Robotization and Investment Advice

Robot Hands
Written by Thomas E. Quinn, CFA, CPA on November 5, 2015

Earlier this year, we wrote a blog titled “Gurus vs. Algorithms.”  Briefly, this was a man versus machine article.  In this study, the academicians concluded that the machines were more often correct but that the humans were not buying it.  Humans preferred the wisdom of other humans, even when shown proof that computer algorithms had a much higher likelihood of success.

Robotization of portfolio management and the crafting of investment articles for the financial services industry is a relatively new phenomenon.  Rather than man versus machine, here we have man partnering with machines to create competitive services at a dramatically lower cost.  Once again buyers of these automated financial services are significantly more trusting of a personal relationship with one of their own than with a black box.  However, the decision to use the lower cost, machine-generated product is not made by and may not be disclosed to the ultimate consumer.

How is “robotization” changing the investment landscape? Is it a good development or an unwelcome one, for providers and/or clients? There is of course no simple answer, but technology properly developed and used is vital to success. We provide our brief assessment here.

The Adroit Adviser

Robo-Advisers are emerging to manage client portfolios without human intervention.  A typical Robo-Adviser will require very few initial inputs and will create and manage an investor’s portfolio from startup until forever.  This management can be done by the machine at a significantly lower cost than the traditional adviser.  There are a number of firms offering this mechanized portfolio management product – Charles Schwab, Betterment, WealthFront, WiseBanyan, FutureAdvisor, Bloom, Motif Investing, etc.   

The distrust by individual investors for using a Robo-Adviser appears to be even more severe than the distrust suggested in our previous blog “Gurus vs. Algorithms.”  In a survey by Spectrem, this new Robo-Adviser technology was acceptable to only 4% of investors over 65 and really not that much better for younger investors, 17% for 35 and under.  However, the acceptance of the technology increases dramatically when it includes a relationship with an adviser with a pulse.  Robo-Adviser and impersonal technology in general appears to be perfectly acceptable when there is a trusted relationship serving as an intermediary.

Once again, this strong preference for humans over machines is not surprising and has implications for the industry.  Working by themselves, we do not believe that a meaningful number of individual investors will be attracted to one of the Robo-Adviser products in the near future.  However, many investment advisory firms focused on high net worth (HNW) investors have been and, we expect, will continue to use these products.

The opportunity for the HNW investment adviser is to dramatically reduce their costs.  Unless the adviser is a market timer or asset class rotator, essentially no investment research group would be needed and those data and personnel costs can be eliminated.  These low cost tools will produce market-like performance and free up the senior adviser’s time to bond with and advise their clients.  In most cases, the end client may not even be aware that a Robo-Adviser is being used by the investment firm … and if they became aware, would probably not be concerned.

With this new technology, the current investment industry bifurcation between HNW and institutional advisory firms will probably increase.  HNW firms succeed on client trust; institutional firms’ success is based on investment performance.  Since institutional firms will continue to focus on research and the creation of above-market returns for their clients, we are doubtful that the Robo-Adviser will emerge as a significant factor in this segment. 

The Articulate Analyst

In recent years, there has also been a growing utilization of Robo-Analysts.  Surprisingly, many Wall Street analyst reports are now being written by machines.  These include reports about company earnings, mutual fund results, product descriptions, market results, etc.  These factual articles are being issued from major corporations like Allstate, Associated Press, Credit Suisse, T. Rowe Price, American Century and Yahoo! Inc.

The buyers/consumers of these reports seldom know that they were written by a Robo-Analyst.  The technology is amazing.  The writings are becoming increasingly accurate and sophisticated.  And of course the difference in the speed and cost savings for these producing companies is dramatic. 

What heights can the Robo-Analyst eventually achieve?  Currently the mechanical analysts are assembling huge amounts of data, organizing/structuring the information, and regurgitating well formatted and reasonably written reports.  The reports certainly do not advance relevant research and analytical thoughts.  The Robo-Analyst can apply certain logic, but converting common sense, sight, dexterity and serious exception processing into computer code is another matter.

Certainly, additional major advances beyond the logically crafted presentation of raw data is difficult to imagine.  But just a few years ago, who imagined driverless cars and trucks.  We expect the speed and sophistication of Robotization to continue to evolve. 

Technology at CornerCap

Except for the cost of our professionals, technology is and will continue to be our most significant cost.  As a firm, we invest substantially in proprietary technology to support our research (e.g, “Fundametrics®), portfolio management (e.g., the “Optimizer”), and client service (e.g., our online portal). We have the same number of employees now that we did with half the assets under management a few years ago.  Our goal with technology is not to replace employees but rather to make all of us more productive as we create increasingly higher quality products and services.

CornerCap Robo-Plus

At CornerCap, our mantra is to provide: “Institutional Investment Research with Boutique Client Service”.  This internal truism means that we seek to achieve the high research and performance expectations demanded by the institutional investment market in addition to the high service and trust expectations demanded by the high net worth market.  This goal is difficult and expensive.  We feel that we have achieved this goal through our early adoption of technology … or customized Robotization.

Our institutional investment credentials started around 36 years ago as the in-house investment advisers for RJ Reynolds in Winston-Salem, NC.  Because of our engineering and systems backgrounds, we started the design, programming and testing of Fundametrics®.  The intended original purpose was to calculate and measure the weekly relative success (or failure) of a variety of equity valuation formulas over a very large stock universe.  If we hired an equity manager at RJR that sold their services based on a specific investment discipline, such as value, growth, momentum, income or whatever, we would use our Fundametrics® research to provide an early alert should the manager start to depart from their discipline.  As RJR senior management noted the success of our research, the primary purpose of our Fundametrics® research was changed to terminating selected outside advisers and transitioning those pension assets to in-house management … better returns at a lower cost.  We might label our Fundametrics® equity research process as our CornerCap Robo-Plus Analyst.

Our boutique client service credentials started 26 years ago when we transitioned out of RJR Nabisco and began growing CornerCap.  Rather than one huge client with RJR, we now have over 300 clients.  While our founding culture was institutional research, over this post-RJR period we have built a staff committed to service above self.  Just like research, this culture takes time and money.  Fortunately, we have always maintained our significant investment in technology and building custom applications.  In the late 1990s we built the CornerCap Optimizer, and like Fundametrics®, we have continued to enhance the software over numerous generations.  The Optimizer is a custom portfolio management tool that incorporates client objectives, constraints, research department recommendations, rebalancing, risk controls, tax efficiencies, etc. It allows the human Portfolio Manager to make customized decisions efficiently and consistently across all client accounts in keeping with each client's unique guidelines. We might label the Optimizer process as our CornerCap Robo-Plus Adviser.

The Bottom Line

Technology clearly plays an important role in improving efficiency and accuracy in investment research and service delivery. We have done our best over our 30 years as a firm to properly invest in software and programming resources to provide “best in class” capabilities for our clients. The goal should always be to create accurate, repeatable, and dependable implementation of our decisions on behalf of clients.

Our industry is in the early stages of “Robo-Advisers” and “Robo-Analysts.” We fully expect them to play a role in our industry, although we expect fits and starts as the industry learns how to rely on them.

The most important feature of our Robo-Plus software is that we built them to our custom specifications; we continually enhance them based on our analysis of research and client needs; and we have sophisticated professionals on our staff who engineered, understand and are committed to improving the process.  The CornerCap Robo-Plus is not a black box.  These are simply tools that make us more effective with research and more efficient with service.

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