Robo-advisors. Opportunity or threat for the german wealth management industry?

TABLE OF CONTENTS

INTRODUCTION

I.CONTEXT

II. SIGNIFICANCE OF THE STUDY
1. FROM AN ACADEMIC POINT OF VIEW
2. FROM AN ECONOMIC POINT OF VIEW

III. RESEARCH QUESTION AND OBJECTIVES

IV. STRUCTURE OF THE RESEARCH PROJECT

V. LITERATURE REVIEW
1. DEFINITION OF ROBO-ADVISORY CONCEPT
A. HOW IS A "ROBO-ADVISOR" OPERATING?
AI. ONLINE QUESTIONNAIRE
All. FUNCTIONALITIES OF ROBO-ADVISORS
Alii. ROBO-ADVISORS INVEST IN ETF'S
B. HOW TO CHOOSE THE BEST ROBO-ADVISORS?
C. ADVANTAGES OF ROBO-ADVISORS
D. DISADVANTAGES OF ROBO-ADVISORS

VI. FACTORS DRIVING THE EVOLUTION OF THE WEALTH MANAGEMENT INDUSTRY
1. TRENDS OF THE WEALTH MANAGEMENT INDUSTRY
A. DEMOGRAPHICAL CHANGES
B. MILLENIALS AND THEIR CHANGING INVESTMENT BEHAVIOURS
C. TECHNOLOGICAL CHANGES
D. CHANGING INVESTMENT ENVIRONMENT

VII.ROBO-ADVISORSFROMAREGULATORYPOINTOFVIEW
1.MIFIDIIANDIMPLICATIONS

VIII.RESEARCH
1.OBJECTIVE
2.RESEARCHPROBLEM
3.RESEARCHQUESTION

IX.METHODOLOGY

X.MARKETRESEARCHOFTHEROBO-ADVISORYANDFINTECHINDUSTRY
1.FINTECHSINGERMANY
A.DEFINITIONOFFINTECHS
B.SIZEOFTHEGERMANFINTECHMARKET
C.CONCENTRATIONOFTHEGERMANFINTECHMARKET
D.SEGMENTATIONOFTHEGERMANFINTECHMARKET
2.ROBO-ADVISORS
A.GLOBALROBO-ADVISORYMARKETSIZE
B.U.SROBO-ADVISORYCOMPANIESCHARACTERISTICS
C.REDMARKETOCEAN:GERMANROBO-ADVISORYMARKET
CI.CONCENTRATIONOFTHEGERMANROBO-ADVISORYMARKET
CII.SIZEOFTHEGERMANROBO-ADVISORYMARKET3
CIII.SELECTIONOFGERMANROBO-ADVISORYPLAYERS&COMPARAISONCRITERIAS

XI.ROBOADVISORSFROMASTRATEGICPOINTOFVIEW
1.POTENTIALCLIENTSOFROBO-ADVISORS
2.STRATEGIESFORROBO-ADVISORYPLAYERSTOINCREASETHEIRCUSTOMERBASE
3.STRATEGICALLIANCES
A.PARTNERSHIPS
B.SELLINGTHETECHNOLOGY
C.DEVELOPINGIN-HOUSEROBO-ADVISORYCAPABILITIES

XII.LEVELOFATTRACTIVENESSOFTHEWEALTHMANAGEMENTINDUSTRY
1.INTRODUCTIONANDDEFINITIONOFTHECONCEPTS
2.PRESENTATIONOFPORTER’SFIVEFORCESFRAMEWORK
A.PRESENTATIONOFTHERANKINGMODEL
3.OUTCOMESOFPORTER’SFIVEFORCESFRAMEWORK
A.THREATOFENTRY
B.RIVALRYBETWEENESTABLISHEDPLAYERS
C.POWEROFBUYERS
D.POWEROFSUPPLIERS
E.COMPETITIONFROMSUBSTITUTES

XIII.INTERVIEWS
1.BANKS
2.CONSULTANTFIRM

CONCLUSION

REMERCIEMENTS

J’adresse mes sincères remerciements à mes anciens collègues de travail de Gambit Financial Solutions, qui m’ont donné l’opportunité de réaliser une expérience positive et enrichissante. Ils ont su m’aider et me conseiller dans mes recherches.

Je voudrais également remercier tous les intervenants, pour m’avoir accordé de leur temps lors des différentes entrevues visant à récolter des informations sur les robo- advisors.

Enfin, je souhaite remercier les membres de ma famille, qui m’ont toujours aidé et soutenu tout au long de mes études.

Introduction

I. CONTEXT

Nowadays, technology develops faster than ever before and is increasingly being used in our everyday life. That's why we stand stand on the brink of the fourth industrial revolution. One of the economic sector that has been the most impacted by technological opportunities is the financial sector. Following the economic crisis of 2008, the financial landscape started to change, which resulted in client loss of trust in established financial institutions. Thus, a large number of new entrants began offering client-facing digital financial tools. Meanwhile, traditional wealth managers were too occupied by meeting regulatory requirements and were facing the crisis complexities, new types of firms saw an opportunity to leverage their technological capabilities for delivering faster and cheaper investment methods to financial professionals.lndeed, technological financial firms, more known under the term ,Fintech", have really taken off since the financial crisis of 2008.

,Robo-advisors" are part of these new type of firms, who are disrupting the finacial sector, more specifiacally the wealth management industry. As a matter of fact, U.S robo-advisers were the first to experience a real success within the industry. The best examples that can illustrate this success are companies such as Betterment, Personal Capital or Wealthfront who are holding the majority of assets under management. Since this incredible success, a bunch of european robo-advisors entered the market, trying to duplicate this american success story. Actually, automated investment managers, referred as ,robo­ advisors" have become a fast growing area within the investment landscape by challenging traditional financial instituions. By 2020, the assets under management of robo-advisors in the U.S is forcasted to attain two trillion U.S dollars which accounts for an annual growth rate of 68% over a five year period.

The question that arises now is the following: How should people invest their money in the future?

In substance, a robo-advisor is a digital platform that uses algorithms in order to construct, manage and optimize an investment portfolio. Besides being cost effective by having lower cost structures, they are faster and make fewer mistakes than human wealth managers. This being possible because they provide unbiased investment advice decisions, that are not emotionally influenced. Considering one of these advantages, the question that arises next is the following:

Are robo-advisors considered as an opportunity or a threat to wealth managers, who might lose market competitiveness over time ?

We are going to answer to this question by analyzing the market potential of robo-advisors and the differents strategies for them to gain market shares.

During the second part of our study we are going to see more in detail how traditional financial institutions can react to this growing competition.

II. SIGNIFICANCE OF THE STUDY

1. FROM AN ACADEMICAL POINT OF VIEW

As robo-advisors are relatively new to the financial industry, there isn’t a lot of academical research which evaluates the impact of this rising technology on the financial landscape.

Indeed, it is too early to make assumptions about the positive or neagtive impact that it will have on the industry and financial markets.

The purpose of this research is to raise assumptions and ask questions about the evolution of the wealth management industry and particularly the possible strategies that they would need to implement in order to stay competitve.

2. FROM AN ECONOMICAL POINT OF VIEW

First of all, the years following the financial crisis, the financial sector has seen significant changes due to technological developments and hence increased digitalization in many areas. Indeed, changing investor behaviours and needs, forced traditional financial institutions to adjust their services in order to maintain their competitiveness. As a matter of fact, digitalization has impacted the financial industry to the point where some core businesses are going to be replaced. According to the economic forum of Davos (2016), robo-advisors and the Fintech ecosystem could cause the loss of 5 million jobs within the financial industry by 2020. Secondly, in the past investment advisory services used to stongly rely on face-to-face business models which resulted the service to be expensive and were therefore only available for wealthy investors.

It has been a decade now, that digital business models such as robo-advisors are emerging, and are predicted to democratize the industry by making investment management services available to a wider class of investors.Thus, automated investment advice is offering the possibility for clients to invest lower investment minimums in diversified portfolios and at lower cost. Finally, after having experienced a huge success in the United States, asset under management for robo-advisors are predicted to grow significantly over the coming years. Many robo-advisors are willing to access the european market from which they can benefit lower regulatory barriers.

As a consequence, investors, financial institutions, and wealth management companies are seeing themselves challenged by these robo-advisors, meaning that they would need to adapt in order to protect their market shares.

III. RESEARCH QUESTION AND OBJECTIVES

The following research question evaluates how robo-advisors are going to challenge the german wealth managament industry and how they are going to compete among each other.

„Robo-advisors: Opportunity or threat for the german wealth management industry?

This study is based on four main objectives:

- Examining the capabilities and potentials of Robo-advisors in the german wealth management industry
- Evaluating the opportunities and threats from the clients perspective and the wealth managers
- Describing the different strategies robo-advisors could implement in order gain market shares
- Analyzing how partnerships between robo-advisors and wealth managers could be beneficial

IV. STRUCTURE OF THE RESEARCH PROJECT

This study is divided into two main chapters. Regarding the first chapter, it is based on a litterature review which explains the different factors of the evolution of robo-advsiors and Fintechs.

The analysis is focused on the strengths and weaknesses of this upcoming technology among investors and wealth managers.

In this part, we will also focus on the Fintech ecosystem and the regulatory enviroment more precisely, MIFID II European Directive Guidelines.

From this analysis, we will come up with assumptions and hypothesis that will further examine the possible strategies that robo-advisors will need to adopt in order to expand their activities and gain market shares. This part of the study will be based on a german market research of robo-advisors which includes a competition analysis and interviews.

V. LITERATURE REVIEW

1.DEFINITIONOFTHE„ROBO-ADVISORY“CONCEPT

Robo-advisors first appeared during the financial crisis between 2008 and 2010, as part of the emergence of Fintechs (Financial technology), in which the disruptive drivers of technology begun to challenge the financial industry.

Robo-advisors are automated investment solutions offering management of client’s portfolios using algorithms. In contrast to face-to-face investment advisers, robo-advisors interact with their customers through online platforms featuring an advanced customer experience without any or little human interaction (Lieber, 2014).

There are a set of predominant factors that helped the rise of robo-advisors, including tightened international regulations in favor of investors, the tremendous market penetration of smartphones and the popularity of low-margin customers but also high-net-worth customers (Haffenden, 2016).

a) HOW IS A „ROBO-ADVISOR“ OPERATING?

In order to develop investment strategies, firms are collecting and integrating previous historic data of financial markets such as return, volatility, risk, and geographical area to data processing softwares. This collection of data is then processed by computers for the development of algorithms and models based on financial theories. Once the data is processed and the algorithms are set, an investment comittee is supervising the investment strategies and making adaptations if it’s needed (Verschueren, 2016).

The financial theories upon the algorithms and portfolio models are based can be seen as follows:

- Markowitz Model – Portfolio theory (Markowitz, 1952)
- Black-Litterman Model (Black, 1992)
- Efficient Capital Markets Theory
- Sharpe Ratio (Sharpe, 1964)
- Kahneman & Tversky

A.I) ONLINE QUESTIONNAIRES

A clear identification of clients’ individual investment preferences is at the heart of robo-advisory (Deutsche Bank , 2017). In order to determine an investment profile, customers are guided through an online questionnaire in which risk tolerance, and investment objectives are assessed over a time horizon.

The result of this questionnaire¹ determines the choice of the investment portfolio.

These questionnaires include on average a total of five to ten questions.The questions that are asked are mutiple choice questions, and the questionnaire can also include both written and graphical questions to gather coherent results.

The most common questions asked by robo-advisors are those which evaluate the risk tolerance, the time horizon and the loss that can be supported by the investor:

- How old are you ?
- How much money would you like to invest?
- How long are you planning to keep this money invested?
- What is the proportion of your initial investment that can be supported by a loss to expect higher return?

Once the questionnaire is filled out, the software analyzes the answers and personal data of the client in order to suggest the client an adapted portfolio. The suggested portfolios are customized and the asset allocation is optimized to the clients initial objective to expect having highest possible returns.

Furthermore, considering the early MIFID II regulation (section VII), the customer is only allowed to select portfolios that are proposed by the robo-advisor.

Some robo-advisors are featured with different scenarios, most of the time pessimistic and optimistic scenarios with a given pourcentage of chance for the client to archieve his initial objective². Besides, the robo also determines the maximal loss that the client could take if the financial markets are unstable.

A.II) FUNCTIONALITIES OF ROBO-ADVISORS

Althought, all the robo-advisors present different features, they generally offer the following common functionalities:
- Account consolidation : This function of the robo-advisor consists in showing an overall view of the client’s financial situation.
- Deposits and automated tranfers : this type of service allows the client to make financial transactions from one bank to another.
- Portfolio rebalancing : this is the process of automatically selling or buying assets that are underrepresented or overrepresented in the portfolio relative to the strategic allocation of assets.
- Tax loss-harvesting : is the practice of selling an asset that has experienced a loss. By „harvesting“, meaning realizing the loss, investors are able to offset tax on gains and income.
- Reinvestment of the dividends : is a practice that allows the investor to reinvest his dividends by buying new shares of an existing portfolio.
- Presentation of reports : Some robo-advisors are featured with reports which gives the client an analysis of relevant data of his investment.
- Financial planning: this feature assess the investor’s actual financial situation and his future financial situation.
- Presentation of investment scenarios : this method considers the chances of obtaining a certain return and attaining client’s obective, this being possible by analyzing the occurrence of possible events. Genreally, the robo-advisor present three possible investment scenarios including the pessimistic, optimistic and a scenario that has chances to most likely happen.

A.III) ROBO-ADVISORS INVEST IN ETF’S

Implementation of investment strategies follows client investment profile identification (Deutsche Bank , 2017). Indeed, robo-advisors choose specific assets that are compatible with investor’s individual preferences. Among the assets which are available to investors, ETF’s (exchange-traded funds), which have become increasingly popular are offering lucrative features for automated investment strategies (Deutsche Bank , 2017).

All robo-advisors that willl be discussed in this paper invest in ETF’s rather than in individual assets classes.

In fact, ETF’s are securities that typically replicate and track broad market indices from different asset classes, thus representing portfolios of securities.

Investing in ETF’s is a simple and cost efficient diversification strategy, considering that each ETF’s has a level of diversification on it’s own (Adjei, 2009)

As a consequence, robo-advisors adopt a passive investment philosophy, by putting a strong focus on obtaining diversification at a lower cost.

Despite the fact that asset allocation is being operated by the robo-advisor, it is the client who decides to proceed some transactions. This is being possible by providing the client an account on a digital platform, where he can take his own investment decisons.

b) HOW TO CHOOSE THE BEST ROBO-ADVISOR?

As mentionned above, each robo-advsior operates under different functionnalities, that rely on a specific algorithmic model. Consequently, the service provided and the performances differ from one robo-advisor to another.

In the section below, we can find the different factors to take into account before choosing a robo-advisor :

- FEES

The fees charged to the investor generally include an annual advisory fee for the robo-advisor services, besides the expense ratios of the composition of the ETF portfolio.

These different costs are associated with managing and operating the client’s account. The advisory fees and expense ratios are calculated as a percentage of the assets under management. When it comes to the fees there are some

variations among the robo-advisors, we will see in section (X.cii) which presents a comparative analysis of the fees between the different german robo-advisors.

- Minimum Investment required

In general, robo-advisors have lower minimum investment requirements as their traditionals counterparts. The reason behind this, is because they want to attract investor with smaller funds. The minimum required varies among the robo- advisor on the market. In section (Xciii) we will see the different investment required between german robo-advisors.

- Functionalities & types of investment

We have seen in the previous sections that their are similarities among different robo-advisors. The most common functionality among robo-advisors is the allocation of the assets. Before chosing a robo-advisor, the investor has to identify the different functionnalities that the robo-advisor offers and see if it meet his needs and expectations.

Some of the robo-advisors also have the advantage to offset taxes on gain and income (tax-harvesting), while others don’t. Additionnaly, there are some robo- advisors who give the investor the opportunity to invest in individual assets such as stocks, while most of them only offer ETF’s portfolios.

- Level of advice

On one hand there are some robo-advisors which only give investment recommendation and the client has make the transactions on his own.On the other hand, there are some robo-advisors who offer a much higher level ofadvice because they also do the transactions for the client.

- Level of human interaction

In fact, there are different levels of human interaction offered by robo-advsiory services.

On one hand there are firms that provide fully automated robo-advisors to their clients , through their digital platform without any human interaction.On the other hand, there are firms that use robo-advisory technology as a financial tool to enhance the client-adviser relationship. In this case the client can manage his investment individually or interact with his wealth manager through adigital platform.

Overall we can say that the future of wealth management is shifting to a more technological driven relationship, value chain, and process flow limiting the need of human interaction.

c) ADVANTAGES OF ROBO-ADVISORS

The digital revolution presents a big challenge for the finance industry, which changes fundamentally wealth management business model’s.Indeed, the enhanced user experience and low costs structure are making robo-advisors a good alternative compared to traditional investment practices.

This section is first going to analyze the competitive advantage of automated investment advice. The factors described below could be determinant for an investor to invest his money through a robo-advisory platform.

Why do clients value robo-advisory services?

- Simplified client onboarding process

As seen in section (IV.b), the first step of the client onboarding process is going through an online questionnaire. The goal of this questionnaire is to identify the goals and investment preferences of the client.

The client onboarding process is relatively straightforward and less time consuming than face-to-face interviews. Indeed, traditional client onboarding process’s can be time consuming and be a lot of paperwork. In contrast, setting up a robo-advisory account takes less than 15 minutes. Customers can upload their bank account details and can start investing immediately.

Secondly, robo-advisory platforms are offering the investor more flexibility because the client can access his investment settings and priorities online.

Finally, the client doesen’t need to make an appointment with their adviser to make changes to his investment portfolio.

- Low management fees

The latest technology developements in financial services in the last decades has driven down costs for end users in general (Deutsche Bank , 2017).One of their most competitive edge is the low cost level compared to traditional fund managers (Permantier, 2017).

Indeed, robo-advisors invoice services that are on average three to four times lower than tradtional wealth managers. This price difference is due to the fact that there’s no human interaction and therefore no salary to be paid to a wealth manager.

Typically, traditional financial advisors charge on average 1% fee for a 100.000$ investment whereas for similar portfolio robo-advisors charge on average 0,4% with a range of 0,15 to 0,67% (Deutsche Bank , 2017). Moreover, in order to be able to minimize their fees, robo-advisors avoid investment stratregies that require additional costs. This is being possible by trading only ETF’s (Exchange Traded Funds) which have low cost strategies. Indeed, ETF’s are taking a passive investment approach and are therefore less expensive to trade and operationally more efficient to run. Another advantage of trading ETF’s is the fiscal impact, which is lower than for traditional funds. In short, the fee level is defintely animportant factor for clients choosing a robo-advisor and the reducation of average costs have certainly been positive for investors.

- Low minimum investment required

As shown in the previous section, just like traditional investment managers, investing through a robo-advisory platform requires a minimum investment. Nevertheless, the minimum amount that has to be invested with a robo-advisor is in most cases lower than the minimum required with traditional advisors.Indeed, wealth management services are available to high net worth individuals taht invest a minimum of hundreds of thousand dollars whereas robo-advsiors are available upon one thousand dollars and some robo-advisors don’t even require a minimum investment.

- Accessibility

One of the major competitive advantage of robo-advsiors over traditional investment advisers is the accessibility. As shown in the paragraph above, they charge very low management fees compared to traditional advisers and the minimum investment required made it possible to target a larger segement of investors. This investment advisory service is getting demorcratized and available to a larger proportion of the population who are willing to see their money grow.

Despite the fact that they are financially more accessible, robo-advisors are available 24h/7, (Deloitte, 2017). In contrast traditional investment advisers have limited availabilities. That’s why continuous availability is a competitive advantage for robo-advsiors. Indeed, robo-advisory firms offer online services through their platform which can be connected with a smartphone, tablet or on a desktop. Thus, investors can easily create an online account, tranfer funds and start investing wherever they are.

- Efficiency

Another major advantage of robo-advisory platforms, is that they allow investors to eliminate wrong investment habits and decisions, since they allocate the assets by minimizing the risk and optimizing the return of the investment.Indeed, bad investment decisions are being avoided through algorithmic driven models, which take into account historic data. Investment decisions are therefore made with a strategic aspect rather than human aspect. For instance, an investor will invest in a portfolio or a firm in which he believes in and that answers to his preferences. Robo-advisors are therefore eliminating emotional based investement decisions and thus reducing the risk of non-pragmatic decision. Moreover, once the money has been invested it is under depositary bank supervision, meaning that robo-advsiory firms don’t have to care about the management of the funds. Nevertheless, most of robo-advisory firms do the rebalancing themselves to keep an optimal level of diversification of their portfolios. Some of them, are giving their clients the posssibility to reinvest their dividends into another portfolio, making the investment process more efficient.

- User friendliness

Thanks to constant technological evolution, automated investment advice is offering an easy way for investors to invest through a digital platform.Indeed, robo-advisors are been characterized by their readiness and user-friendly platform for investors who would like to invest their money online.In order attract a large proportion of an entire investor community, robo-advisorshave created mobile apps and websites that are user-riendly and therefore easy to use. The objective of these platforms is to attract the investor that’s why it has to be easy to use, and understand. This new user experience is a real competitive advantage for robo-advisors compared to traditional investement advisers who tend to make the investor confused with their lack of clarity and lots of informations. Robo-advisors are in that sense thought to be used for investors who’d like to invest their money in the easiest way possible and avoiding any uncertainities (A.T Kearney , 2015).

Conclusion of the automated advice advantages

As described above, the market is changing rapidly and in favour of the investor. The market has shifted from a product based paradigm to a customer centric approach. That tells us that investors are more willing to invest in financial products that are easy to understand, to use and with a transparent information.

Indeed, the accessibility of financial instruments through digital channels is meeting new investor’s generation expectations and making it more user-friendly. This digital transformation is democratizing the wealth management industry allowing a larger segment of customer to have access to tailored investment advice.

Additionally, robo-advisory services allow new advantages that can’t be met with traditional investment advisers. Among these most important advantages we have a digital solution that enhances the relationship and the interaction with the adviser and the user-experience that makes investment easier to understand.

Automated investment advice is therefore dedicated to a young investor class that have low starting capital and have affinities with digital investment channels. Nevertheless, robo-advisory investment solutions also answers to a demand of an older generation that doesen’t have enough capital to afford a wealth manager. Generally speaking, robo-advisors has been designed for investor who have an affinity with technology and enjoy a digital experience.

d) WEAKNESSES OF ROBO-ADVISORS

Althought robo-advisory services present a lot of advantages, they have been criticised for some reasons. Some of the drawbacks that we will see here after are persuading investors to continue investing ther money with traditional investment advisers.

The disadvanatges of automated advice are described below:

- Lack of human interaction

In the article „Potentials and limitation of virtual advice in wealth management“ (Cocca, 2017), the author raises the question of the importance of human interaction between the adviser and his client. It seems that despite technological advances, there is still a long way to go before we get to a stage where informations systems and robot advisors are able to replicate this kinds of advice that a human being is able to provide (Cocca, 2017).

The author dresses conclusions about virtual advice that present some disadvantages. Indeed, trust can be seen as the quality of the investment advice provided which is a problem in virtual advice environments where advisory is replaced by a machine. „A person seem to still trust a human counterpart more than a machine“ (Cocca, 2017).

In interaction, the machine is far from able to replicate the subtle and varied communication and interaction patterns of a person“ (Cocca, 2017).Moreover, it has been stated that the more wealthier and older the person, the more important the human interaction is.

A survey conducted through this study shows that private banking customers are open minded in terms of the use of online financial services, but personal contact with their client adviser is just as important to them (Cocca, 2017).„For a majority of the customers, there is no question of the use of a pure online services offering.“ (Cocca, 2017).

- Lack of flexibility

Most of robo-advisory platforms monitor the whole investment process.Once the money has been transfered and invested in a portfolio, robo-advisors monitors the asset allocation, rebalancing and reinvestement of eventual dividends into a new portfolio. When it comes to Exchange Funds Traded (ETF’s), they are also characterized by low flexibility because they can’t be chosen personally by the investor. As a result, this lack of flexibility doesen’t suit to a wealthy investor who expects his investment to be tailored and personalized.

Finally, robo-advisors are not flexible regarding investors who present othertypes of needs over longer investement horizon. Indeed, portfolios are rebalanced at specific deadlines, thus if the investor wants to withdraw funds from his investment he is generally going to pay an extra fee. This being not the case fortraditional investment advisers who are more flexible when it comes to changing customer’s objectives and needs.

- Weak assessment of investment customer’s preferences and risk tolerence

Another limit that can be discussed is the quality of the online risk tolerance questionnaires, which is at the heart of robo-advisory client discovery process. Indeed, risk tolerance questionnaires practiced by robo-advisors can be critized because they do not get to the heart of understanding the entirety of an investor financial needs and goals (Cocca, 2017). Indeed, the applied algorithms and risk assessement seem to be rather simplistic in some cases.

For instance, robo-advisors pose on average around ten questions but only 60% of questions actually have an impact of risk categorization (Scholz, 2016).Hence, Huxley and Kim (2016) are raising the question if robo-advisors questionnaires are reliable, accurate and valid from a psychometric point of view (Tertilt, 2018).

Conclusion of automated advice weaknesses

The disadvantages described above are typically influencing the final customer to invest his money through a robo-advisory platform.

Among the arguments that do not play in favour of automated advice we have:

- If investors want to make active changes of their asset allocation
- If investors expect financial planning and additional advice through human
interaction
- Investors who are more wealthy and need tailored and customized advice
- Investors who are willing to combine passive and active investement with
Exchange Traded Funds and individual class of assets.

Even if automated advice presents some disadvantages for a certain class of investors, technological advances will over time reduce the gap in order to satisfy wealthier investors. Considering its initial stage and huge potential, weaknessesof robo-advisory services can be considered as temporary.

VI. FACTORS DRIVING THE EVOLUTION OF THE WEALTH MANAGEMENT INDUSTRY

a) TRENDS OF THE WEALTH MANAGEMENT INDUSTRY

A.I)DEMOGRAPHICAL CHANGES

There are three major demographic shifts that will impact the wealth management industry during the next decade : rising life-expectancy, aging advisors and transfer of wealth from baby-boomers to their children.

Life expectancy & retirement

Life expectancy from the so called „Baby-boomers“ born between 1945 and 1975 has grown in developed countries from OECD.

As a result, this generation is facing a real need for saving their earnings becauseof the rising health care costs and their current expenditures as their living longer. That’s why this group of the population might invest their money through an automated investment adviser as they’d like to keep the same living standards after getting retired. Althought, this trend is more likely for robo-advisors which are located in North America because of the pension system, rather than in european countries where the pension system which is slightly different.

Considering the need of a pension plan, baby-boomers remain a good target for automated investment companies. Generally speaking, with ageing demographics, pension plans are entering in a run-off phase.

In Europe for instance, 30% of pension plans have negative cash flows, meaning that there’s more money paid out in retirement benefits, than money receieved from member’s contribution (Dassault Systems , 2017).

As a consequence, a new generation of investors called the „Millenials“ are likely to emerge and become the biggest investor group over the 15 years.

Inter-generational transfer of wealth

According to a study made by Dassault Sytems (Dassault Systems , 2017) the potential inter-generational transfer of wealth is estimated to 15$ trillion in the U.S and 12$ trillion in Europe by 2020.

Historically, wealth transfer from one generation to another have resulted to a 90% changing advisors which represents an opportunity and a threat for the wealth management industry. It has been recommended that wealth management firms must build multi-generational relationships with their clients if they’d like to meet the expectations of their new clients.

The aging advisor population

The advisor population is aging and is rapidly preaparing for a significant transition. For instance, 43% of US financial advisers are over the age of 55 years, which means that the industry is expecting one third of its workforce to be retire in the next 10 years. That’s why the wealth management will need to recruit 240000 advisers to maintain their current service levels.

Actually, the aging advisers phenomena is creating two main challenenges to the industry.

First, there is a growing generational gap betwen the advisers and the future investors which makes it difficult to understand and adjust to the needs and preferences of a younger generation, resulting in a weakened client-adviser relationship (Deloitte , 2015).

Secondly, many advisers have faced slow adaption to the new tools such as mobile channels and, thus to evolve to a balance between human and technology based advice.

A.II) MILLENIALS AND THEIR CHANGING INVESTMENT BEHAVIOURS

Who are the clients of these robo-advisory firms?

The clients of these robo-advisors are typically Millenials aged between 24 and 35 years. This young generation of investors are characterized by their quick adaptation to new technologies, they prefer self-service approaches and are therefore considered as initial users. Considering that there’s a growing demand for this connected investment advice services which is getting very popular for this new generation of investors. During the early years of robo-advisory between 2013 and 2014, almost 50% of its clients were millenials. Actually there is limited information about European robo-advisory client demoghraphics. In Germany for instance, there are estimates that client are on average 40 years old and have a monthly net income of 4000€ and are university graduates. Furthermore, it has been shown that more educated clients use robo-advisors more often than less educated clients.

Changing investment behaviours

For this section we based our reflexion on an report published by Deloitte (Deloitte , 2015) who tackles the ten disruptive trends of wealth management industry.As called in this report, the „re-wired“ investor is referred as an investor who can be associated with new thinking patterns, standards, and expectations.

This class of investors include the generation X and Y but also the baby-boomers. For instance, this generation of investors doesen’t want to be treated as part of a segement but instead as unique individuals. Indeed, they’d like to be serviced according to their specific goals and preferences that’s why they expect to receive tailored investment advice (Deloitte, 2017). Meanwhile, they want to stay in control of their financial situation, understand the advice they receive and make their decisions themselves.

This category of investors expect to be able to access advice anywhere and at any time, this being possible with digital channels.

The rewired investor is perceiving risk as a downside more than volatility. Therefore, advisers have had to emphasize capital markets and hedge strategies that seek downside protection.

Another changing investment behaviour is related to the fact that these upcoming generation of investors feel entitled to the same investment products and strategies than High Net Worth Investors (HNWI).

This is forcing financial institutions to think through new ways to give their retail clients alternative investments and new assets classes.

Loss of trust

Fundamentally, the relationship between the investor and its adviser is based on trust. However, the financial crisis in 2008 has generated a loss of trust from the investor toward the financial markets and more precisely investment advisers. Additionnally, clients enjoy new ways of investing their money and expect an enhanced client experience. These new expectations reflect the need for the investor to be involved in the investment process and to have control over his investments.

Finally, investors consider transparency of fees and performance as determinant factors of trust. Indeed, they expect more than just quartly performance reports summarizing their financial situation.

A.III) TECHNOLOGICAL CHANGES

During the recent years, the smartphone wave has certainly changed the interaction between people and their bank. A majority of these interaction is made through internet, mobile banking applications, social media and less human interaction.

This can be explained by the fact that Millenials generation feels even more confortable as they have been growing with digital tools (Cocca, 2017).

It has been explained that this younger generation has a lot of affinities with the use of social medias. As the use of social medias are increasing investor’s communities started to emerge. These investors communities are sharing investment informations and their tips for better investment decisions. As techology plays an important role for this new class of investors who want transparent information anywhere and at anytime. A survey made by Ernst & Young states that 59% of future investors within three years will be using mobile apps or internet websites to interact with their banks (Ernst & Young, 2015).

Moreover, Big Data and Cloud technologies are also part of the major technological changes that play an important role in the investment universe. As volumes of data continue to grow exponentially, for instance in 2012 2.8 zettabyte were created and in 2020 this figure is expected to grow to 40 zettabyte.

As a result, Big Data is about is revolutionize the whole industry, with leading wealth management firms who are continiously investing in advanced data analytics and data management. Indeed, nowadays most of wealth management firms use simplified analytics to deliver business value but in the future we expected to see firms use more descriptive and predictive analytics that will combine all kinds of data.

These technological transformation presents several advantages, for instance, this will allow firms to acquire new clients, to assess their investment preferences and risk tolerance. As a result, most of the core processes will be impacted by data analytics for instance, client acquisition, sales, client retention, client advice and business performance management (Deloitte , 2015). On the other hand cloud systems are going to differentiate thanks to their operational and cost efficiency.

A.IV) CHANGING INVESTMENT ENVIRONMENT

The financial crisis of 2008 has changed the investment environement for both the investor and wealth managers in different ways. Indeed, the investment landscape has experienced three lows and two highs (Deloitte , 2015). On one hand, low interest rates, inflation rates and slow economic growth have made it difficult for investors to generate high returns on their investments. On the other hand, financial markets have been challenged by high volatility and high levels of financial leverage. As a result, investors have less sense of direction that they use to have because of an uncertain financial climate over the industry.

Conclusion of the wealth management industry trends

The wealth management industry is facing a time of significant change and disruption. New forms of advice and new ways to deliver that advice are emerging. That’s why, competition postion will erode by creating loosers and winners across the industry while mass affluent investors will be likely to benefit from all the changes across the industry, wealth management firms will have to adapt strategically to these dynamic shifts.

VII.ROBO ADVISORS FROM AREGULATORY POINT OF VIEW

1) MIFID II AND ITS IMPLICATIONS

In general, the regulatory envionment for financial institutions has become increasingly strict following the financial crisis. Since the 2008 financial crisis, new reglations have been introduced addressing various segments and business models. Previously, the Markets in Financial Instruments Directive (MIFID I) has had a large regulatory impact on wealth management and asset management activities in recent years.

Considering the financial crisis, MIFID II was build to create more transparency and strenghten investor protection. Indeed, the revised regulation (MIFID II) aims to address updates of the original MIFID I regulation release and is taking into account the lesson learned during the financial crisis.

MIFID II has come into force on January 3rd 2018 and the areas that will have an regulatory impact on the wealth management industry include, fees (inducements), cost disclosure, product governance and research commissions.

As we ill see it in this following section these new rules have been set to change business models in the investment industry.

For the time being, there isn’t any specific european regulation dedicated to robo- advisory and Fintech companies. However, rules about investment advice have been implemented before the arrival of Fintech companies.

Moreover, since there isn’t a general european directive that dictates these firms, and that they are operating under different business models, each country has the duty to protect the investor.

In Europe, there are three main entities that supervise the finance industry, among them we have the European Securities and Markets Authority³, European Banking Autorithy⁴ and European Pension and Occupational Pensions Authority⁵.

As there has been a massive arrival of Fintech firms in the early years 2000, these authorities started to get interested about the impact of digitalization of the banking industry.

First of all, ESA’s institutions has identified some potential risks and opportunities for automated investment advice in order to evaluate if any regulatory or supervisory action was required. On december 2015 the three Supervisory Authorities ESMA, EBA and EIOPA published a discussion paper on automation on financial Advice⁶. The paper that has been published by ESA’s is divided in four parts. The first part describes the characteristics of automated advice.

The second part is focused on the advantages, and the third part of the potential risk of automated advice. Finally, the last part screens the evolution of financial automated advice and its impact on the financial industry. Each part raises open questions⁷ addressed to stakeholders. Once the questions are anwered by the different stakeholders, ESA entity will assess the given feedback in order to decide if supervisory measures are needed.

If the financial market authorities decide that supervisory rules are necessary, they would need to comply with the following general principles (European Banking Institute , 2017).

- Express a neutral position regarding technological financial evolution in order to promote fair competition between new entrants and traditional players. However, a neutral postion should be applied only if, financial innovation doesen’t bring potential risks or doesn’t intensify existing risks.That’s why regulators should pay attention that risks are well monitored and assessed in order to have control over the developement of these new entrants within the financial industry.
- Rugulators should avoid to implement specific rules according to the different business models among new entrants. Indeed, it is recommended to implement general rules that apply to any technological firm rather than specific rules that apply to single players. The aim of implementing general rules rather than specific onces, is to avoid any segmentation among financial technological firms.
- Regulators should base their approach on the existing regulatory context, which is based on risk assessement. Indeed, the risk dimension should be analyzed from the Fintech rather than the technology itself. These risks can be either related to cybersecurity or to customer protection.
- Additionally, Fintech start-ups are often suject to liquidity and solvency risks that should be taken into account. Finally, any digital innovation risk should also be assessed by ESA’s.

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¹ Appendice 1 Birdee Money Experts Questionnaire

² Appendice 2 Birdee Money Experts Dynamic Portfolio Projection

³ ESMA

⁴ EBA

⁵ EIOPA

⁶ https://www.esma.europa.eu/sites/default/files/library/jc_2015_080_discussio n_paper_on_automation_in_financial_advice.pdf

⁷ Appendice 3 : Questionnaire from the Joint Committee on automation in financial advice (ESAs)