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The advent of robo-advisors

Fintech revolution is here and robo-advisory services are a big part of it. They will possibly change how we manage our wealth

The advent of robo-advisors

Start-ups are the flavour of the season. Venture-capital funds are eager to write out cheques for any newbie business that claims to use technology to 'disrupt' any conventional business. So, after making a beeline for companies that introduced 'tech' into shopping, fashion, medical advice, taxi booking and food, the marriage of tech with finance is the current rage in the VC world.

Uneasy fit
Suddenly, in India too, the air is thick with businesses calling themselves 'robo advisors'. Robo advisors are an automated, software-driven replacement for a real human financial advisor.
Therefore, to understand what robo advisors do, we need to take stock of what an ideal human advisor does. A financial advisor is supposed to offer objective financial advice to his clients for a fee. The process starts with credibility development, where the advisor sits with the investor to discuss his income, expenses, saving habits and financial goals. A risk-evaluation and asset-allocation exercise follows. Then comes portfolio construction, where the advisor helps the investor with transactions. But the process doesn't stop with buying up a few dozen products. For the advice to be truly effective, the portfolio needs to be periodically rebalanced, tweaked and rejigged until the investor gets to his goal.
However, this is not even the most important thing an advisor does. To really serve investor interests well, the financial advisor also needs to play psychiatrist when the market's going down to keep the investor from straying off track.
To be honest, a very small proportion of financial-advisory business in India is structured like this. Most financial products - insurance, mutual funds or post office schemes - are sold by agents who are focused on selling a product and are heavily reliant on commissions from it. Then there are wealth-management firms and private bankers, who supposedly cater to sophisticated clients but are equally wedded to targets and transactions. This results in rampant mis-selling, investors being saddled with unsuitable and unaffordable products and regulatory micromanagement of commissions and fees.
The Indian investor's reluctance to shell out any fee for financial advice stands in the way of genuine full-service models too. With so much free 'advice' floating around, who will pay for it? All this is why robo-advisory services, an imported concept from the Western world (where the human-advisory models are well developed), make for a rather uneasy fit in the Indian context.

The Indian model
But the gaps in the financial advisory space in India could also mean that we may have a leapfrogging opportunity in financial-advisory services, similar to what has transpired with mobile telephony or terrestrial television. Just as terrestrial TV stations were bypassed by satellite TV and universal landline telephones by mobile phones, it's possible to visualise a future where most Indians who invest have an algorithmically driven virtual advisor.
It's important to note that all the technology that is required by an automated financial platform is in place in India. We already have digital-payment systems, eKYC, online fund transactions, online statements of investments. In theory, a mechanical tying up of all these would deliver a 360-degree service.
What's missing? Actually, the main part is missing. This would be all icing, no cake. The trust, the track record, the alignment with the customer's interests, the hand-holding of the customer until he gets to the goal are the key components that are missing in this case.
So will the new crop of robo advisors be an improvement over conventional human advisors? Or will they just transplant the same business models (and thus the same problems) to the online world? As robo advisories start hitting the Indian investor with high-pressure marketing, that's the big question.
To answer that, we may need to take stock of what is it that Indian robo-advisory platforms offer. Value Research reached out to half a dozen firms that have made a splash in this space to understand this.

Indian robo models
Players in this space are the first to admit that the term 'robo advisor' is used rather loosely in India. As financial advisory services in India run the whole gamut - from helping an investor do automated SIPs in funds to taking over all his money-related decisions - the term 'robo advisory' is also used to refer to any of these services, provided that there's an automated element to it. Current robo-advisory models in India seem to fall broadly into three types: financial planning, goal advisory and hybrid models.

Financial planning
These platforms hope to take over all the personal-finance decisions of the investor and function as one-stop shops for advice as well as execution. Robo-advisory platforms such as ArthaYantra, 5nance.com and ICICIDirect fall into this category. On these platforms, even a completely uninformed investor can use online tools to map out his income, expenses and savings; set his financial goals for different years; get his risk profile assessed; arrive at a customised asset allocation - through algorithm-driven programs, of course.
He can use these platforms to execute his trades too. While this is optional, these platforms provide active incentives (or disincentives) to encourage their clients to stay with them for a lifetime. Once an investor has signed up, these firms also monitor his investment pattern and portfolio on an ongoing basis and suggest mid-course corrections if needed.
But having said this, each platform has a slightly different take on this core proposition. ArthaYantra, one of the early movers in the Indian robo-advisory space seems to come closest to a fully automated robo service. It prides itself on using lab-tested algorithms in every aspect of financial planning, be it mapping out asset allocation, profiling an investor's risk appetite or constructing actual portfolios, using machine learning and millions of data points to factor in every possibility. It has a proprietory Personal Finance Quotient which regularly ranks investors on their financial health.
Its founder and CEO, Nitin Vyakaranam, says that most financial advisors in India are product oriented and don't make the necessary connections between buying a product and how it affects your overall finances. Plus, they don't care about your past financial mistakes. But ArthaYantra addresses these two aspects too to construct a fool-proof financial plan.
"If you buy a home, it impacts your monthly cash flow, taxes, your will and your insurance needs. But traditional wealth managers will often just advise you on buying the property and be done with it. Reversing your past mistakes and cleaning up your finances must be the first step to constructing your financial plan. We had a customer who came to us with 14 insurance policies last year. We got him to surrender them and bought him a ₹2 crore online term cover. When he unfortunately passed away a few months ago, we informed his wife he had a ₹2 crore term cover due for payout. Finance is as important as medicine to a person's life, but very few realise that!"
The more recently launched 5nance.com claims to differentiate itself by hand-holding the consumer until he reaches his financial goals. Founder and CEO, Dinesh Rohira, explains, "We look not just at the investment-advisory piece but also at all the money-management needs of a consumer. In the offline world, the advisor is often available to the consumer when he wants to make an entry into an asset class. He doesn't get much guidance on exit. So ownership of the exit gets transferred to the investor himself. We actually take ownership of his goals."
5nance's other USP is that it offers a range of asset classes on its platform - mutual funds, corporate deposits, physical gold, bonds, and even loan and credit-card products on the liabilities side. It claims a proprietory asset-allocation model, which uses both technical as well as fundamental factors to provide tactical advice on asset allocation to investors.
Once registered, an investor on 5nance goes through a four-step process. First, his assets, liabilities, earnings and expenses are mapped to optimise his savings. Two, he can plan his goals on the site - child's education, marriage, second home, retirement. Three, a simple questionnaire is used to assess his risk profile. Finally, 5nance helps him execute those transactions and get to his goals.
ICICI Securities, a colossus in online broking, has recently launched its own robo advisor as a paid service for investors. Abhishake Mathur, who spearheads this venture, explains that while the mapping of an investor's goals, asset allocation, execution of trades and ongoing monitoring are all fully automated functions, one thing that distinguishes this service from other robo advisories is the human intervention at the very beginning.
"We meet up with every client to really understand his finances, his cash flows and aspirations. I believe that just putting up a questionnaire on the site and asking the client whether he has a high-risk profile never works. A lot of robo advisors globally use psychometric testing to arrive at a client's risk profile. But the responses to these types of questionnaires depend a lot on market conditions. If you approached any investor in 2007 and asked him if he was a risk taker, he would have said, "Yes, I am an aggressive investor." In 2008, the same client would have taken the opposite position. We also need to sit with the client to understand his goal priorities. Buying a third home is very different from buying the first one."
After a two-hour face-to-face session in which ICICI's personnel collect comprehensive information about each client, he signs up on the platform. The automation takes over from there. Algorithms are used to come up with an asset allocation to meet the stated goals. Simulation is used to come up with a four-pronged plan on allocation, savings/withdrawal rate, expected growth and mid-course corrections. A USP is the Track and Act feature, which allows a client to monitor his progress in real time. This engine also tells clients where to park sudden windfalls or which assets to sell if there are emergency cash needs.
While these end-to-end services offer possibly the most desirable version of robo advice, they may come up against two key entry barriers from investors. First, all these platforms don't allow much time for an investor to build up a relationship with the advisor. An investor looking to sign up is expected to immediately provide (or migrate) his entire financial history, full details of his assets and liabilities as well as future financial obligations to the platform to avail of the service. Not all investors may develop this level of comfort with a new platform overnight.
Second, though these platforms don't force investors to execute transactions through them, an investor looking to use the full gamut of their services may end up eventually doing his transactions on them too for convenience sake. This could mean that they are not exactly low-cost, as they could entail both an advisory fee and distribution commission for the investor (see below for fee models).

Goal advisory
While most financial advisors in India, both online and offline, try to focus on driving product purchases by investors (that's where most of the revenues are), some new-age platforms are looking just at the first-leg goal setting.
Not wholly a robo-advisory service, BigDecisions.com swears by big data analytics to help its users make the right decisions even before they get to the stage of financial planning.
Manish Shah, founder and CEO of BigDecisions.com, explains "Most robo advisors are answering the question 'Where should I invest?' But if an investor wants to save for his kid's education, the most important job is to first help him arrive at the right number for that goal. You can even ask whether he should be pursuing that goal! That's where we come in. We can tell you what it may cost to put your daughter through a US master's degree versus a US undergrad course so that you actually set the right goals for your financial plans."
To do this, BigDecisions collects data on big-picture financial trends (the annual inflation in school fees, the actual cost of medical treatment across cities, the real cost of delays in a construction project and so on) and marries this with the data from its users to guide investors on their big decisions.
The data piece in this platform comes from innovative calculators that are on the site (there's a cost of smoking calculator, for instance) and the aggregated user data that helps each investor gauge if his financial behaviour is out of whack with his peer group. "Two million people have used the platform and we have more than half a million records now. So, I can aggregate that data and slice and dice it into geographic, age-wise and income-wise clusters. So if I tell you that eight out of ten people in your age group spend far less on entertainment than you, isn't that a powerful tool?"
The platform is not into either financial planning or distribution of products. "People like it that we don't actually distribute any financial products. They hate to put in data and have marketers call the living daylights out of them," he jokes.
But investors using the platform for setting their goals have to approach their advisor for an actual asset allocation or financial plan and other product providers to execute their transactions.

Hybrid models
Then there are the online-distribution platforms in the business of financial services which are experimenting with 'robo' elements to offer value-added services to their investors.
FundsIndia, the popular online platform for mutual funds, offers some robo-advisory elements on its platform. Its co-founder, Srikanth Meenakshi explains, "In India, one cannot offer a narrow-band solution to investors. If a customer comes to you for the first time, you cannot force him to accept your entire gamut of services as a package. Nor can you avoid human interactions. That's why on the FundsIndia platform, we have different levels of service. Investors can consume them at any level and with any degree of human involvement they choose."
FundsIndia has four types of automated tools on offer. If an investor logging on already has goals and his asset allocation in mind, he is offered the Select Funds tool, which captures house calls on the best funds in each category. If the investor hasn't done the arithmetic on asset allocation, there's the SIP Designer, which does the math and tells him how much to invest. There's a ready-to-go portfolio that helps an investor make a lumpsum investment. Finally, there's the comprehensive Smart Solutions which takes care of goal setting, asset allocation, fund mapping, investment and handholding of the investor until the goal is attained. The core fund selection function is done wholly by in-house (human) researchers.
So where does the robo part come in? Srikanth explains, "All the readymade solutions - from Select Funds to Smart Solutions can be used by consumers without any human intervention whatsoever." But he says that Indian investors aren't wholly comfortable with automated solutions yet, which is why human advisors do step in. "Currently purely robo services are used by 30 per cent of our users and 70 per cent still like to talk to people before investing."
Mutual-fund investing platform Scripbox doesn't have a large menu of assets or even solutions to offer. Its credo is to totally simplify mutual-fund investing for first-timers who are bewildered by the thousands of options and sub-options present on the menu.
It uses algorithms to construct readymade portfolios that new investors can striaghtaway buy into. Sanjiv Singhal, co-founder of Scripbox, explains, "With very low understanding of finance, I think a completely automated model for financial planning is challenging in India. Seventy per cent of our investors are first-timers. Getting into deep financial planning with such investors is almost like telling a guy who wants to buy his first shirt to go to Brooks Brothers for a custom-tailored one. So we use thumb rules. If people have five-year money, we suggest that they can go for equity funds. If they need it within five years, they can opt for debt funds. Once an investor decides on the asset class - equity, debt or tax savings - we provide him with a readymade curated portfolio." Scripbox uses purely quantitative filters to select funds without the human bias.
Given that these platforms allow investors to take a simplified approach to investing, without sharing all their financial details or migrating all their investments at the word go, they may be preferred by first-timers. But while they offer a flexible take on the concept of robo advice, it should be understood that these platforms are more distributors than advisors in the legal sense as they do rely on commissions from fund purchases.

How popular
So now that we have run through the menu of robo services in India, how popular are they? Are investors thronging to them? Given that many of these firms are recent debutants to the space, their investor numbers aren't large yet. 5nance.com, starting out in November, has about 4,000-5,000 registered users. ICICIDirect claims ₹300 crore in assets under advice. The seasoned FundsIndia says about 10,000 of its 75,000 users tap into its SIP Designer and Smart Solutions. Given that the mutual-fund industry in India features about four crore investors, and over two crore investors hold equity demat accounts, they aren't making a big dent yet.
Given low levels of financial awareness as well as the need for human intervention in many aspects of the service (accurately profiling risk, prioritising goals and counselling the investor through nasty market falls, for instance), in India robo advisors aren't really the mean machines that the Western world is talking about, which can stamp out human advisors in short order.

The weak spots
But given the under-developed state of financial advisory services in India, human advisors and financial-product firms can certainly not afford to sit back and relax, as
more and more robo advisors make their debut.
At the very least, they should be examining if they should also be using the state-of-the-art tools and data analytics that robo advisories use, instead of rules of thumb (like the 100 minus age rule), to improve the quality of their financial advice.
For those distributors who offer limited value addition to their customers, those who are transaction oriented or peddling a single product because it offers high commission, robo advisors can pose a potent threat to margins. Robo advisors don't really need an all-India branch network, a team of relationship managers or large research teams to provide basic product advice. Once they have a core set of online tools and centralised research, they can easily scale up their service to offer it to thousands of investors. This means that they can function at a fraction of the costs that some large wealth-management firms or banks do. This means low-cost services that can draw away clients from the bigger firms.
The ease of transacting online and the regulatory push towards self-service products that obviate distributors (such as mutual-fund direct plans, online NPS accounts and online term-insurance plans) could also open up the possibility of robo services focused only on goal setting, financial planning or product selection, after which the investor can use the direct mode to execute his transactions. Such models may again drive down fees and force human advisors to stick to just one leg of the advisory chain.
While such possibilities are quite some distance away, given the nascent state of financial-product penetration in India, it would not do for either financial firms or the advisory community to underestimate the eventual impact of the march of robos on their business.