Long reads

Global downturn will be a test for the robo-advice model

Jamie Crawley

Jamie Crawley

Reporter , Finextra

With experts fearful of the Coronavirus outbreak setting the wheels in motion to a global recession, many customers of robo-advisers, unused to prolonged periods of volatility in markets, could be in for a shock and will look for appropriate advice and guidance.

Last weekend, I logged on to my Nutmeg portfolio for the first time in a fortnight or so and was not at all surprised to see the healthy return it had been enjoying for some time had been slashed. 

A couple of days later, I looked at it again and found that it was now 4.5% down on what I initially put in when I opened the account.

A COVID-19-induced crash of equities saw markets endure their worst day of the post-financial crisis era andthe FTSE 100 had £144 billion wiped off its value on 9th March 2020, giving it its biggest one-day fall since 2008.

My Nutmeg portfolio, with its seven out of 10 risk setting, well over half of which was allocated to developed market equities, lost comfortably over 10% of its value, taking the full force of the sell-off brought on by Corona-related panic and triggered by an oil price war between Saudi Arabia and Russia.

Admittedly, I have only myself to blame for not reacting to the warning signs and amending my preferences accordingly to a lower risk setting. Nonetheless, this has rather brought home the risks that lie in any type of investing, even in the zero-effort version offered by apps like Nutmeg.

While digital wealth managers enjoy a degree of popularity, their use remains relatively niche. Consumers are far more likely to keep their extra money in a savings account offering a negligible rate of interest, and after last week it is not hard to see why. Pathetic as most savings accounts’ rate are, at least there is no chance of making a loss!

“There will always be a need for savings accounts, given their easy access to guaranteed balance maintenance,"Keith Denerstein, director of investment products and guidance at TD Ameritrade tells Finextra Research.

“However, given the low interest rate environment that is likely to persist for some time, those seeking capital appreciation will likely turn to financial markets.” A lengthy period of volatility may have consumers turning back to savings, however.

Broadening appeal

It remains to be seen how deep the rot will set in over the coming months and if the Coronavirus outbreak does lead to a global recession, as some commentators say is plausible. Either way, beginner investors using robo-advice platforms may be in for the first severe downturn after several years of consistent, if shallow, growth.

“World equity markets had a strong year in 2019 and investors who either started their investment journey or held their nerve to ride out the volatility of markets at the end of 2018, benefitted from this performance,” says Neil Alexander, Nutmeg’s new CEO.

Return, of course, does not come without risk, and Alexander acknowledges this would prove a hurdle for many customers, particularly those who prefer having cash to hand if necessary.

Financial inclusion is supposed to be one of robo-advisers' chief selling points, providing a low-cost, easy-to-access platform that anybody can use to gain exposure to bonds, stocks and funds. Investing is meant to be no longer just the realm of the rich and the financial expert: younger people and those with minimal capital and experience can join the fun as well.

“Digital wealth management platforms are becoming increasingly sophisticated in their ability to cater to a wide variety of client values and needs,” Denerstein says. “This allows a growing number of investors will be able to find strategies suited to their particular needs and financial situations.”

Thus far, however, this does not appear to be the case. A recent research paper by Deutsche Bank found that the typical client of a digital wealth manager in Germany is aged between 45 and 54, is 80% likely to be male, and earns a salary three times the median income.

Senior Deutsche economist, Orçun Kaya, told Finextra Research that  this conclusion was “surprising and paradoxical,” and suggests robo-advice platforms need to become more polished and well-rounded offerings to broaden their appeal.

Mixing old and new

They also be struggling to identify their core demographic. While the digitally centric offering would hold more appeal to beginners, seasoned investors (with more capital to put up and therefore more appealing from a profitability perspective) may be put off and seek a more traditional service.

“Many investors are accustomed to either managing their own portfolios or meeting face-to-face with a financial professional who does it on their behalf,” Denerstein says. “There’s an initial sense of trepidation when that advisory relationship moves to a digital environment.”

Denerstein does however see an increasing number of people willing to embrace new technologies, particularly as robo-advice platforms establish track records of positive customer response.

“We see many late adopters becoming increasingly willing to use them,” he adds. “That trend will likely continue as digital investment products becoming increasingly sophisticated in their ability to cater to a broad range of investing strategies.”

Furthermore, supplementing digital wealth platforms with machine learning tools would enable TD Ameritrade, Nutmeg and others to cater digital experiences to the preferences of their clients.

“Of course, humans will continue to play a role for those seeking a human/digital hybrid experience,” Denerstein sums up.

Should we be about to enter a sustained period of downward traffic across global markets, users of robo-advisers could be looking for a greater human-led service to help steer them through the choppy waters.

This is where high-street banks and other incumbent financial institutions may seize the opportunity to plug the advice gap and use their greater resources to offer services that provide this. Indeed, many are already doing this.

Where incumbents can fill the gap

A recent report by Deloitte highlights the decline in both new investment platforms coming to market and in the funding they are attracting. This points to incumbents entering the market either through acquisition of robo-advice platforms or launching their own, as TD has done. Lloyds Bank and Goldman Sachs both plan to do the same later this year.

However, this has proved a tricky move to make. Investec closed its Click and Invest service in May 2019 citing a lack of appetite from consumers. In August 2019, UBS discontinued its own automated online investment service, believing its potential to lure young investors was limited. Both closures came only two years after their respective launches.

“The added value of digital in financial services cannot be overlooked, and traditional players are starting to acknowledge how innovative products can really enrich their offering,” says CEO and founder of Moneyfarm Giovanni Daprà.

“That said, we’ve seen ‘traditional’ players struggle to introduce their own proprietary digital solutions.” Neil Alexander adds: “Traditional incumbents who are looking at the space from the outside are definitely thinking about how they fit in it.

“But, as we’ve seen with the relatively short-life of some incumbents’ robo-advisory offerings, there's more to it than launching a website or bolting a ‘digital’ offering onto an existing proposition.”

 The problems then lie deeper for the likes of UBS, Investec and potentially Lloyds and Goldman Sachs. They have to contend with legacy business models, as well as legacy systems.

“Incumbents are generally more P&L focussed than customer focussed,” says Michal Kissos Hertzog, CEO of digital bank, Pepper.

“Partnerships with digital challengers could be the way they proceed, just as we have seen them do with Big Tech.

“Goldman Sachs has worked with Apple, so we can easily see them working with Stash or Wealthfront.”

This may be how incumbents can offer the user experience required to attract customers in sufficient numbers and make the maintenance of the platform worthwhile. This is of paramount importance when there is little guarantee of healthy revenue.

As is often the case when incumbents attempt to replicate the services officed by startups and challengers, circumnavigating legacy systems and legacy business models becomes an impediment. Therefore, the trend of traditional financial institutions buying up smaller challenges or partnering with technology giants will probably continue in this space.

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