man-vs-technology-data

A rookie drug analyst called me in despair. Formerly with a multinational pharmaceutical company, he had recently added an MBA to his MSc in organic chemistry and PhD in biochemical engineering. He had just signed with a boutique research firm, and I was one of the first portfolio managers he’d ever met.

“The economics don’t work,” he said. “I’ve made a huge mistake coming to Wall Street.”

Using the aggregate trading volume of all drug stocks sampled over several years, he estimated total annual commission revenues. “There is not enough revenue to support even a small fraction of the drug analysts on the street,” he concluded.

But he had forgotten to include potential investment banking revenue. Smart guy, correct arithmetic, wrong conclusion.

Or was it?

Let’s look at another situation where smart people may be drawing incorrect conclusions: the rise of robos.

Robo-advisors can sign up clients quickly, establish a portfolio with a suitable asset allocation, monitor, and rebalance it, all at a fraction of the cost of a full service advisor. That’s 0.75% versus 1.75%, including product costs.

If asset allocation and monitoring a portfolio are the main functions in the advisor’s value proposition, the robo is hard to beat. Robos are an industry response to two realities. First, Gen Y are the customers of the future but are unlikely to invest the way their parents and grandparents did. Second, the absolute number of advisors in North America has been declining over the past decade. If robos don’t fill the need, it’s unclear who or
what will.

Technology replaces jobs

In 1900, 40% of jobs were related to agriculture. Only 2% were by 2000, according to David Autor’s 2014 paper, “Skills, education, and the rise of earnings inequality among the other 99 percent” (Science, Vol. 344, Issue 6186). Technology allowed for massive productivity gains and freed individuals from monotonous, tedious and dangerous tasks.

Technology also works to complement existing jobs. Take the introduction of the ATM in the U.S. in the 1970s. Between 1995 and 2010, their numbers expanded from 100,000 to 400,000, James Bessen wrote in a 2015 IMF paper. One would expect there to be close to zero tellers during the same period, but actual employment rose slightly, from 500,000 to 550,000, between 1980 and 2010. ATMs lowered the operating cost of branches and increased the demand for tellers.

While the number of tellers at each branch declined by 33% from 1988 to 2004, the number of branches grew by 40%, partly because of bank deregulation. Branches changed from a focus on cash transactions to customer relationships enabled by technology. In Canada, branches are more about client relationship development than transactions. Cross-selling opportunities have also become important.

Meanwhile, the investment industry has fought a rearguard battle against inevitable change. Eliminating embedded commissions, as the industry suggests, will undoubtedly limit access to financial planning services for investors with modest portfolios. However, the mass affluent investor with $100,000 to $1 million in liquid assets is already neglected. Full-service firms continue to raise minimums, making the situation worse.

For investors with less than $100,000, robo-advisors have actually made the situation look better. While investment solutions are still rudimentary, low-cost diversification, coupled with automatic deposit and flexible reporting, provide a good starter kit. Basic financial and tax planning tools are not far behind.

Logical progression

The logical progression is for technology-enabled advisors to manage more portfolios, clients and assets than they otherwise could. Like the teller who shifts away from transactions, advisors will need to shift focus away from investment management and toward financial, tax, estate and life planning. This will include managing lifecycle financial needs, such as insurance protection in the family formation phase of the cycle, and longevity protection post-work. Like the teller, the emphasis will be on managing relationships.

But this is where a problem is brewing. Relationships take a long time to develop, and anyone who has dealt with banks knows that turnover can be frustratingly high, even at the premium service levels, let alone at branches. Early attempts to implement robo-like services have been focused on asset levels, not relationships.

Advisors are encouraged to give up smaller accounts to in-house robo-services even though everyone knows small accounts incubate large accounts. A better approach would be to give advisors the appropriate tools to onboard, monitor, manage and engage clients with modest portfolios so they can develop relationships over time.

Like the drug analyst whose actual role was not what he assumed it to be, advisors need to evaluate the evolving nexus between investment management, relationship management and product placement. If they are not using technology extensively now to streamline their processes, they soon will be. How many advisors will be replaced by robos? Likely all of those who do not incorporate technology into their practices—and reasonably soon.

Robos can close the advice gap, says CSA

In its comment paper on banning embedded commissions (81-408), the Canadian Securities Administrators say online advice has “the potential to increase access to advice over time.” The paper says automation could allow robo-advisors to serve more households than traditional channels. Given that online advice also tends to be less expensive, while still offering value drivers like rebalancing and asset allocation, CSA says, “We anticipate that its growth could potentially increase investors’ access to advice in the future.”

Mark Yamada is President of PÜR Investing Inc., a software development firm. Disclosure: PÜR Investing Inc. provides risk-based model portfolios to Horizons ETFs.

Originally published in Advisor's Edge Report

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