Most robos probably don’t need to use AI
The futuristic image of robo advisors conjures up notions of artificial intelligence and robotics.
The futuristic image of robo advisors conjures up notions of artificial intelligence and robotics, instilling fear in the wealth management industry at the prospect of being disrupted.
The more simplistic robo advisors have merely acted as a platform for the mass market to invest in ETFs (exchange traded funds), whilst some are using more complex algorithms to re-balance portfolios.
However, few are implementing complex machine learning techniques that could be deemed to be truly using artificial intelligence (AI), such as engaging in direct investments that could effectively replace a human active manager.
Where the majority of robo advisors use a goals based approach to generate asset allocation, the majority put their clients’ investments into a collection of pre-defined model portfolios.
Most robo advisors use a collection of passively managed ETFs for their investment proposition. According to Deloitte, approximately 70% of ETF providers operate on an “ETF-only” approach. This is unsurprising as these products are incredibly cost effective, whilst allowing diversification in portfolios.
The technology is still in its infancy and is heavily dependant on the quality of the software.
Issues concerning liability and consumer protection, however, will have to be re-examined in the future as the technology piece becomes more complex.
Although some robo advisors are offering active management through a hybrid of automated investment and human lead asset management, this approach is notably more costly (for example, UBS’ SmartWealth). Some robo advisors are offering more esoteric passive strategies such as Smart Beta funds – which attempt to beat a specified index using a set of investment strategies that emphasise the use of alternative index construction rules to traditional market capitalisation based indices, in a bid to capture market inefficiencies.
Although most robo advisors have not been implementing sophisticated AI techniques, the poor performance of the active management industry has meant that the requirement to do so is not paramount.