SCM Direct: Robo-advisors are ‘financially unviable’

Jul 13th, 2016 | By | Category: ETF and Index News

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By Alan Miller, Founding Partner and Chief Investment Officer, SCM Direct

Robo-advisers are seen by many as the saviours of financial mankind – they are going to solve the mythical advice gap, make great investment decisions and make their financial backers millionaires.  In reality, most robo-advice models are simply offering direct to consumer investment solutions, via exchange-traded funds rather than genuine advice.

SCM Private closes multi-asset ETF owing to lack of investor interest

Alan Miller, Founding Partner and Chief Investment Officer, SCM Direct.

SCM Direct researched 10 UK ‘robo-advisers’, and found their average fee excluding VAT for a £25,000 portfolio, was 0.59% pa i.e. £147.50 per annum.

As start-ups, most ‘robos’ do not have brands so require well-funded strategic marketing campaigns. We estimate a successful online campaign costs circa £3.15 per click.  Based on a conversion rate of 1.75%, the customer acquisition cost is £180 per account.

The robo-adviser business model appears to be employing, more investment management staff, more IT staff, more sales and marketing staff, more customer service staff, and more compliance staff.  Even if they could achieve the average cost base (0.52% of AUM) of four leading large private wealth managers/direct platforms, the cost of managing a £25,000 account is £130 per annum.

SCM Direct calculates that it would take nearly 11 years to make a profit.

SCM Private calculates the time it would take for robo advisors to make a profit

SCM Direct calculates the time it would take for robo-advisors to make a profit

One new UK robo-adviser firm in an article by Citywire, said “I wouldn’t expect to be reaching breakeven before we have £2 billion AUM,’… We’re talking about several years, maybe five or six.”  

The various venture capitalists, private equity and professional private investors are flushing their clients money down the toilet via UK robo-advisers.

Vanguard Group have reported that their redemption rate is currently close to 40%, bringing the average holding period down to about 2.5 years, according to www.wealthmanagement.com.  We believe that a 3-year estimate is a good guide to UK robo-advisers, given their younger investor targeting so by the time these robo-advisers could in theory make a penny, their clients will have gone!

Regulatory Issues – Significant Potential Liabilities

We found evidence of misleading statements, misleading performance, misleading fees, and a lack of appropriate regulatory permissions.

Performance

One robo-adviser showed performance by converting the returns of its euro portfolios prior to 2015 into sterling, even though an employee told us that these euro portfolios “are different to the UK ones”.  Furthermore, these returns were shown before “taking account of their fees”.

Advice

SCM Direct’s research found that 80% relied on client risk questionnaires to select investments yet 25% did not possess regulatory permission to give advice to retail clients. 

In our view, if a ‘robo-adviser’ chooses a strategy based directly on answers to specific personal questions, then surely this must be advice, as it is based ‘on your information’ and is being presented as suitable based on your particular circumstances.

Anyway, it is highly debatable as to whether robo-advisers are giving advice in the widest sense that the name ‘robo-adviser’ might suggest.  Many do not look in detail at the overall financial attributes and requirements of each client.

In 2011, the Financial Conduct Authority (FCA) reviewed 11 risk-profiling tools and found that nine of the eleven tools had weaknesses which could, in certain circumstances, lead to flawed outputs.

The top securities regulator in Massachusetts recently stated in a Reuters article that “fully-automated robo-advisers, as they are typically structured, may be inherently unable to act as fiduciaries and perform the functions of a state-registered investment adviser

The UK Financial Services Panel has rightly pointed out these risks to the FCA: “Tools that are poorly developed and/or monitored have the potential to give rise to widespread systemic mis-selling and therefore further undermine confidence in the sector.”

Fees and Charges – Highly Confusing

One of the most appealing competitor advantages of robo-advisers compared to traditional incumbents is their lower fees.  However, only 30% added up all their own fees, all the underlying investments costs, and other charges to produce one overall total fee number.  In fact, none of the companies provided any indication of the full underlying transaction costs including the spreads, even though ETFs will naturally have a spread between the buying and selling price.

We found numerous statements on fees and other matters within the sites analysed, which were extremely misleading in our view.  We even found one site where the legal documents were missing most of the pages.

Our conclusion is that there is little evidence of robust innovation, as new robo-advisers appear to be fundamentally financially unviable and/or seem to be regularly flouting key FCA rules.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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