Why Robo Advising is Taking Off in the UK

Why all the hubbub around Robo investing? Robo advisors are a new crop of fintech firms that have sprung up to provide low-cost, on-line professional investment management to the masses. This is accomplished by investing in exchange-traded funds (ETFs) according to an individual’s risk tolerance. ETFs are funds traded on a stock exchange that track indices like the FTSE 100 or baskets of commodities or bonds, providing exposure to the market as a whole.

Robo Advisors Instead of Traditional Wealth Managers?

Traditionally, people invest their money in one of two ways: either picking stocks or mutual funds themselves through a brokerage account or by trusting a wealth manager to make investment decisions for them. There are inherent issues with both of these methods.

How many of us have stared at the overwhelming number of funds available, unable to choose an investment? Or as the market changes, do we actually readjust our portfolios to reflect the new financial environment? While it’s safe to say that most would welcome a professional investment manager’s guiding hand for our nest eggs, their fees and minimum investments have historically been prohibitive. Access to traditional investment managers is well outside the scope of the general population, as they commonly:

So how is the average person meant to get professional investment management, providing diversification and risk management, for a low cost? Robo advisors attempt to do just that. Robo advising is meant to provide a level of professional management to individuals unable or unwilling to pay private wealth managers, but who do want investment guidance.

How do Robo Advisors Work?

Instead of picking individual stocks, which is labour intensive and expensive to do properly, Robo advisors usually invest your money into ETFs, which track indices like the FTSE 100. The ETFs are chosen by professionals and in-house algorithms, according to qualities like your risk profile and the size of your investment pot.

Risk profiles are determined through online risk assessments that ask questions to determine your aversion to risk. You may be asked about your investment timeline (i.e., how long your money can stay invested before you need it back) or how much you are willing to accept the (potential) large losses that may accompany a high investment growth strategy.

Robo advisors aim to reduce risk by diversifying your assets, for instance by:

Depending on your risk tolerance – from conservative to aggressive – the robo advisor algorithms and professionals will decide how to invest your money for you.

Active (e.g., Stock Picking) vs Passive (e.g., ETF, Robo, etc.) Investing

Passive investing is the concept of investing in the market as a whole, whereas active investing is trying to pick “winners,” e.g., individual stocks that will go up. Done properly, active investing is costly because it is labour intensive (i.e., involving thorough analysis of a company’s current and future financials and place amongst competitors).

Robo Advisors use the principal of passive investing by investing in index-tracking ETFs, providing exposure to market indices. Historically, passive investing has done well relative to active, individual stock picking (whether wealth manager or self picked). While individual money managers may have strong, market-beating years, they also have poor years with lower-than-market returns.

A number of studies have shown that active, individual stock picking strategies fall behind market performance as a whole (i.e., indices). The S&P weighs in on the active vs. passive investing debate through their S&P Indices Versus Active Funds (SPIVA) Scorecard, published since 2002. Their research shows that 96% of active funds underperform their benchmarks over a ten-year investment horizon; said another way, only 4% of active funds outperform their benchmarks over ten years. That's a pretty low number, revealing that the average investor would historically net higher returns through a passive investing style.

The table below illustrates the low percentage of time that (active) European equity funds have outperformed their (passive) benchmarks.

Percentage of European Equity Funds that Outperform Benchmarks

Given data like this, we can see why robo advising is catching on. Not only are the fees relatively low but also the results of passive investing have historically exceeded active management. (Remember that historical results are not an indication of future results, however.)

By investing in index-tracking ETFs, the robo advisors are betting on this to be true – that investing in the market as a whole produces better returns than stock picking. Instead of hiring lots of analysts to pick individual stocks (which is expensive), robo advisors use a few professionals to pick index-tracking ETFs for different risk profiles. How they add value is by picking which ETFs look attractive and suit different risk profile (e.g., it is generally assumed that the higher the percentage of stocks in your portfolio, the more risk you carry). As time goes on, robo advisors claim to monitor the markets and rebalance the portfolio as markets and conditions change.

Players in the Robo Advisory Market

Nutmeg is possibly the most commonly-known "robo advisor" as the first major entry in the UK market. A number of other robo advisors have opened their doors (well, websites) since. We wonder if Vanguard will be the next major player. Vanguard’s Personal Advisor (i.e., robo advisor) service has taken off in the US, but they have yet to open UK operations. Is the UK next for Vanguard?

Below is a list of some current UK robo advisors, with a summary of their features. This is by no means a complete list and we are not recommending any advisory firm in particular. They are listed in alphabetical order.

Summary of UK Robo Advisors