Wednesday, May 31, 2017

Robo-Advisors - The Future of the Investment Industry

recent study by the CFA Institute (Chartered Financial Analysts) looks at the future of the investment profession.  The CFA Institute is a global, not-for-profit organization and is the world's largest association of investment professionals.  Currently, there are approximately 2 million workers in the investment industry, managing around $100 trillion in assets for clients.  The report looked at the findings from a survey of 1145 investment industry leaders , looking at the trends that will impact the investment business in the future.  Here are some of the more interesting findings, particularly those related to how the investment industry will have to adapt to changes in the marketplace.

Respondents were asked to rank the future importance of the following ten skills:

1.) Ability to articulate a compelling vision for the institution.
2.) Ability to instill a culture of ethical decision making 
3.) Consultative selling skills 
4.) Crisis management skills 
5.) International and cross-cultural skills (including foreign languages) 
6.) Knowledge of science, engineering, and mathematics 
7.) Relationship-building skills 
8.) Sophisticated knowledge of IT (e.g., programming, artificial intelligence) 
9.) Specialized financial analysis skills
10.) Understanding of corporate governance/regulations

Here are the results:

Note that only 20 percent of the CEOs of asset management firms believed that analysis skills will be important over the next five to ten years.  This says a great deal about where the investment industry is headed as you will see in the following paragraphs.  According to the study, 70 percent of respondents expected that investors will increase their allocations to "passive investment vehicles".  This strategy involves maximizing returns by reducing the amount of buying and selling by investing in funds that mirror the market indices.  Passive investing has also been referred to as "investing on autopilot" since very little input by either the client or the investment professional is required.  The study notes that passive funds are offered as "loss leaders" and are used to attract customers to value-added products like estate and retirement planning among others.  The leaders of the investment industry also note that "robo-advice" and its cyborg variants are becoming the preferred tool for delivering investment advice to clients.  Because of the amount of data involved, robotics, smart algorithms, machine intelligence and artificial intelligence are becoming increasingly important to automate services offered in the investment industry.  Here is a quote:

"In a world where the cost of information discovery races to almost zero, the speed of parsing this data also increases far beyond human capability. Enter machine intelligence. Combining these things with consistency and freedom from human bias is a recipe for significant disintermediation.

The informational gains from big data can flow from natural language query, plus the combination of predictive and prescriptive analytics, driven by computers whose hardware and software architectures are designed to emulate human thinking. In short, if what a financial professional does relies on a formula, then it is ripe for disintermediation and margin erosion as machine intelligence, coupled with big data, takes over. Examples of formulaic activities in finance include financial statement analysis, reading annual reports, listening to earnings calls, valuation, and trading.

Of course, finance has always relied on judgment and drawing valid inferences from data, which is the good news for financial jobs. But finance professionals do suffer from cognitive biases and limitations, and machine learning is designed to de-bias subject matter. “Technology is an asset,” says a CFA charterholder who manages a $20 billion portfolio at a Canadian asset management firm. “It doesn’t have to be a threat. You should be strong enough in your convictions to be able to use that technology to better service your clients.”"  

So, what does the future look like according to investment industry leaders?  They see an investment industry future with far less human involvement, rather, using robo-advisors:

"Robo-advisers are basically a class of financial adviser/intermediary that provides portfolio management with minimal human intervention. Instead of human-based active portfolio management and asset allocation, extensive customer questionnaires about finances, coupled with passive management strategies and asset allocation algorithms, are used to construct investment portfolios....Robo-advice and its variants become preferred style or tool for delivering investment advice and execution to much of the retail/ private wealth segment. "

So, what is the bottom line?  The study notes that there are both benefits and drawbacks to automated financial advice.  The benefits include lower costs and greater access and the risks include market fraud, mis-selling of products and lower quality of service.  The study also notes that robots-funds will become core to the private wealth management field.  That said, the biggest benefit to the investment industry is the drop in costs to the industry itself since  it will require far fewer credentialed financial professionals who expect to make a healthy living off of their commissionable transactions.  The pending lack of human intervention means that services can be offered for much lower costs than those that have been experienced in the past.

Let's close with this quote:

"Given the powerful combination of big data, combined with machine intelligence, it becomes very easy for highly refined, goal-specific asset allocations to become possible. For example, imagine a world in which the unique risks identified by a customer are mitigated by a customized, algorithm-created, derivative product with a complicated design but noncomplex and user-friendly engagement."

Robo-advice appears to be the future of the investment industry whether we like it or not.  While it may provide investors with lower costs, there are significant downsides to the reliance on artificial intelligence in the investment industry, the home of trillions of investors's life savings.   No matter how "smart" artificial intelligence becomes, it still is completely incapable of predicting human behaviour, particularly the type of random emotional behaviour that occurs when investors perceive that the market is about to crash. 


  1. Your last sentence implies that human advisers, unlike robo-advisers, are capable of predicting random emotional behavior. Do you really believe this?

    1. No, I'm just saying that neither humans nor robo-advisors will be able to predict random emotional behaviour (i.e. there will be no advantage to having a robo-advisor during a period like that which occurred in 2008 - 2009).