EXCHANGE-TRADED funds (ETFs) were supposed to make investing easy. Instead of spending hours researching individual stocks and bonds or paying an expert fund manager, investors could simply buy a few ETFs. But now there are too many to choose from. BlackRock offers 346 in America alone. Some investors need help allocating their money between different funds. Many companies now offer “automated wealth managers” (AWMs) that perform this service.
AWMs have been around for less than ten years, but they have proliferated, offering different services in different countries. Often, they are called “robo-advisers”, but this term can be misleading. Some offer clients detailed advice about how to save. For example, Wealthfront, an American AWM, predicts the cost of sending a student to a given college, taking into account increases in tuition fees and likely financial aid. It then suggests how parents can save in a tax-efficient way. Other AWMs are simpler. Wealthify, based in Cardiff, rejects the term “robo-adviser” because it does not provide advice. It merely allocates clients’ funds based on how much they wish to invest, when they expect to need the money and the degree of risk they will accept.
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Nonetheless, AWMs have a few things in common. They typically invest in low-cost ETFs and charge very low fees. Annual charges are usually only a fraction of a percentage point of an investor’s total savings, plus any fees levied by the ETFs.
AWMs target cash-conscious investors who cannot afford or do not wish to pay a human adviser. Millennials are considered good customers because they are used to doing things online and are starting to earn money. But generally they do not have a lot of it. Individual savers tend to have small portfolios. At Betterment, the largest independent American AWM measured by assets under management, the average client had $27,400 in June 2017. At Wealthfront, its rival, the average client had $40,900.
Their business model leaves AWMs with a problem. To make a profit despite low fees, they must attract lots of client money. Michael Wong, an analyst at Morningstar, an investment research firm, estimates that, depending on its model, an AWM would need between $16bn and $40bn to cover its costs. No independent AWMs have reached profitability, though some are close. Betterment says it has $11bn under management.
But for most AWMs, profitability remains distant. Only a few manage over $1bn or have more than 100,000 clients. To get more clients, many are tying up with established wealth managers. On October 5th Aviva, a British insurer, said it would buy a majority stake in Wealthify. Michelle Pearce, Wealthify’s co-founder and chief investment officer, noted that Aviva has 15m customers in Britain, who can use her firm’s services through Aviva’s portal.
To stay independent, AWMs need to get big quickly, in part by seeking customers established firms neglect. Similarly, acquired AWMs often pitch their products to people their parent firms would not otherwise serve. These customers tend to have little wealth and to be new investors. There are dangers in this: they may place too much faith in AWMs’ more optimistic projections of future riches. Wealthfront even allows its customers to borrow against the value of their savings, on the basis that its funds will provide better returns than its interest rates of 3.5-4.75%. Like their human counterparts, robos may have a tendency to oversell their investing prowess.