) and the UK’s Retail Distribution Review (RDR). Nonetheless, regulators have said that asset managers are responsible for their robo-advice systems and ensuring compliance. Others see robo-advice as an effective cost-saving mechanism at a time when overheads are climbing dramatically as it could theoretically replace a number of client-facing roles.

One area digitisation could make marked improvements is around client on-boarding. At present, fund managers must conduct significant amounts of due diligence on potential clients such as know-your client (KYC), anti-money laundering checks and compliance with tax legislation such as the Foreign Account Tax Compliance Act (FATCA) and the Organisation for Economic Co-operation and Development’s (OECD) Common Reporting Standard (CRS). This is often a highly manual and protracted process, and clients can at times find it off-putting. Furthermore, fund manufacturers will also be required to assess client suitability under MiFID II.

“Good technology could enable easier client on-boarding. If the digital passport is embraced, it could make it easier to on-board clients,” said Martin Parkes, director for government affairs and public policy at BlackRock, speaking at the Association of the Luxembourg Fund Industry (ALFI) Conference in London. Nonetheless, there are challenges. Parkes highlighted that cyber-security protections at robo-advisers needed to be robust given the sheer volume of confidential and sensitive data they would possess. “With new technology comes new risk,” he added.
This is not unreasonable. Analysis undertaken by the US Securities and Exchange Commission (SEC) found 88% of broker dealers and 74% of investment advisers had been affected by cyber-threats directly or via a third party. The reputational impact of being hacked can be substantial. KPMG surveyed institutional investors running more than $3 trillion and found that 79% would not put money in a business which had been hacked.

Perhaps the biggest issue for robo-advisers is trust. High-net-worth-individuals (HNWIs) and wealthy clients tend to prefer a personalised service from their investment advisers and are also willing to pay for that. A Legg Mason study of 5,370 HNWIs across 19 markets found just 37% of those aged between 40 and 75 trusted robo-advice. Just one third of respondents said they were comfortable receiving investment advice from an online platform compared to 62% who said they were happy with obtaining similar advice from a financial professional.

Robo-advice does seem to have more appeal among younger investors. Another study by Legg Mason of 1,000 investors aged between 18 and 39 found 85% were comfortable with robo-advice and 80% said they would trust such advice. Research by Z-Ben Advisors, a China-based consultancy, found nearly half of all money market fund sales in China were now done online, an increase from 5% in 2012. The proliferation of mobile technology and apps is something fund managers should be cognisant of. This does raise the question as to whether robo-advice is better suited for mass affluent generalist inquiries than servicing HNWIs.

Regulators including the UK’s Financial Conduct Authority (FCA) have taken note, particularly as they recognise an advice gap has emerged following passage of RDR. The FCA’s Financial Advice Market Review (FAMR) was likely to recommend that an advice unit supporting the development of automated advice be created. Last month, the FCA confirmed it would pre-empt this recommendation and establish the unit ahead of time in May 2016.

Others feel disruption could happen from elsewhere, such as major technology giants like Google and Apple. Miller Guo, chief executive officer at GF International Asset Management, a Hong Kong-based asset manager, highlighted the huge increase in assets enjoyed by Alibaba’s asset management business Yu E Bao. Yu E Bao has raised more than $90 billon after two years.

There is speculation tech giants such as Google, Facebook or Apple could launch asset management businesses. Google commissioned research into developing an asset management business in 2014 although little has been heard since. Fund managers are certainly worried about this. 79% told a State Street study that they were alarmed that a major technology provider could upset their investment management businesses. Others are less sure. There is a strong possibility these technology firms may get involved in distribution given their huge reach. However, technology firms are not enthusiasts for regulation and may find the volume of regulation they would be subject to if they launched fund management businesses too much.

Plugging the investment advice gap is critical, particularly in Europe where most investors appear to be hoarding cash. Some feel that managers need to just do a better job of communicating their message to end consumers. “The fund management industry is very good at communicating between itself and with governments with friendly regulatory regimes such as Luxembourg. However, it is bad about communicating with two audiences. The first is governments and regulators of major economies, and the second is with ordinary people,” said Tony Langham, co-founder of Lansons Communications.