Open letter to Mark Carney on Robo-Advice

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I am very pleased that Mark Carney has robo-advice on his mind. For him to be speaking about a nascent industry, he must believe that firms using technology to help manage people’s money will grow to become a significant part of the market. This is a fantastic promotion of the industry and one I am extremely proud to be a part of as we put the client back into the heart of our service.

However, in his speech he appears concerned about robo-advisors becoming a risk to our well-functioning financial system. The argument is that they may lead to excess volatility or increase pro-cyclicality as a result of herding. I see his attack on robo-advice as misinformed for several reasons.

Let’s start with the facts.

Assets currently managed by European robo-advisors are a drop in the ocean, at approximately £1 billion. It sounds like a big number until you start to put this into perspective. The UK’s asset management industry is the second largest in the world, managing £6.9 trillion of assets, so robo-advisor’s assets amount to less than 0.02 percent of the total assets managed by the industry. The recent FCA Asset Management Study has highlighted many worrying concerns about the practices of incumbent asset management firms that need to be addressed. Issues that are impacting a far greater number of investors than the robo advice sector is currently serving; issues that robo-advisors can actually help fixing.

For example, £109 billion are currently managed by what the FCA defines as closet indexers. This means that investors are paying expensive active management fees for funds that do little more than mirror the index. We estimate the fees being paid to be on average 1% higher than they could be otherwise in cost-effective trackers, which means that investors pay over £1 billion too much in fees for these funds, even though little to no added value is created by the fund managers.

So what’s most important right now? Exposing closet indexers for which clients overpay by £1 billion in unnecessary fees every single year or hit on robo-advisors who advocate for more transparency in investment management, push for lower costs and provide a better service for their clients than traditional products? Who don’t pretend to offer active management while just replicating an index? This is a deep miscalculation of priorities by the Bank of England chief.

The real systemic threat is the 60 - 40 portfolio.

Furthermore, what Mark Carney doesn’t say in his speech is that herding has been around for years. Currently, most retail investors are sold off-the-shelf model portfolios (for example, a portfolio which naively holds 60% equities and 40% bonds) through traditional advice channels. These portfolios suffer from herding and channel many clients into exactly the same positions. Without the use of technology, there is no way to provide truly individualised portfolios that will be adjusted differently in changing market environments. The established players therefore have to make shortcuts and as such people get placed in exactly the same portfolios that are adjusted in exactly the same way as conditions change. That means that in addition to a substantial portion of “actively managed” funds being no more than index-trackers in disguise, the traditional approach of model portfolios leads to herding on a huge scale.

When arguing that robo-advisors may encourage herding, Mark Carney furthermore assumes that all robo-advisors have the exact same investment methodology. This simply isn’t true. It is like saying that all fund managers have exactly the same investment methodology, an assumption he doesn’t seem to be making. Some robo-advisors use the same methodology as traditional fund managers. But others, like Scalable Capital, use data-driven models to drive investment decisions for thousands of individual, non-identical client portfolios - and due to the optimisation at individual level and based on big data, they are often different from those of a fund manager in charge of one large portfolio (their fund) for thousands of investors.

I felt obliged to write this letter as I wholly believe that comments based on a lack of information and playing in the hands of the incumbent asset management industry are extremely damaging to retail investors. The status quo is broken and, even worse, investors do not even know due to the lack of transparency. By making throwaway remarks like this there is a danger we will be stifling innovation when it is needed the most. People are unable to save for their futures as inflated fees, due to legacy technology and an unwillingness to change established processes, are eating into the majority of their returns. We would like to extend an open invitation to Mark Carney and his team to visit our offices and meet the hard-working, passionate people who are working tirelessly to try and make a difference where a difference needs to be made.