The Massachusetts Securities Division recently fired a shot heard around the robo-adviser world when it declared that the online financial advisers may not be up to snuff as fiduciaries for investors. If that’s the case, it means they may not qualify as investment advisers in Massachusetts.
Regulators must of course hold all financial advisers to a high standard, but robo-advisers — the most investor friendly financial innovation since the index fund — are on the frontlines in the fight for better outcomes for investors. It’s worth considering whether it would be better to improve robo-advisers’ shortcomings rather than discouraging their proliferation.
Massachusetts is the first regulator to suggest that the bots are a problem, but that move follows a growing chorus of commentators and regulators who have raised similar questions. The Securities and Exchange Commission and the Financial Industry Regulatory Authority, for example, jointly cautioned last year that robo-advisers may not provide advice that is right for investors’ financial needs – which is a cornerstone of the fiduciary standard.
The beef with robo-advisers is threefold: 1) The robots know too little about their investors’ overall finances; 2) Investors have no one to call when Mr. Market’s dark side appears, and 3) The robots disclaim some fiduciary obligations in their client agreements.
All three are legitimate criticisms, and also easily addressed.
First, aggregation technology can already gather every detail of your financial history in seconds — from bank accounts to mortgages to spending history — and will soon be a feature of every robo-adviser. That will allow the bots to tell you how much you should save, whether you should pay down that mortgage (yes, for example, if the expected return on your portfolio is less than your after-tax mortgage rate), and how your cable bill fares compared to your neighbors’. And the best part is that the information is always current.
Second, some robo-advisers already offer live advice and my guess is that all of them will eventually follow suit. There is little doubt that the best return on investment comes from resisting the temptation to sell when markets tumble, and some investors need human encouragement in those moments. Providing that support will ultimately be more profitable for both robot and investor.
Third, I suspect that many of the techies behind the robots have never read their client agreements and may be embarrassed to learn what’s in them. One such agreement, according to Massachusetts, states that the client is responsible for determining what’s in his or her best interest. That’s a bit like my mechanic telling me it’s my responsibility to determine what’s wrong with my car and how it should be fixed. Regulators are right to cringe at such provisions and, fortunately, removing them need be no more complicated than using a word processor.
Now, let’s think about what the robots get right: They deliver high quality financial advice to anyone who wants it at a reasonable cost — a feat that had eluded the financial industry until the bots arrived. (There is still an unfortunate gap between the quality of advice for the ultrarich and everyone else, but technology will eventually bridge that divide too.)
Let’s not take these advances for granted, particularly in light of recent threats by traditional brokerages to drop middle-class and working-class investors in response to the Department of Labor’s recently released fiduciary rule. Those threats are laughable in no small part because middle-class and working-class investors can turn to robo-advisers. But if regulators adopt the view that robo-advisers are not an acceptable alternative, regulation may have the unintended and strange consequence of forcing middle-class and working-class investors to fend for themselves.
Let’s also not overstate the powers of flesh-and-blood advisers (and I include myself). Too many (though obviously not all) advisers are thinly cloaked salespeople masquerading as professionals. Can even the best advisers compete with the robots when it comes to aggregating financial data, analyzing risk, slicing and dicing portfolios into customizable variations, and unemotionally executing those portfolios? I doubt it.
Yes, we will always need real life advisers to create investment strategies and to comfort investors during market corrections, but it’s time to render unto the robots what is theirs.
Robo-advisers are in their infancy. They have the DNA, however, to embody the high aspirations baked into the DOL’s new fiduciary rules. Let’s give them a chance to grow up.
By Nir Kaissar
Bloomberg
Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young. — Ed.
