Robo-advisors are another option for South African investors, but what do they do and should you use them?
The number of investment products available to South Africans runs well into thousands. These include passive products listed on the JSE, active products such as countless unit trusts, and more advanced structured products.
One could argue that the investment options are becoming limitless and there is something available for everyone's risk appetite. On the other side of the same coin, it has become a daunting task to understand all the options available, and particularly to decide which one is best-suited for you. Putting them into one comprehensive investment portfolio is no mean feat. This problem is not only faced by investors, but also by financial advisors, who are increasingly looking for technology solutions which can assist them in giving better financial advice.
So what does the future hold for solving the task of giving comprehensive financial advice in today’s dynamic and complex market? Niels Bohr, a Danish physicist, famously said, 'Prediction is very difficult, especially about the future'. With that in mind, let’s start by looking at how this problem is dealt with overseas.
Enter the robo-advisor
Robo-advisors are online platforms which provide an automated investing service. Their aim is to solve the issues of managing an investment portfolio on behalf of their clients, and in this way remove the middleman and put the control in the hands of the clients. The client completes an online investment process, after which the platform automatically recommends a pre-constructed investment portfolio based on the information provided.
Typically, the investment process consists of a risk questionnaire together with information about the client's financial goal. The data is then analysed, and the platform will suggest an investment portfolio. Robo-advisors usually have a number of pre-constructed investment portfolios, which they recommend by matching an investor's risk appetite with the portfolio's risk level. The final step involves showing the investor a dashboard with their proposed investment. The dashboard is interactive, and often includes additional information (such as historical and projected analysis) which explains the investment.
The whole process is digital and can be completed online with very little administrative burden. This makes it exceptionally convenient and simplifies the process of creating an investment portfolio given the myriad of investment choices. So, who is using robo-advisors??
Typically, robo-advisors target investors in their 20s and 30s, who are starting to save for their personal and retirement goals. Historically, this demographic has been underserviced by traditional financial advisors due to the relatively low net income of these individuals.
It oftentimes simply does not make economic sense for traditional financial advisors to target these individuals. As a result, the majority of financial advisors target high net income individuals for which they are well rewarded.
Another possible reason for the low service levels in this demographic is that the targeted generation enjoys the use of technology and likes to do their own research. Overseas, the millennials appear to be the perfect target market when it comes to using robo-advisors for their financial needs.
Apart from the convenience factor, a huge drawcard for robo-advisors is the ability to keep costs low when compared to their human counterparts. The saving in fees is due to the automation process of acquiring new clients and the use of passive products in their investment portfolios.
The underlying products used by robo-advisors are primarily passive, such as portfolios of exchange-traded funds (ETFs). Although the argument of passive versus active investing is beyond the scope of this article, it is well known that passive instruments have lower fees than their active counterparts.
The benefits of low fees together with the use of ETFs will have a significant positive impact on the long-term performance of these investments. Historically, high net value individuals could negotiate lower fees depending on the amount they invested. Robo-advisors pass this benefit to all income groups irrespective of the sum invested.
The most prominent criticism of robo-advisors is that one size does not fit all when it comes to financial advice. One can make a strong argument that human advisors can have a much better feel for the financial position of the investor and give a better overall service. Cash flow planning, liability analysis, existing portfolio restructuring and estate planning are currently beyond the capabilities of a robo-advisor.
The question of how the underlying investments in the investment portfolios were selected is also an important one. Is the robo-advisor truly independent and does it look at all investment options in the market? Or is it part of a product provider and therefore recommends only their products? Based on these answers, the investor should have an indication of what level of independence he or she is receiving from the robo-advisor in question.
Lastly, it is important to note that the role of robo-advisors in investment portfolios is not entirely passive. By selecting the underlying products, making rebalancing decisions and incorporating their views into the investment portfolios, robo-advisors can play a similar role to the traditional asset managers.
Should you use them?
On the whole, robo-advisors can be a fantastic option, provided you understand what you are getting from them. They offer to service a new market of savvy investors using the latest technology, giving them convenience and access to sophisticated investment portfolios. All of this at significantly lower fees and irrespective of the amount invested.