Individuals are becoming increasingly responsible for their (pension) savings decisions. Unfortunately, many are not equipped to take complex financial decisions because they are subject to numerous biases. Simply put, they need advice to make crucial decisions.
“In that context financial advice is key; we know that there is inequality in access to advice. Robo advice could be a solution,” says Marie Brière, board member of Inquire Europe and Head of Investor Research Center at AMUNDI.
A ‘robo-adviser’ is an online platform providing financial advice or allowing the automated management of a portfolio of assets. The market for robo-advice is rising fast, estimated to be at around $1 trillion. Robo-advisers define goals, assess personal preferences, construct and communicate an optimal investment strategy and send alerts or automatically rebalance portfolios when asset allocation strays from its target.
According to the European Parliament (2021), robo-advisers can be classified in three ways: generic, personalized, and managed account. The personalized category is the only one which relies on human-robot interaction and where the client makes the final investment decision.
“This distinction is important, because we see that there are two potential developments in the field of robo-advice. Either we think that it’s a good idea to keep humans in control of their personal finance decisions – and maybe learn from that process. Or we think that humans can make mistakes due to biases and decisions must be fully delegated to the robo-adviser. This is something that deserves more investigation,” says Brière.
One of the most interesting promises that robo-advisers offer is for greater financial inclusion. By reducing costs, new technologies can reach traditionally under-served clients. This segment of the market requires lower initial capital to open an account; if this barrier is removed, middle class participation should drastically increase.
Brière and Bianchi, professor at Toulouse School of Economics, conducted research to determine exactly how robo-advisers help improve individuals’ financial decision and how clients interact with them.
Their findings indicate that, in contrast to typical human advisers, investors seem to be attracted by robo allocations that are: 1) very different from their current allocation and 2) riskier.
“This is quite surprising because if we look at the academic literature on human advice, this is completely contrary. Humans try to reduce the distance between the advice they are giving and the client’s portfolio. Here we find that is not case. People are ready to accept an allocation that is very different from what they had in their portfolio. It looks like they trust the advice.” The bottom line is that clients receiving robo-advice are trading more frequently and this has led to an increase in their net inflows.
“We also found that clients with robo-advice tended to save more, and increased their asset allocation to equities, by about 9%” says Brière. “We were also curious how people reacted to the alerts they received and if they rebalanced their portfolios. Results showed that alerts were associated with a reduction in the distance to the target equity share proposed by the robo.”
When assessing the impact on performance, those who utilized robo-advice saw an increase of about 3% on their annual returns (controlling for risk). Two third of that improvement came from a more adequate portfolio rebalancing behaviour. Additionally, in terms of financial inclusion, it was proven that the robot is able to induce larger portfolio changes for smaller investors.
“We found that the robo adviser was able to induce significant asset allocation changes, increase inflow and attention, caused clients to increase their equity exposure and rebalance, which led to an increased performance. This cannot be taken for granted because for the robo-advisor we studied, the decision was left to the client, meaning that they did not have to follow the advice. We also find the robot can promote financial inclusion.” Learn more about Marie Brière’s vision for the future of robo advice via a presentation which was made for Inquire UK. The research ‘Augmenting Investment Decisions with Robo-Advice’ and ‘Robo-Advising: Less AI and More XAI?’ are both accessible to the public.