Investment advisers have a fiduciary duty to act in the clients' best interests. As it applies to the robo-advisers now on the scene, I don't think the technology has advanced to the point that they care enough to reliably serve clients' best interests.
I'm not talking about having an empathetic robot that can master the art of holding a client's hand during a down market. I'm talking about whether the science of algorithmic decision-making is sufficiently mature to fulfill the second of the twin fiduciary duties of loyalty and care.
Most if not all of the startup firms are RIAs and therefore investment fiduciaries. They also routinely tout their ability to act in clients' best interests. Therefore, the presumption is that they must have the duties of loyalty and care covered.
Loyalty, which centers on conflicts of interest, currently receives most of the media and regulatory attention. The robos have a natural advantage in this regard because they circumvent conflicts associated with the compensation arrangements of human advisers.
PROFESSIONAL COMPETENCE
The duty of care may not share the limelight with the duty of loyalty, but it is no less important. A fiduciary, even a virtual adviser, must meet the “prudent man” rule, which essentially requires professional-grade competence. Here again, automation has at least one advantage. It can reliably perform routine or time-specific functions. For example, given statistics that only about half of all live human advisers have rebalancing software, robos are way ahead of the game in this aspect of the duty of care.
As
Wealthfront Chief Executive Adam Nash argued recently in an interview, “Computers are completely rational, and they have nothing else to do. This service in the cloud will watch your account 24/7.” Certainly, in terms of monitoring and rebalancing, a computer is tireless.
But the duty of due care demands more than managing the routine. The question is, can robos deliver sufficiently sophisticated professional expertise to serve clients' best interests in complex situations?
To get a sense of how robo-advisers stack up with regard to due care, we decided to take a look at four of them:
Betterment, Financial Engines, Financial Guard and Vanguard. We found their approaches to be spotty, particularly with respect to data collection and analysis of other assets and liabilities, and risk tolerance — all key components of a duty of due care. Beyond the investible assets, only one robo (Financial Engines) asked about other income and none asked about existing debt or overall net worth.
With regard to an investor's risk tolerance, the robos offered no more than a couple of cursory questions. One provided two choices for determining risk tolerance, based on age or “your attitudes toward risk.” In clicking on the latter option, the investor is given four pie charts with progressively more aggressive portfolios from which to choose. In clicking on each pie, historical performance for the last 10 years, including best and worst years, are displayed. The second and final question asked about short-term market expectations, even though the robo-adviser warned that investing with a long-term perspective was recommended. The five options ranged from “very pessimistic” to “very optimistic” about the market “in the short term.” If you agreed with the recommended option, the middle option, it meant you are “happy with the current recommended allocation,” or “I just don't know for sure.” This falls well short of trying to understand how clients are going to react to the ebbs and flows of managing a portfolio.
MANY OPTIONS
One website (Betterment) provided options for retirement planning,
financial planning, IRAs (which one might assume would be part of retirement planning),
trust services and tax harvesting services. If you click on IRAs, a “Do a 60-Second Rollover” link pops up. Curiously, the firm's Form ADV checked only the box for
portfolio management services, not
financial planning as suggested by these options.
In summary, I question whether the robos of today truly can claim to fulfill the duty of due care. Even in a narrow scope of engagement, such as saving for college, serving the client's best interests is dependent upon understanding the particular facts and circumstances involved. Open-ended questions and the ability to probe for details can be critical to that understanding.
While automation may mean that the robos have nothing better to do than churn out work, the work they do may not be enough to displace the need for a prudent professional at the controls. Human advisers are most in demand in complex situations where the stakes are highest.
Blaine F. Aikin is president and chief executive of fi360 Inc.
