Fintech: Robo-advisors developing a better value proposition

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 30, 2018 - August 05, 2018.
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As robo-advisory platforms become more common around the world, the focus of these service providers has shifted to creating a robust investment framework rather than just providing a convenient and affordable way to invest, says Michele Ferrario, co-founder and CEO of Singapore-based robo-advisor StashAway.

After all, robo-advisory platforms are already commonplace in some countries, with the bigger players in the US — such as Wealthfront and Betterment — managing billions of dollars. The first robo-advisor was established a decade ago.

“Globally, robo-advisory models are maturing. The basic value proposition of a very nice user interface and low-cost investing is not enough anymore and the importance of the investment framework and asset allocation is gaining prominence. You will see that the new players in Europe have a very strong focus on risk management and asset allocation and you will see more established US players talk about how they manage money,” says

Ferrario on the sidelines of the Wild Digital Southeast Asia 2018 conference.

By comparison, robo-advisors are not as common in Southeast Asia. Last year, Singapore welcomed this innovation and granted StashAway the first Capital Markets Services Licence for retail fund management using an automated investment platform.

StashAway is now expanding to

Malaysia and has applied for a licence from the Securities Commission Malaysia (SC). Interested individuals can sign up for the waitlist at

“Two years ago, the regulators in this region did not look at the digitalisation of wealth management. Yet now, you see the Monetary Authority of Singapore and the SC become the two most progressive regulators so far in this part of the world. MAS opened up the licence to digital wealth managers and the SC is creating a different type of licence to facilitate this,” says Ferrario.

Other robo-advisors in Singapore and also those from India have expressed interest in expanding to Malaysia. That is because there is a market gap that these service providers can fill in the region. As Ferrario points out, investment products here are still relatively expensive to access.

“It is incredibly expensive to invest in Singapore, Malaysia and other countries around here. You still have very high entry fees when you buy unit trusts and you still have retrocessions going from product manufacturers to the distributors. These things do not exist anymore in the US and Europe, and I think technology provides a reason for the industry to mature,” he says.

Getting financial advice is also reserved for the wealthy, says Ferrario. “If you want to invest money in an intelligent way, what you get offered today is very expensive advice in the form of high entry and management fees for managed products, and you don’t really get the right holistic financial advice on how to diversify your portfolio. That does not exist unless you are very wealthy. So, the value proposition gap of what we offer versus what is offered in the market is much larger than what the early robo-advisors provided to customers in the US.”

This was a pain point he noticed when he was group CEO of Singapore-based

Zalora. He did not have the time to manage his money and wanted help. “What I could find was only people trying to sell me products I did not need with crazy high fees, mostly unit trusts or investment-linked policies with high fees that do not target my needs, but were simply the flavour of the month for the banks or advisers I was speaking to,” he says.


Building a robo-advisory model

Ferrario teamed up with Freddy Lim, co-founder and chief investment officer of StashAway, to build a robo-advisory model. Lim was previously managing director and global head of derivatives strategy at Nomura. Ferrario also has a panel of advisers that includes experts on portfolio management.

“We believe that the asset allocation strategy that we have built, called the Economic Regime-based Asset Allocation (ERAA), is more sophisticated than others you can find in the market because we put risk management at the core of our strategy. As a customer, you would want someone who looks at how much risk you are taking and try to make sure the risk is managed over time across different economic cycles,” he says.

At StashAway, there is no minimum investment amount, but the annual management fee is between 0.2% and 0.8% per annum. The robo-advisor has 28 risk points, which translates into 28 types of portfolios, that represent the risk levels of clients. The portfolios are designed to achieve average net returns of between 3.8% and 9% over the medium to long term, depending on the investor’s risk profile.

According to its back-testing, which goes back 15 years, the lowest risk portfolio saw an average return of 4% per annum while the higher risk ones generated an average return of 8.8% per annum, says Ferrario. “It does not mean that it gives these returns every year. This is a long-term product. When you think about

retirement and long-term goals, you need to think about returns across cycles.”

Users can enter their risk profile and financial goals into the system, which then allocates a suitable portfolio. The goals could be retirement planning or short-term ones such as a big purchase. As a result, the final aggregated portfolio investment is unique to each user.

“Let’s say you have two goals — to buy a house in five years and send your son to Harvard University 15 years from now. These goals have different timelines, so they will have different asset allocations as they will have different risk profiles across asset classes,” says Ferrario.

The system will invest in exchange-traded funds (ETF) that are exposed to various asset classes, from equities and bonds to gold. Users will not be able to choose the asset classes because the portfolio is constructed according to the model created by the experts on the team.

“You will have portfolios across geographies and sectors. You will have fixed-

income instruments, bonds across geographies and with different maturity dates, government versus corporate bonds, convertible bonds and inflation-linked bonds that protect against inflation,” says Ferrario.

“I am not saying all of these will be in every portfolio. Some of them will be and every portfolio will have some level of diversification between 7 and 12 asset classes per portfolio.”

Most robo-advisors invest in ETFs because they have low entry fees and it is a simple way to gain exposure to most asset classes. There have been studies in the US that highlight how active fund managers have failed to outperform ETFs that track underlying indices and how asset allocation rather than security selection drives returns for portfolios, says Ferrario.

“We only invest in plain vanilla, very simple, very large and very liquid real-

asset-backed ETFs from big providers. The reason you want liquidity and real-

asset-backed ETFs because they reduce the additional risks that come with synthetic ETFs. We do not touch leveraged ETFs or smart-beta ETFs because we do not know how they will behave when markets act weirdly. We want simplicity,” he adds.

The company invests in 19 ETFs, which have exposure to various asset classes.

The portfolios are checked daily by the algorithm and rebalanced on a weekly, monthly or quarterly basis if any discrepancy is observed between the target and actual asset allocation. This rebalancing changes the user’s actual asset allocation to match the target asset allocation.

The computer also takes in monthly economic data and adjusts portfolios accordingly. However, Ferrario points out that this kind of adjustment — called re-optimisation — can be optional and only occurs when there is a change in economic trends.

“If you are in a good economy with positive growth and low inflation, your portfolio, for example, may have some technology equities, some Asia ex-Japan equities and European equities, and maybe fewer fixed-income securities and gold. If the economy goes into a recession, you will see your equities portion decrease and move towards more defensive sectors such as consumer staples. You will see more allocation to fixed income and a bit more gold. That will help reduce your losses,” he says.

“And when the economy recovers, it moves back to an aggressive portfolio. We do that by constantly maintaining your risk level.”

StashAway’s strategy involves investments with a three to five-year horizon and is designed to ignore market noise and focus on economic fundamentals. That is why the re-optimisation is only expected every three to seven years.

“Like what is happening right now. It is still too early to see [if that is needed]. The economy is still doing well, the US is doing particularly well, with the emerging markets suffering more. We have seen some decoupling from what is happening in the US and some of the emerging markets. So, what our platform does is analyse all of the economic data and adjusts the valuations of the asset classes and potentially adjusts the portfolio composition by asset class,” says Ferrario.

For instance, a June post on the

StashAway blog points out that US growth has outpaced global growth since September last year, suggesting that US-based assets will play an increasingly important role in the diversification of global portfolios going forward.