The emergence of robo-advisors and AI in ETFs is gaining steam, and how those products are being used and developed is being scrutinized by the financial industry and regulators alike, said participants at the ETFs Global Markets Roundtable held in London last week.
Robos aren’t often about investing, rather they are a bit like the “Wikipedia” for investors seeking to get informed, said Deborah Fuhr, co-founder and managing partner of ETFGI, the consulting and research firm that hosts the events.
“Many go to robos to understand the terms, a bit about asset allocation, about risk profiling. But most will not invest without talking to someone,” she said.
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The real opportunity, she added, is in a hybrid model like that in the US, which firms like Charles Schwab and Vanguard have benefited from.
Smaller robo-advisors that are emerging to compete are disadvantaged, Fuhr added, particularly as the cost of client acquisition is some $1,500.
“None of the robos are really yet quite profitable. It’s going to be a challenge for those that come from a technology background as opposed to banking, where you have access to clients,” she said.
Moreover, this form of advisory is likely to be the next route for regulators to look at, said Tara O’Reilly, a partner at law firm Arthur Cox based in Ireland.
“Regulators believe that robo-advisors are a democratic way for investors to access cost accessible investment advice,” O’Reilly said. “But as the growth of access continues, then that will mean it’s another area of focus for regulators.”
Regulators are already engaging with robo-startups to scrutinize their model to identify risks and challenges: do they deliver cost and meet investor expectations? Do they use their buying power to actually benefit the consumer, or are they so vertically integrated that there’s a conflict in terms of how services are provided?
“As we see that technology impact, you will see more focus from regulators,” said O’Reilly.
In the future, will there be an ETF of you?
Exposure to AI
One of the latest areas of technology impact on the ETF industry is from the advance of artificial intelligence and machine learning, which manifests itself in very different ways across the sector.
On one side, are the kinds of ETFs that select companies with exposure to advanced technologies, for example, L&G ROBO Global Robotics and Automation GO UCITS ETF, which has some $1.3 billion in AuM.
It’s returned 3% year to date, and 34% year over year as of 22 April 2018, according to LGIM data.
“We started off identifying an area that we wanted to create an investment for, and robotics and automation was clearly going to be one of the key drivers into how our society is going to look different in the future,” said Howard Li, head of ETFs for LGIM, speaking to MarketBrains.
LGIM is not, however, an expert on robots and AI, so to select the right companies for the index the buy-side firm takes an active research approach.
That means working with ROBO Global and its strategic board comprised of AI advisors, academics and entrepreneurs with clout in the sector.
“We are not just trying to identify investments based on some sort of traditional investment filter: it’s: understand the technologies, understand the companies, understand what they do, the ecosystem it works in, and then put together that kind of portfolio,” said Li.
ROBO Global has a database of about 1,000 companies, many of which are private. The universe of listed companies is then taken by ROBO Global and investment filters are applied to make the index investable and scalable, Li explained
This also means that it’s not like traditional tech stock indexes, in which the usual suspects — Facebook, Amazon, Netflix — are almost always included, he added.
“From a portfolio perspective, (ROBO Global has) got companies that are healthcare, and energy, in logistics, so quite a cross-section,” said Li. “If there’s some pressure on traditional technology stocks, this is actually a portfolio that’s quite diversified.”
“With all this data, can it be more personalized? The answer to that is yes.”
A far more controversial aspect of advanced technologies in the ETF industry is how AI is affecting the financial sector specifically: will machines be able to populate an index better than humans?
Artificial intelligence is able to capture all the data that humans simply don’t have time to read, and with processing power understand the relationships between this information, Li explained.
“I increasingly see data as a currency. Data is power (and) the more information that you have, the better capacity you might have,” he said. “But if you have all this information and you don’t know what to do with it, then it’s of no use to anybody.”
Machines will help filter out the noise and make sense of vast quantities of data so that it’s consumable, and then humans will be able to work with it: “It’s going to shift the industry, but it’s not going to replace humans in the industry,” Li noted.
Future of AI in ETFs
As products continue to innovate, Li predicts that there will be more strategies getting packaged as ETFs: hedge-fund like, factor and multi-asset strategies, for examples.
At the same time, educating the end investor needs to improve as well: “We can come up with these perfect strategies that we think solves a problem, but if we can’t explain them and we can’t explain both the benefits and the risks to the end investor, that’s of no use.”
In a previous interview, MarketBrains spoke to one of the biggest European robo-advisors, Scalable Capital, and one of their future outlooks was excitement over whether technology could create portfolios that would be tailored to the individual.
So, will there be an ETF of you? Could wearable tech and your computer activity make you a tradeable investable index?
Li said: “With all this data, can it be more personalized? The answer to that is yes.”
“But will computers be able to process all the information to know my life choices? It depends on how much we as humans are willing to interact with them, I don’t think it’s impossible.”
The next ETF Global Market Roundtable is in New York on May 15 for US and Latin America, which will host Virtu Financial and Invesco PowerShares. See the agenda and register here.