Enormous progress is being made in the field of artificial intelligence, and the practical implications of this new technology are being felt in many areas of finance, but especially in wealth management. Can the distinctively traditional, highly personal private banks keep up with the robots? Silvia Pavoni investigates.

Artificial intelligence (AI) is a much-discussed subject, and one that has engaged the minds of scientists and philosophers while at the same time inspiring the imaginations of writers and artists. Professor Nick Bostrom, head of the Future of Humanity Institute at the University of Oxford, predicts that the creation of human-like robots will lead to either utopia or extinction for humans; while in Ex Machina, film director Alex Garland hints at a romantically dark future where robots are set to outsmart people.

More practically, AI has engaged the finance world too, where self-learning systems are already used to manage investments. Traditionally, wealth management has been associated with expensive, personalised face-to-face advice that only the richest members of society could benefit from. Now, with the growth of online platforms based on automated assessments of a user's risk appetite, and automated portfolio creation, services and products are offered with significantly lower fees, and can be accessed instantly by anyone with a laptop or smartphone – something proving particularly appealing to younger generations.

And this is a phenomenon that potentially has wider consequences, as it mirrors a change in attitudes towards savings and investments in both developed and emerging markets. This is crucial at a time of creaking public finances and plummeting pension expectations.

The robots are coming...

Wealth management is a sector that can easily leverage economic trends. Indeed, the mass affluent group – typically described as those with between $100,000 and $1m in disposable assets – and individuals with between $1m and $2m are forming the fastest growing and broadest wealth segment group in the world, according to data from US bank Citi. This group’s total wealth is predicted to grow from $88,000bn in 2015, to $145,000bn by 2020, with the largest growth estimated to come from emerging markets. Currently, the mass affluent the world over tend to be served by retail banks through standardised and often limited products. Personalisation is a trait of private banking services, usually reserved for wealthier clients.

“Robo-advising is democratising wealth management,” says Francis Groves, senior analyst at Swiss research firm MyPrivateBanking, and co-author of a recent report on the subject, 'Robo-Advisers 2.0 – How automated investing is infiltrating the wealth management industry'. “Financial advice is rather expensive, so you need to be quite wealthy for the advice to be effective. Robo-advising fits in well with the spirit of the time, the zeitgeist of the decade: it is internet-based, accessible for people of the millennial generation, [and it reflects people’s] prudent attitude towards their finances,” adds Mr Groves.

Robo-advising is gaining traction, with a growing number of robo-advisory firms popping up across the US, as well as in Europe, Canada, Australia and, more recently, Hong Kong. From the relatively well-established Wealthfront and Betterment in the US, to Nutmeg in the UK, Vaamo in Germany, MoneyFarm in Italy, 8 Now! in Hong Kong and Sydney-based Stockspot. In its recent report, research firm MyPrivateBanking has identified 14 firms active in this field, and more companies have either recently launched or are about to launch operations, with large venture capital flows being poured into the sector.

The value of these robo-advisory firms is so broadly recognised that they have started to be included in corporate employee benefits packages; for instance, Google now offers free Wealthfront advice to staff. The appeal of robo-advising is rooted as much in its revolutionary technology as it is in demographic trends.

“Many people think of the automated services revolution as purely about technology, but it is just as much about demographics – 60% of our clients are under 35,” says Adam Nash, Wealthfront’s chief executive. “For most of our clients, we are their first investment service, since our minimum is so low [$500], as is our management fee. The average wealth manager is more than 50 years old, and their clients are also over 50. They have built their business on the needs of the baby boomer generation.”

Nutmeg’s co-founder, Nick Hungerford, adds: “Not many wealth managers are getting young customers. If banks do not improve in various segments of their business, slowly but surely newcomers such as Nutmeg will come and steal their profits.”

Robo-advisors, a few examples

Nuts and bolts of it

A robo-advisor is essentially an online firm that offers algorithm-based risk assessment, automated portfolio selection and automatic portfolio rebalancing. Thanks to their self-learning systems, these companies can enrol and assess clients, and provide them with investment strategies and products without the need of any human interaction. Their mantra is to keep the whole process simple, clear, personalised and inexpensive.

Because of the automated nature of their work, new digital firms charge only a small fraction of the fees billed by private banks. Wealthfront charges 0.25% on portfolios of more than $10,000 and no charge at all for those amounting to less. Betterment has a sliding fee structure that goes no further than 0.35%, and is inversely related to the size of the portfolio. In the UK, Nutmeg’s fee scale goes from a maximum 1% for portfolios of less than £25,000 ($39,000), to 0.3% for those of more than £500,000. Crucially, across the robo-advisory world, investing $500 would get the same standard of advice that $5m portfolios would get.

Fees across the whole sector tend to be low, and their structure extremely clear. In contrast, fees for traditional wealth managers are not as clearly broken down and ultimately add up to significantly higher figures. This is particularly true in the UK, according to many in the sector.

One way that robo-advisors have cut costs, allowing them to offer such low fees, is by putting paid to the assumption that interpersonal connection is essential to wealth management: they see their own real estate simply as a cost rather than as an asset. Nutmeg’s chief product officer, Scott Eblen, says: “We are based in a totally unremarkable street in an unremarkable building: this makes a big difference [to cost].” Further, these new wealth managers attract exactly the technical brains needed to develop the needed technology, who might otherwise view banking as an uninspiring sector.

“Coming from Google, [I know that] there’s a hesitation for tech people to go work for a bank, while a start-up sounds more appealing,” says Mr Eblen. “So, for the creative types, the designers, the engineers, there’s something more appealing about joining Nutmeg, where there’s so much potential to change people’s lives for the better. [Tech types] don’t necessarily see this in a bank, even if a bank aspires to do that.”

Friend or foe? 

What does this mean for private banks? At the end of 2014, the world’s assets managed or administered by investment professionals amounted to $9200bn, according to estimates by consultancy Deloitte. The $20bn that robo-advisors will manage by the end of this year, according to MyPrivateBanking, is a small fraction of the total. Even if growing fast, the $450bn it may reach in the next five years remains a small sliver of the whole wealth management cake.

The real threat, say many, is in the speed at which people’s preferences, expectations and attitudes towards technology and banking are changing when it comes to managing their money. Private banks may not be able to keep up, due to their heavy regulatory burden, legacy technology issues and, in some cases, damaged reputations. If demographic trends are long in the making and easily predictable, the demands of the new generations may indeed require faster reaction times by incumbents. Should they fail to adapt, established names and their business models risk becoming obsolete or redundant.

Furthermore, capturing today’s mass affluent individuals would likely lock down the richer clients of the future. The rich clients of the present, however, continue to absorb private banks’ attention.

When private banks do serve affluent clients, perhaps family members of wealthier individuals, the level of profitability of the smaller segment is rather high, points out Boston Consulting Group (BCG) in its 'Winning the growth game' survey. According to BCG data, in developed countries, wealth managers’ average margin in the mass affluent segment is 122 basis points – which means that the bank makes $122 for every $10,000 invested. This compares with 80 basis points for clients owning between $1m and $20m, and 39 basis points for clients with disposable assets of over $20m. However, the survey points out that private banks do not want to “over-serve” mass affluent people at the expense of their increasingly demanding main high-net-worth market. Greater focus, lower fees and the more personalised approach that robo-advisors offer to affluent clients are understandably welcome.

Shifting perceptions

As private banks centre their attention on the demands of the wealthy, much of the innovation disrupting investment management is taking place outside of the market. And this, some argue, is putting traditional wealth managers on the defensive. “Let me be clear, we do not refer to ourselves as a 'robo advisor', nor do our clients. This is a term created by the traditional industry, in an attempt to undermine our value,” says Mr Nash. He adds that Wealthfront, which now oversees $2.25bn of assets, defines itself as an automated investment service.

While they might belittle these innovative new offerings, most large banks are, however, trying to breed similar innovation through incubators. UBS’s chief operating officer for wealth management, Dirk Klee, says: “If you look at our innovation centres, one in Zurich, one in London, one coming up in Singapore now and possibly other places in the future – maybe in China or Israel – we provide those spaces to innovative people who don’t want to work in a bank environment. We give them a challenge: to come up with an idea to solve a digital issue that we face as a bank.”

Mr Klee also points out that automation would also help narrow the gap between demand for advice and the limited numbers of good advisors in the market. “There are only so many highly trained client advisors that you find in the market, and technology can help you spread your know-how over a larger population, including affluent clients,” he says.

But while such centres have potential, the ability of a large, traditional wealth management institution to adapt to these new innovations is often lacking. Mr Eblen cites a specific case in which an established wealth manager had created an independent automated investment solution. “[It was] half there in terms of creating a great customer experience, and then the company's legal department [must have] got involved and put all the traditional boiler plates on top of the clean-cut product," he says.

"Even just the basic sign up process: if you explain the legal terms or conditions of the product in plain English, that’s a lot more appealing to people. [Otherwise] people assume that it is a traditional product skinned in something that only appears to be new,” adds Mr Eben.

Mr Groves shares a similar view, saying: “Robo-advising works if the website is very simple. And they all look very simple and are dedicated to one function: enrolling clients. [It has to be] uncluttered, easy for people to understand. This is an advantage compared with [traditional] wealth managers, particularly if the wealth manager is linked to a retail bank. Banks’ websites are like big supermarkets, everything is on there. Robo-advisors’ websites are more like ice-cream parlours: you go there with the clear objective of getting an ice-cream and that’s what you find.”

Wealth managers’ average revenue margin by client segment

The digital age

Nonetheless, innovative projects that see traditional wealth managers aiming to create an automated, independent service, either internally or by joining forces with a robo-provider, are generally seen as a positive development. In the US, Charles Schwab’s Schwab Intelligence Portfolio was indeed welcomed by the market. As was brokerage and custody house Fidelity Institutional Wealth Services’s partnership with robo-advisors Betterment and LearnVest.

Similar developments and partnerships are under way in emerging markets, too. In Singapore, DBS Bank is using technology firm IBM’s cognitive computing solutions, which include the first cognitive computer, Watson, to improve the financial advice that it gives to its affluent clients. More is to come, according to BCG’s Singapore-based partner Federico Burgoni. “[Algorithm-based services] are driving digital expansion. I have two clients that are launching [an AI platform in Asia]; they’re between eight to 16 months away,” he says.

Mr Burgoni stresses the current relevance of investment services in the region’s banking market, where the expansion of the mass affluent classes has stirred local lenders into action. While revenues on assets on services to clients worth more than $1m is about 100 basis points, the figure goes up to about 160 basis points in Asia for banks serving mass affluent people – these are mainly local retail banks or regional specialists with strong physical presence, such as Standard Chartered or HSBC, he notes.

“Private banking [for high-net-worth individuals] has always been offshore only – so if you had lots of money, this money was offshore, in Singapore or Hong Kong, and managed by the big guys, such as UBS or Credit Suisse,” says Mr Burgoni. “With the emergence of the affluent segment, this is changing; that money is now managed onshore. So if you are an affluent Malaysian, you would have your [investment] account with Maybank, locally. Onshore wealth management has doubled over the past five years. This is the hot topic of the moment; there isn’t one single local bank that is not interested in wealth management right now.”

Similarly, online firms offering account aggregation are popping up in Latin America, and are starting to think about possible expansions into online investment platforms, such as GuíaBolso in Brazil or MoneyMenttor in Mexico.

Further developments

More developments ought to come out of developed markets, too, from dealing more effectively and securely with issues such as client identity, to expanding robo-advisory to the retiring baby boomers. The ability to connect to an investment provider from a well-populated, high-profile LinkedIn account or a verified Twitter account, for example, could be considered better proof of identity than a passport, which can be easily forged, especially in its digital copy, says Mr Eblen.

Mr Eblen also imagines solutions where investment accounts are seamlessly integrated in to peoples' everyday lives. So, as an investor starts researching mortgage rates online and maybe also properties to buy, their portfolio could seamlessly adapt on the assumption that they would need to make a large cash payment for a house deposit in a few months time. 

The pensions market is also packed with business opportunities. Mr Nash points to investment firms such as Vanguard in the US, which is successfully bringing its tech-assisted advisor model to pensioners. This market is set to flourish in the UK, too. From April 2015, UK investors have been free to take any amount of cash from their defined contribution pensions – funds to which both employee and employer contribute – with no obligation to buy an annuity. This is a drastic departure from a market which had been accustomed to caps on withdrawals and information on the fund’s value typically being released on an annual basis only – a market which innovative firms are now looking at very closely.

The human touch

Robo-advising is a small phenomenon compared with the size of the traditional wealth management sector. Unsurprisingly, many remain unconvinced that human interaction may become superfluous when managing people’s money. Indeed, given the option, most people would double check with a specialist fellow human if in doubt. “If you wake up with a headache in the morning you can punch in ‘headache’ on Google, get 20 million links and probably find out what you have; but you’d still call a doctor,” says Mr Klee. Indeed, 90% of UBS’s ultra-high-net-worth clients prefer personal interaction, he notes.

This sentiment is echoed by Michael Benz, chief executive for wealth management at Standard Chartered, who does see a future where technology will play a larger role in wealth management, particularly in the emerging markets, but he says that this will not replace good human advice.

Not all potential investors can afford good human advice, however, while the automated kind is becoming increasingly available. “[People who enjoy] the experience of fancy lunches and nice offices would tend to gravitate towards more traditional institutions, but as there is greater transparency about costs, people will generally move more towards tech solutions,” says Mr Eblen. “I think that wealth managers [are following the fate of] travel agents: 15 or 20 years ago people assumed they had to go out and find someone to [book a holiday]. Now they realise that they can do it themselves, get better value and do everything online.”

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