‘Active’ asset management took another hit yesterday as the Financial Times revealed that Q1 2016 turned out to be the worst quarter for active investors over the last two decades. Beyond alarmist headlines, although the topic of asset management has already benefited from extensive coverage, I believed a simple reminder of the notions at stake could be useful. Given the complexity of the issue, I have thus decided to split this post into two parts – the second will be published in the coming days.
First and foremost, it is important to note that the phrase ‘asset management’ in a retail context often mixes up two distinct steps of the asset allocation process. The first step is the fund allocation process, which is typically the only one fully transparent to the customer, who can decide, on his own or with the help of an Independent Financial Adviser (IFA), how he would like to split his wealth between financial instruments, including shares, bonds, funds and cash – either directly or through a fund mix. The second step is the proper investment process which is made at fund level and not fully communicated to the customer. For instance, when I decide to buy a share of the BlackRock Global Equity Fund, I know by having a look at the fund’s spreadsheet that the fund will be primarily invested in developed economies and IT companies will roughly weight 15% of the total portfolio, but the average individual cannot have access in real-time to the full portfolio composition – probably made of hundreds of positions. And yet, both parts of the chain have been under attack.
In the UK, the retail financial advisory industry indeed trembled on its bases in 2013, when the recommendations of the Retail Distribution Review (RDR) got enforced. One of the consequences of this work was to prevent financial institutions from implicitly charging customers for investment advice – through higher product fees – and to have them make the financial advice fees explicit and separate instead. The regulator’s primary (and laudable) aim was to enhance market transparency; by splitting out the cost of advice, the customer would be able to assess whether he got ‘value for money’ from his IFA and, if relevant, he would be able to ‘shop’ for alternative advice and/or investment solution. In practice, however, the cost of ‘standalone’ financial advice proved too high for many simple customers – 85% of whom are not willing to pay more than £200 for online advice – who decided to move away from all forms of financial advice. For the regulator, the situation became perilous, leaving on one side IFAs fighting for a disappearing market and, on the other side, the vast majority of the population converting itself to ‘DIY investing’ and playing the mad chemist with their savings. This situation is even more worrying when we know that nearly half of people over 50 admit they do not understand stocks and shares ISAs, and only 14% of people feel confident planning their retirement goals without financial advice.
Unfortunately, unless the RDR is revoked – a very remote scenario -, the role and importance of IFAs will keep shrinking at fast pace. In the long-run, IFAs will likely be needed only to deal with very complex, high-stake situations (e.g. high net worth individual with assets in multiple jurisdictions) and, to a lesser extent, to reassure customers who are ready to pay a high price for the ‘human touch’. For instance, RBS announced last month that its financial advisory services would be dedicated to customers with at least £250k to invest.
For the remainder of the population, the advice gap has been progressively filled by ‘robo-advisers’. A ‘robo-adviser’ asks the customer a series of simple questions in order to assess his risk profile and the investment period length and in return suggests a range of funds that the customer could be interested in investing in. Not only does it prove to be a cost-effective and efficient solution – Italian adviser MoneyFarm is not charging customers for advice related to investment considerations up to £10k -, but the cold-blooded feature of the machine also prevents human biases which led to underperformance – including herd sell-offs in bear markets. Pioneers in the area have attracted significant appeal. Decimal Software for example now holds $3bn of ‘funds under advice’. Big names are now entering the game, starting from the US, with BlackRock acquiring FutureAdvisor in August 2015 and Goldman Sachs buying Honest Dollar, a ‘robo-advisory’ start-up targeting savings accounts for retirement. In the UK, all the major banks have expressed interest, including Barclays, RBS, Lloyds and Santander UK.
In this context, there was little surprise in the Financial Conduct Authority’s decision to help banks set up robo-advisers as part of the Financial Advice Market Review. The rise of the ‘robo’ era does not put an end to possible fraud and mis-selling threats though. As the algorithms will be ultimately defined by humans, the regulator will have to ensure that the most profitable products for the bank are not artificially pushed by this new kind of advisers – but in this case, at least, the algorithm produces by definition an auditable written trace which should make the settlement of complaints relatively easier.
In the second part of this post, we will discuss the investment process, highlighting the debate between ‘active’ and ‘passive’ investing. In this arena, the blood has been flowing for years, if not decades, and has opposed the most highly recognised investors and scholars, including Warren Buffett himself – that’s it for the trailer, more to come in the coming days.
In the meantime, a report from CBS bringing the role and functioning of ‘robo-advisers’ to life, including an interview of Betterment‘s CEO.