Not all Robo Advice propositions are equal

Not all Robo Advice propositions are equal
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From Arnold Schwarzenegger’s original iconic Terminator to HAL, the malevolent computer in Stanley Kubrick’s 2001: A Space Odyssey, much of popular science fiction has depicted robots and machines as bloodthirsty creatures engaged in world domination and wanton destruction. Why then, with such inauspicious credentials, would anyone be prepared to undertake robo-advice and put the future of their life savings in the hands of a computer algorithm?

The rise of robo-advice

The truth is that robo-advice, where computers aim to mimic human financial advisers, is on the rise in the UK following the US example where many big names have entered the market, either through acquisitions or by building their own robo-advice propositions.

Critically, the main issue facing such propositions lies in ensuring that the algorithms and asset models underlying such processes are fit for purpose.

Fit for purpose modelling

Although the idea of robo-advice in the UK may be new, the use of computers to generate forecasts of individuals’ future financial positions has been around for decades.

But, with robo-advice comes a completely new world where advisers are, primarily, no longer required to take part in the advice process. In such circumstances, it is more important than ever that compliant advice processes are in place which provide individuals with financial forecasts that are as realistic as possible. This will not only help individuals to understand the potential range of outcomes from different financial strategies, but will also allow them to make informed decisions which will directly impact their future wealth and lifestyle.

But how can this be achieved effectively and compliantly in practice?

eValue’s Insight Asset Model

Successful and compliant robo-advice processes not only need to be well designed, in order to engage consumers, but the underlying asset model used for the financial planning must be fit for purpose and result in realistic future outcomes that are both suitable and reliable.

At the heart of eValue’s solution lies a reliable, robust and market-leading stochastic asset model. By coupling this with innovative design and gamification techniques, eValue’s robo-advice solution not only enhances the user experience but also aids consumer understanding. Recommendations are provided to consumers in the form of a suitability report and vital management information is collated for compliance monitoring.

Real world model

eValue’s Insight asset model is a real world Economic Scenario Generator (ESG) model this means that asset classes which have a higher expected volatility, generally have a higher expected return. This approach can produce realistic forecasts of possible future investment returns enabling investment risk and return to be communicated more effectively. Not only does eValue’s asset model aim to help consumers understand the risks they are taking on over different timescales, it also enables them to have realistic expectations about the outcomes that may be achieved and make sensible and suitable decisions about the investment opportunities that are available to them.

Interest rates and future income

When interest rates increase, the future expectations for cash and bond returns also rise, at the cost of capital losses in the short term on bonds. Other asset classes have some dependency on interest rates too. In addition, the relative strengths of different currencies are also linked to interest rates which determine the market expectations of future exchange rates.

To be fit for purpose, an asset model needs to provide a realistic view of the potential evolution of interest rates over the long term. However, in this time of low interest rates, not all ESG models are currently realistic. eValue, on the other hand, has undertaken a considerable amount of research and effort to improve its own Insight asset model to take account of the current low yield environment and provide credible forecasts.

Inflation

For robo-advice propositions to be effective, individuals need to be able to relate the outcomes from an asset model to their investment goals. In order to do this, investment forecasts need to take account of inflation. Telling someone that £10,000 invested for 20 years could give then £25,000 may sound great but misses the point that £25,000 would only buy £15,000 worth of goods at today’s prices.

Therefore, in order to be fit for purpose, asset models need inflation to be coherently linked to the asset returns and other factors within the forecast. For example, when asset returns are generally high, the chances are that inflation will also be higher, and vice versa.

Plausible and realistic scenarios

When used to produce a range of long term possible investment outcomes, eValue’s Insight asset model produces realistic projections which enable consumers to make sensible financial decisions. This means that not only are the overall forecasts realistic but each individual scenario, which makes up the forecast, is also sensible and capable of occurring.

Suggesting a potential outcome which, in reality, is impossible is obviously not particularly helpful to consumers when it comes to making investment decisions.

In summary

Although much of the current emphasis on robo-advice is on ISAs and general investment, the potential is there for such processes to be used to help consumers in making informed decisions about their retirement choices.

With new pension freedoms, consumers now have more control than ever before over their pension assets. However, with these new proposals comes a greater need to provide individuals with realistic forecasts of what they may obtain in the future. The only way to achieve this is to ensure that the underlying asset model used in any robo-advice proposition is reliable, suitable and realistic.

eValue’s solution is not only a real world model but also takes account of both interest rates and inflation and produces plausible scenarios. In this way, consumers can be confident that they are being provided with the means to take sensible, suitable and informed financial decisions through a compliant and robust computer based process.

Perhaps the future is more as envisaged by Iain M. Banks than Philip K. Dick!


Bruce Moss, Strategy Director & Founder of EValue

Bruce has spent over two decades leading development and delivery at EValue. Today, the online stochastic advice systems he pioneered are used across the UK. As a partner at Towers Watson, Bruce gained considerable experience on pension and benefit issues and his views are often sought by the media.
Bruce is a Fellow of the Institute of Ac

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