Digital intelligence: Robo-based financial advising through a downturn

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Since its introduction in 2008, robo-advisory technology has created new opportunities—particularly by expanding wealth management services to younger clients. Now, with more challenging market headlines, it raises the question of how robo-based services should prepare in the face of equity market downturns, and potentially even a prolonged bear market. To address younger clients, many of whom have never experienced a market correction, transparency and education are starting points. With these possible headwinds, institutions should think about strategies such as product expansion, revenue diversification, or consolidation.

Transparency is key, particularly for digital engagement

Most of the clients who have entrusted $200 billion-plus to robo-advisors have had to deal only with short-term market fluctuations. Due to the mostly up-market since 2008, a reduction in client engagement or investable assets has been a fairly lower concern for many of the digital advice platforms—whether FinTech startup or incumbent.

Consequently, the industry can do more to prepare for heightened market volatility or an inevitable market downturn. Transparency is a critical ingredient and institutions can develop engaging means to educate clients about market fluctuations and risk. For example, performance evaluation is often the last step in the wealth management process and may occur only at certain intervals. This seems quite dated in the world of digital advice. Instead, wealth managers may want to think about providing the key contributing factors for portfolio return at more regular intervals in a quantitative and qualitative manner. For clients, understanding key reasons why their account increased or decreased in value provides both transparency and education that is beneficial regardless of market direction.

A challenge in providing frequent performance evaluation is the conflict between long- and short-term goals. The potential for “panic selling” (or modifications to risk profiles which drive significant changes in portfolio allocations set by robo-advice platforms) will increase in market downturns and human nature, which drives this, is difficult to overcome. When providing market education, not losing sight of the long-term goal in the midst of explaining short-term fluctuation can be a critical component. Following the 2016 Brexit induced volatility, many robo-advisors responded by halting trading for a few hours, sending out emails and twitter messages to clients exhorting them not to make changes to their portfolios, and adding significantly to their call-center based advisor capacity.

For example, institutions can explain short-term portfolio change in the context of long-term historical measures, which can help alleviate concerns and limit rash decisions. Considering the single largest reason for investment underperformance is a behavioral bias that leads to poor market timing decisions, providing the assistance to avoid overreaction to fear and uncertainty can measurably change long-term performance.

Portfolio evaluation is more than a scorecard. It is an opportunity for engagement where a qualitative approach can provide a long-term sanity check to complement a quantitative measure. And this is true for all-digital or hybrid-robo approaches.

Dusting off the strategic playbook

A goal of robo-advisors is to seamlessly add discipline-focused tools to help clients reach their goals. This is true throughout market cycles and could prompt institutions to reassess their respective long-term strategies. Looking at incumbent wealth managers as a proxy, many have diversified beyond market- or transactional-based revenue partly in an effort to add stickier and more predictable revenue streams.  Investor discipline can build confidence and increase the potential for interaction with these higher margin products.

  • Diversification to steadier revenue sources 

Revenue models dependent on market-based activity such as trading commissions or advisory fees will be most exposed in a bear market. Many incumbent wealth managers have added savings deposit capabilities, credit, or payroll services in order to strengthen ties directly or indirectly with clients and emerge from a downturn in a stronger position.

Many FinTechs have begun to expand beyond their initial product offering, and an increase in market uncertainty could accelerate the need for strategic options for robo-advisory institutions. This could include product expansion to include basic banking products via partnership, acquisition, or internal development, with the latter option seeing increasing interest given the newfound activity for licensing options.

Younger clients may increasingly seek to change spending patterns or protect their savings in a down market through fixed rate or higher yield savings products. This should be a stark reminder that the relationship between saving, investing, spending, and credit provides a more complete financial picture. Firms that can help clients manage financial decisions across this full relationship are bound to provide value through complete market cycles.

  • Options for countercyclical products

Younger clients have had a very low uptake of more mundane solutions such as life insurance, annuity, and fixed-income products. For some robo-advisory approaches, where a personalized or model portfolio is built from a risk profile questionnaire with minimal human involvement, some of these investment options may not be viable.

Still, the risk-return of these products compared to equities or other lower-touch investment options may become more attractive in a down market. This, in turn, may assist in familiarizing a younger generation with a subset of products that have fallen by the wayside. Some insurers that have had more relative success with life insurance have positioned the product as part of a wider solution rather than as an individual product sale. As such, broader financial planning beyond model portfolios offers a countercyclical option to diversify revenue while focusing on their clients’ full balance sheet or aggregate financial health.

  • Market consolidation 

Thanks to the $50 billion-plus in FinTech funding over the last five years combined with a bull market, the industry has not experienced the sort of massive shake-up that often brings a run of consolidation. Putting valuations aside, institutions that have flexibility with capital to invest both internally and externally through a full market cycle are more likely to build long-term value.

The financial services industry will continue to evolve, likely at an increasingly faster pace, and many narrow or singularly focused robo-advisors will need to assess their strategic options and capital allocation for long-term positioning. Given the level of innovation in financial services, consumer choice will increase. Long term strategies should aim to capitalize on this trend which will require product expansion and balance sheet flexibility in order to capitalize.

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Julien Courbe

Financial Services Leader, PwC US

Scott Evoy

Financial Services Advisory Digital Leader, PwC US

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