What should an institution look for in a robo advisor?

By Dan Tammas-Hastings, MD of RiskSave


A host of new institutional players are entering the digital advice space. IG index, Santander and RBS (via Coutts) recently and with many more to come. At the same time many robo advisors bulking up their B2B presence and many legacy institutions are actively looking to collaborate with fintechs. With this in mind, we ask what should institutions look for in a robo advisor?

For institutions entering the space robo-advice (aka digital wealth management) can bring new products, distribution pipelines and (hopefully) profit centres whilst also encouraging client retention by creating ‘stickiness’. But there will also be responsibilities and liabilities.

In our view; when evaluating robo-advice options, firms should focus on maintaining the highest compliance standards and then differentiating with expertise in investment performance and risk management.


Regulatory issues must be mastered!

  •       KYC and suitability – regulation should always be a focus, at the forefront are Know Your Customer (KYC) and Suitability. Suitability requirements vary from jurisdiction to jurisdiction but require advisors to make suitable investment recommendations to clients based on their knowledge of the clients’ circumstances and goals. It is important that the product is both ‘suitable’ for the client and the operating environment.


  •       Disclosures – disclosure ensures that users understand the nature of the service they are receiving as well as the risks they undertake. As required of human advisors, robo-advisors should clearly disclose costs, fees, and other forms of compensation or conflict of interest. Robo-advisors should similarly disclose relevant technological, operational, and market risks to clients, alongside forms of re-dress.


  •       Data protection and cybersecurity – digital advisors should use the strongest data encryption, conduct third party risk management, maintain appropriate cybersecurity insurance and maintain business continuity management plans.

Investment and risk management allow for differentiation


  •       Investment framework – ideally LDI – liability driven investment – templates capture the bulk of the retirement market and are considered the gold standard in the pensions industry. They can cut risk significantly for a given a defined return expectation.


  •       Algorithm design – digital advisors should ensure that investment professionals with experience in large multi-asset portfolios are closely involved in the development and ongoing evolution of the investment framework. For large financial service firms portfolio sizes will quickly reach institutional scale which leads to risk management and execution issues not found by traditional advisors, these issues should be recognised before arising.


Model assumptions should be based on generally accepted investment theories, and use of third party developments should be thoroughly stress-tested before implementation; further, the robo advisor should have the systems to isolate and explain various factors within a portfolio for risk management and ex-post performance attribution.


  •       Product range – a broad product range is a necessary but not sufficient criterion for success. Whilst the current crop of robo advisors have been built from Vanguard and BlackRock funds – it is likely that a more sophisticated market will demand a broader range of funds and the potential for individual security selection. Allowing for individual securities allows superior risk-return characteristics and the potential for granular liability hedging.


  •       Trading – robo advisors must have in place strict policies and procedures concerning their trading practices. Due to back-office constraints much of the process has yet to be automated at many of the larger players and as such operational risks remain and should be understood. Such procedures should include controls to mitigate risks associated with trading, slippage and execution errors, and include supervisory controls and procedures. Risks associated with trading practices should be clearly disclosed.


Robo advice is a force for financial inclusion


There is real hope that robo advice or digital asset management could finally enable the provision of advice to mass-market segments, including segments that have previously been unreached by financial advice; the FCA estimates this could be as many as 16 million people in the UK alone.

We believe that an advanced robo advice model is likely to have wide market appeal and certainly has regulatory support. We’re excited by the range of new options that the market will deliver in the near future which should aid both financial literacy and inclusion.


Dan Tammas-Hastings is Managing Director and founder at digital asset management firm RiskSave. He founded the company in response to inadequate risk measures and a lack of transparency dominating the financial services industry. After a successful career as a fixed income trader specialising in GBP derivatives at Merrill Lynch and as a hedge fund manager, managing multi-billion £ portfolios across credit and rates, he is now a leader in risk management and is in charge of strategy and investment at RiskSave. Dan has been awarded both the CFA and FRM charters and is a graduate of the LSE and the University of Cambridge





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