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Robo-advisers on the rise

Jan 11 2017 17:48
Carin Smith

Cape Town - There is significant growth potential in automated investment advice platforms - so-called robo-advisers - within financial services industries globally, according to Steven Nathan, CEO of 10X investment services.

He explained that technology developments created three mega trends regarding consumer behaviour and how business delivers to consumers. Firstly, information became freely available and easily obtainable. Consumers could do research on the best investment product, investment performance or investment fees available, for instance.

The second mega trend was connectivity and networks. Information could be shared quickly through social media and social platforms. This would include "good or bad" information about how to invest, or what shares to buy. Thirdly, computing power is getting cheaper so it is becoming easier for companies to enter markets.

"Consumers have become more educated and connected to each other. Referrals have become a more powerful source of information rather than, for instance, a traditional advert. Technology plays a big part in how companies can provide products in a better way," Nathan told Fin24 on Tuesday.

"So, in the investment space we see consumers becoming more educated. Ten years ago there was not much information available about good and bad investment products and the impact of fees, for instance. People just relied on advisers to tell them what was going on. They just received information and believed what they were told. Now people can find out the facts for themselves."

Nathan sees a move for consumers to be more empowered and more pro-active in taking initiatives to look for the best deal.

His definition of the term robo-adviser in the investment space refers to the concept of "automatic best advice".

"We all want the best advice. A lot of people have been sold bad products in the retirement annuity space in the past. There were high fees and a lack of transparency, for instance. So, there has always been a big question about the quality of advice. Often advisers have been a bit of a Trojan horse, selling a product rather than the best advice. National Treasury is trying to improve the quality of financial advice through legislation," explained Nathan.

With the concept of robo-advice, the claimed value proposition is that it can give better advice and that automation can provide a better experience. Nathan explained that the "better advice" component relates to traditional financial advice being expensive. It is claimed that robo-advice can cut costs by up to 75%.

"A lot of robo-advisers provide a financial plan that is quite formulaic and based on good principles and without a hidden agenda."

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How it works

Nathan explained that in practice you would go onto a robo-advice website, where you will be asked for some details to do an online plan. You therefore use a tool to do your own automated financial plan. A goal will then be projected for you.

"The investing industry is very complex. For instance, there are more than 1 400 unit trusts available today. We also find that in SA the average investor pays at least 3% in fees. Robo advisers charge less than 1% for everything, so there is a big cost saving," said Nathan.

He added that these robo-advisers are promoting low cost index funds. An index fund is low cost because it is an automated investment tracking process. On the other hand, an active fund manager will say he can do better, but then also charge you more.

"Of course we all want to beat the index. Research, however, shows that 80% of active funds actually underperform the index. That is why a big trend now globally is a switch out of high cost active funds to low cost index funds," said Nathan.

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Which robo-adviser?

Nathan explained that although robo-advice has been around for about nine years, it has only started to gain popularity over the last three to four years.

"So it is a bit too early to say which one is the best. We at 10X, for instance, only have one strategy and all our clients are invested in that. We think subjectivity and choices lead to bad outcomes," he continued.

"It is hard for people to know whom to trust for financial planning and investing. When you look at quality of a robo-advice plan, you could compare fees, performance, transparency and simplicity. Integrity must come into it."

A practical approach

Nathan said there are three key investing principles to look at when deciding on an investment choice. The first is that time drives investment risk. In other words, your time horizon determines your optimal or best portfolio to invest in.

For example, if you own a range of different investments, like shares, property, bonds and cash, you can have a high equity portfolio - up to 75% in shares - and 25% in bonds and cash. A medium approach would be 50% in each of the two categories, while low equity would be only 25% in shares and 75% in cash and bonds.

"High equity gives the highest return, but when markets are down you can do worse. The fundamental point, however, is when I say time drives risk then, if you invest for five years or longer, the high equity fund becomes lower risk. There is a long-term impact. If you invest for more than five years, it should be in a high equity portfolio," suggested Nathan.

READ: What will really disrupt SA’s financial services industry?

The second key principle is that index funds beat active funds about 80% of the time.

"Maybe you have a strong conviction about a fund manager you know, but it is impossible to guarantee who will beat the market, especially over long time periods which are relevant to long-term investors," said Nathan.

The third key principle in his view is to minimise fees.

"Try to get the fees you pay as close to 1% as possible. You don't need complex investments and you don't need an active fund manager, so consider the total cost of investing," he suggested.

"The beauty of a robo-adviser should be that you can do your full financial plan online without committing to anyone. You can see if it makes sense and if it is compelling. Empower yourself to make a decision that is right for you, rather than outsource this fully without understanding your financial goal, your investment portfolio and total fees."

He added that there are not many robo-advice options in SA yet, but there are still ample opportunities to learn about financial planning.

"Empower yourself to make the best decision. See what risk is appropriate for your time horizon. Look at the complexity and total fees and how transparent a service provider is on fees," he concluded.

Disclaimer: Fin24 cannot be held liable for any investment decisions made based on the advice given by independent financial service providers. Under the ECT Act and to the fullest extent possible under the applicable law, Fin24 disclaims all responsibility or liability for any damages whatsoever resulting from the use of this site in any manner.

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