Only the right DFMs can thrive in robo-advice world

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One hundred and thirty years ago a remarkable thing was happening.

The financial sector was taking around 1.5% to 2% of global GDP. The extraordinary thing is – it still is.

Indeed recent research from French economist Thomas Phillion has shown  it has taken almost exactly that much for all of the last 130 years.

Despite the technological disruption that has been thrown at it, the World Wars that have tormented it and the birth of serious regulation the sector has found a way to add enough value to keep taking this cut. 

Is it surprising that sometimes it feels like nobody likes us?

This incredible resilience is found in the financial advisory sector almost more than anywhere else. In the scheme of what the sector has faced over this time the disruptive impact of ‘robo-advice’ is unlikely to merit a footnote – provided we learn a couple of lessons from history.

So let’s start at the Great Depression. During the bull market that proceeded it stockbrokers in the United States made a killing off ordinary Americans - charging huge fees for trading. The embryonic US securities regulator responded by fixing the price of each stock trade at a sum equivalent to $200 in today’s money.

The rationale was clear – it was time to stop stockbrokers gouging people.

Of course it didn’t work because it led to the price remaining fixed for two generations until 1975. It removed the incentive for those generations of financial advisers to do anything other than trade stocks – which is what they did.

On 1 May 1975 the price of trades was floated. Stockbrokers celebrated; seeing it as an opportunity to raise prices. They were wrong. In the days that followed a then small-time broker called Charles Schwab bought a computer and according to Michael Kitces the price of trading stocks in the United States fell by 90% in the 20 years that followed. A whole business model gone. So what happened to the stockbrokers? They simply evolved.

They became in essence the sellers of emergent mutual funds to these same individuals – by no means an unconflicted model – but far less conflicted. Consumers got more diversified portfolios and the advice profession began offering an on-going service. 

Waves of further disruption followed and financial advisers evolved each time, delivering a steadily improving proposition to consumers. 

Direct to consumer platforms appeared nearly as soon as the internet at the turn of the century and made it possible for consumers to buy a mutual fund themselves. So rather than selling mutual funds advisers began selling fully diversified portfolios – delivering better aligned incentives and better positioned portfolios.

There is no doubt that the industry now faces a new disruption as it becomes possible to buy off-the-peg diversified portfolios matched to an individual’s personal goals at a massively-reduced price.

Does this mean that over the next 20 years 90% of advisory revenue will collapse? No. But it does mean that 90% of the value attached to the increasingly simple task of getting someone invested in a diversified portfolio might. This is bad news for the providers of low active share multi-asset funds and there are plenty of them.

Financial advisers though will evolve because they are in a profession that possesses the one quality that best protects a job from technological disruption: touch.

Consider two people. One is a barber. He cuts hair, shaves with a cut throat razor, listens to problems and helps us come to terms with encroaching grey. The other is a Japanese fund manager who has pored over research reports for twenty years and considers himself invaluable. 

I once stared into the eyes of such a fund manager whilst he boasted ‘thank goodness I can’t be replaced by a robot.’

I asked him this question. Would you rather go to a robot barber or a robot fund manager? Personally I will trust an algorithm with my stockpicking and keep a human being holding the knife.

Tactile jobs, human jobs, are the key to surviving disruption.

For this reason it is fund management companies and direct to consumer platforms which have the most to fear from robo advice – which is of course exactly why it is Charles Schwab and Vanguard which have made the world’s largest investments in this area. It is also why major fund management companies are giving away diversified models which re-balance for free if you buy their funds.

Financial advisers who simply see their job as getting savings invested in balanced models will of course struggle but those who have evolved to true life planning may be barely touched. The advantage of their tactility will carry them through as it did through the birth of the internet and platforms. This is not naïve, this is what history teaches.

A couple of principles though must be key to staying on the right side of this trade.

Firstly, we must see technology as a means of enabling advisers to spend more - not less - personal time with clients. It is tempting to perceive opportunities for automation as a means of freeing businesses from expensive client time. But this would sacrifice the greatest advantage the profession has against disruption.

Secondly, we must remember that robo-advice will drive down the economic value attached to the process of getting diversified. Therefore, it would be a grave error for advisers to partner with firms who charge a lot for providing this service and have business models, operating systems and wage bills that make it near impossible for them to lower prices. 

These firms will shackle advisers to trying to defend a pricing point for an element of their service which is seeing its economic value fall. Whilst the advisers themselves can evolve fast enough to defend their fees through their client contact – their partners may not.

Many major discretionary fund management firms in the UK today for example charge north of 1% but make profit margins barely higher than 10 basis points. How can these firms hope to drive down costs and retain their profits against near-free diversification services? That is a battle best avoided by advisers.

Instead advisers must pick partners who are built efficiently, can deliver propositions at a far lower pricing point 

The right strategic choices will allow financial advisers to survive and thrive whatever disruption is thrown at them.

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Albemarle Street Partners

Albermarle Street Partners is an established discretionary investment manager and investment consultancy that believes a successful investment proposition is one crafted around the advice philosophy of diligent financial advisers.

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