Like all new technology, there is a feeling of scepticism when trying to answer the question whether robo advisors are legitimate investment services. Original responses to the market offerings of early robo advisors were that it was just a fad, and that it would never work because the fees were too low and people would not be comfortable trusting their investments to algorithms working in the cloud.
The old stodgy players that grew up in the traditional investment management space were the quickest to discount the impact robo advisors were going to have on the industry.
The trouble is, they were all dead wrong.
Robo advisors are gaining huge traction globally. Assets under management is growing, people are reacting positively to the low fees, and the performance has been great.
In this article, we are going to dive into the growth of robo advisors to prove they are not going anywhere, and are an investment option people should strongly consider.
Here at RoboAdvisors.com, we get asked the following question all the time: “Are Robo Advisors Legit?”. Our answer to the question is always an unequivocal yes, and we refer to the following table which highlights a number of the major players in this space right now. Robo advisors are going global, and the assets under management (AUM) is steadily increasing.
For clarity, in the following table, the “Model” column refers to if the robo advisor offers strictly automated products or a hybrid model. In the automated structures, the investment service is 100% automated with little to no human intervention by investment advisors or managers. In other words, there is no option for additional advice from a team of humans.
The hybrid model on the other hand, combines the automated investment platform with the option of getting advice and direction from a team of investment professionals who are able to help with specific client requirements. This can include advice on managing taxes, or adjusting the risk profile on a portfolio to better match the asset allocation to the investor’s needs.
The most common proxy for assessing how well the investment industry is doing is assets under management (AuM). Depending on how individual firms define asset under management, the reported numbers can vary slightly. However, firms are strongly encouraged to report their AuM based on a standard methodology, to ensure journalists and potential clients are able to compare firms consistently.
Here is how Wikipedia defines asset under management:
Assets under management (AUM), sometimes called funds under management (FUM), measures the total market value of all the financial assets which a financial institution such as a mutual fund, venture capital firm, or brokerage house manages on behalf of its clients and themselves.
Although robo advisors have no where near the same level of assets under management that the whole industry enjoys, the growth rate has been nothing short of extraordinary. KPMG recently did some analysis on the growth of the robo advisor industry to determine if robo advisors were viable investment options, and prepared the following chart to show that in fact they are. The estimated compound annual growth rate for robo advisors over the next five years is 68%:
This also estimates that over $2.2 trillion will be managed by some form of digital advisor. It is clear to see why some of the biggest names in the investing industry like Schwab and Vanguard are quickly moving into the robo advisor space.
Another way to look at assets under management is to examine how quickly firms are growing their assets under management to specific benchmark levels. The quicker that firms can get to certain threshold levels, the more those companies look like they are doing something right.
Take the $1 billion in assets under management mark for example. With certain robo advisors in particular, achieving this $1 billion AuM benchmark happened in only a fraction of the time it took more traditional investment management firms.
The best example of this is between WealthFront and Charles Schwab. WealthFront is one of the largest robo advisors globally, and has been growing massively. Charles Schwab is one of the oldest, and well-respected investment management companies in the world. Schwab has been around for 40 years. WealthFront has been around for nine years.
Here is how fast it took both firms to reach the coveted $1 billion in assets under management (source CB Insights):
What took Charles Schwab six years to do, WealthFront was able to do in only two years. Money is moving quickly into rob advisors and they are quickly gaining traction on the more traditional investment management firms.
If the growth of robo advisors was just limited to one country, like the United States, it would be very easy to discount the impact they were going to have on the market.
However, robo advisors are not only based in the U.S., and some of the largest growth areas are located globally. To get a sense of the sheer scale of the global impact, have a look at the following picture prepared by CB Insights:
Even though this image was only created in April of this year, it is already out of date as additional global players continue to pop up.
Deal flow, or the abundance of business proposals and investment pitches that are being received by financiers such as investment bankers and venture capitalists to fund new start-up companies is another good proxy for how much interest a particular area is enjoying.
The higher the deal flow – or money being directed to investments in new companies – the better the indication that that business prospects are good.
In the overall Financial Technology industry – or FinTech as it is referred to – over 250 companies have raised approximately $32 Billion in 766 deals since 2013. That is a staggering investment level and shows what private investors are willing to commit to the opportunities within FinTech.
As a subset of this massive investment amount, the deal flow for the robo advisor space has been growing steadily.
What this indicates is that investors in these robo advisor companies believe that there is huge growth potential within the industry, and are trying to capitalise on that potential.
In order to provide you with just how much investment is being made into robo advisor firms, we have prepared the following table from information available publicly on the web. It highlights that big investments are being made into robo advisors, and once again answer yes to the question, “are robo advisors legit”.
That growth of robo advisors and the impact to the industry is clear to see when looking at all the data presented above.
But why are robo advisors doing so well? What are the reasons they are disrupting the market so much? I think we can sum it up in the following bullet points:
• The significantly lower fees (and in some cases zero fees) compared to traditional investment management fees has extended the market for advice to more people who have not been able to afford investment advice before.
• Robo advisors allow investors to have more control over their investment dollars, and do not need to trust or rely on other humans for advice. Another way to put this – there is a lack of trust in the investment industry and robo advisors provide a more transparent service.
• As robo advisors get more sophisticated, the advice they will be able to offer via the algorithms will become more personalised and targeted over time. The advice will continue to get better and better.
• Traditional investment management firms are starting to incorporate robo advisory services into their traditional model. This is increasing awareness of the power of robo advisors and will continue to contribute to the massive gains in assets under management.
• Technology is making it easier to break into the financial management space, and smart people will continue to look for ways to apply this technology to provide better, and cheaper, quality investment advice. For example, we will see more and more investment options and more niche type investment services pop up. For example, investing directly in real estate via robo advisors.
Overall, robo advisors are not going anywhere and are here to stay. As an investor, I am especially excited about the opportunities robo advisors bring to helping me grow my wealth. I can now do it cheaper and better that I have been able to do on my own. That should put the fear in traditional investment management firms and force them to adapt. The alternative is simple: those old stodgy firms will simply disappear.