• It is important to understand the underlying assets that a robo is buying because it influences the fees being paid
• Transparency is key. Make sure the robo is clear about its fees; who designed the algorithm; why it works; where the money is custodied and what happens if the robo goes under
• Ned Phillips, founder and CEO of Bambu, believes believes robo-advisors are not about a secret algorithm

Unfortunately for us all, humans are prone to poor decision making. Gullibility, overconfidence, or even plain old mood swings can affect the choices we make. From buying a stock on a rumour, or selling in sheer panic, these shortcomings have led to the birth of robo-advisors.

And there can be no doubt that robo-advisors are taking off around the world. Assets under management at these robos are expected to more than quadruple to $2.2 trillion in 2020 from $500 billion this year, according to a report by KPMG in December.

"The pace at which changes are coming about are much more rapid than online broking or other parts of financial services," says Julian Le Noble, co-founder of Smartfolios, a business-to-business (B2B) player providing digital investment platforms for financial institutions, at The Asian Banker’s The Future of Finance Summit. "In Asia the opportunity size is immense and the cycle to bring the solution to market is much shorter."

Compared to the millions that one would have to hold at a private bank, robos usually have a low or minimum balance and charge fees of less than 1% next to the 2% or 3% that traditional advisors in Asia charge.

Due diligence

While it all sounds attractive, it is important that investors do their due diligence. And surprisingly, or not, it is not as intuitive or as simple as one would hope.

One difficulty in choosing a robo is that they take all sorts of shapes and sizes, from what the underlying assets are to the algorithm being used.

Many robos including Singapore’s Stashaway that was launched last month, purely invests in exchange-traded funds. Others such as India’s RoboAdviso, invests in mutual funds.

And Singapore-based Crossbridge Capital, which caters to accredited investors, utilise exchange-traded funds (ETFs) to represent a certain asset class but once the asset class gets to critical mass they replace the ETFs with individual securities.

It is imperative to understand the underlying assets that a robo is buying because it can influence the fees being paid.

Charlie O’Flaherty, head of digital strategy and distribution at Crossbridge, says the rationale behind his company’s strategy "is to eliminate the redundant or "stacked fees” of the ETFs as well as in-built tracking error that they carry."

Generation game

Many in the industry also tend to categorise robos into first generation and second generation. Early pioneers in the industry such as Betterment and Wealthfront, both based in the US, use algorithms based on Modern Portfolio Theory.

This Noble prize-winning hypothesis published by Harry Markowitz in the Journal of Finance in 1952 is a mathematical framework for assembling a portfolio of assets such that the expected return is maximised for a given level of risk.

Second generation models, however, including Singapore’s Stashaway, goes beyond the Modern Portfolio Theory framework.

"Our economic-regime based asset allocation framework (ERAA) is way more sophisticated than what is currently available in the market," says Michele Ferrario, co-founder and CEO at Stashaway." Unlike pure Modern Portfolio Theory, ERAA takes into account the impact of economic cycles' on returns, volatility of asset classes and adjusts for mid-term valuation gaps."

Yet for the layman, trying to decipher between algorithms based on modern portfolio theory or not is troublesome and time-consuming. Hence, some proponents of robos say that level of detail while choosing may not be required, especially for a retail investor.

''Many robos don't share information about their algorithms and I think as a retail investor it's not necessary to understand the algorithm behind it," says Tanmai Sharma, CEO and founder of Mesitis, which makes Canopy.

Better invested than not

For retail investors, O’Flaherty at Crossbridge says that the biggest benefit is just getting people invested in the first place.

"There’s no reason to be all in cash and it's an incentive for people to save," says Crossbridge’s O’Flaherty. "In the long term, people are always better invested than not. Average investors aren’t typically keen on studying markets and their portfolio and deciding what to invest in, so in a way robos are taking away a lot of that pain of investing."

Ned Phillips, founder and CEO of Bambu, a B2B robo-advisor firm, believes there’s no secret algorithm.

"It’s about which one is easier to use,’’ he says. "Which one understands you? And do you like the interface?"

The beauty about robo-advisory is that it is goal-oriented, whether it is buying a new car or saving for retirement, the first questions that most robos ask is what you want to get out of it.

"Nobody wakes up one morning and says `oh wow, I really want to buy a balanced portfolio today’," continues Phillips. "But people do get up and say – oh I wish we had a bigger house. Or I wish my kids could attend a different school. It’s about goals."

Transparency is a key factor while shopping for robos. Is the company clear about the fees you will have to pay; on who designed the algorithm; why it works (even though you may not understand it); where the money is custodied; and what happens to your money if the company goes under? It’s important that these answers are upfront and easy to navigate to.

Robo-advisors definitely do make investing easier, but make no mistake, there are inherent risks involved. Yet in this low-interest environment there is no reason for savings to be kept in cash so doing the research could pay up in the end. In the past, the people with the least money had the least knowledge and got the least service but with robo-advisors the playing field has been levelled slightly and that is no small feat.