What is a robo-advisor?

Robo-advisors or Robo-advisers are a class of financial adviser that provide financial advice or Investment management online with moderate to minimal human intervention.  They provide digital financial advice based on mathematical rules or algorithms. These algorithms are executed by software and thus financial advice do not require a human advisor. The software utilizes its algorithms to automatically allocate, manage and optimize clients’ assets.

There are over 100 robo-advisory services. Investment management robo-advice is considered a breakthrough in formerly exclusive wealth management services, bringing services to a broader audience with lower cost compared to traditional human advice. Robo-advisors typically allocate a client’s assets on the basis of risk preferences and desired target return. While robo-advisors have the capability of allocating client assets in many investment products such as stocks, bonds, futures, commodities, real estate, the funds are often directed towards ETF portfolios. Clients can choose between offerings with passive asset allocation techniques or active asset management styles.

The tools they employ to manage client portfolios differ little from the portfolio management software already widely used in the profession. The main difference is in distribution channel. Until recently, portfolio management was almost exclusively conducted through human advisors and sold in a bundle with other services. Now, consumers have direct access to portfolio management tools, in the same way that they obtained access to brokerage houses like Charles Schwab and stock trading services with the advent of the Internet.Robo-advisors are extending into newer business avenues.

The customer acquisition costs and time constraints faced by traditional human advisors have left many middle-class investors underadvised or unable to obtain portfolio management services because of the minimums imposed on investable assetsThe average financial planner has a minimum investment amount of $50,000,while minimum investment amounts for robo-advisors start as low as $500 in the United States and as low as £1 in the United Kingdom In addition to having lower minimums on investable assets compared to traditional human advisors, robo-advisors charge fees ranging from 0.2% to 1.0% of Assets Under Managemenwhile traditional financial planners charged average fees of 1.35% of Assets Under Management according to a survey conducted by AdvisoryHQ News.

In the United States, robo-advisors must be registered investment advisors, which are regulated by the Securities and Exchange Commission. In the United Kingdom they are regulated by the Financial Conduct Authority.

What are the biggest robo-advisor?

As of October 2017, robo-advisors had $224 billion in assets under management.

The following are the largest robo-advisors by assets under management:

Company Country AUM (millions of US$)
The Vanguard Group U.S. 83,000
Charles Schwab Corporation U.S. 19,400
Betterment U.S. 9,058
Wealthfront U.S. 6,763
Personal Capital U.S. 4,344
Nutmeg Great Britain 751
Wealthsimple Canada 574
E-Trade U.S. 400
Ally Financial U.S. 18

Hedge fund

A hedge fund is an investment fund that pools capital from accredited individuals or institutional investors and invests in a variety of assets, often with complex portfolio-construction and risk-management techniques.[1] It is administered by a professional investment management firm, and often structured as a limited partnership, limited liability company, or similar vehicle. Hedge funds are generally distinct from mutual funds, as their use of leverage is not capped by regulators, and distinct from private equity funds, as the majority of hedge funds invest in relatively liquid assets.[4][5]

The term “hedge fund” originated from the paired long and short positions that the first of these funds used to hedge market risk. Over time, the types and nature of the hedging concepts expanded, as did the different types of investment vehicles. Today, hedge funds engage in a diverse range of markets and strategies and employ a wide variety of financial instruments and risk management techniques.

Hedge funds are made available only to certain sophisticated or accredited investors and cannot be offered or sold to the general public. As such, they generally avoid direct regulatory oversight, bypass licensing requirements applicable to investment companies, and operate with greater flexibility than mutual funds and other investment funds. However, following the financial crisis of 2007–2008, regulations were passed in the United States and Europe with intentions to increase government oversight of hedge funds and eliminate certain regulatory gaps.

Hedge funds have existed for many decades and have become increasingly popular. They have now grown to be a substantial fraction of asset management, with assets now totaling around $3 trillion.

Hedge funds are almost always open-ended and allow additions or withdrawals by their investors (generally on a monthly or quarterly basis). The value of an investor’s holding is directly related to the fund net asset value.

Many hedge fund investment strategies aim to achieve a positive return on investment regardless of whether markets are rising or falling (“absolute return”). Hedge fund managers often invest money of their own in the fund they manage.[10][11] A hedge fund typically pays its investment manager an annual management fee (for example 2% of the assets of the fund), and a performance fee (for example 20% of the increase in the fund’s net asset value during the year).[1] Both co-investment and performance fees serve to align the interests of managers with those of the investors in the fund. Some hedge funds have several billion dollars of assets under management (AUM)

Risk management
Investors in hedge funds are, in most countries, required to be qualified investors who are assumed to be aware of the investment risks, and accept these risks because of the potential returns relative to those risks. Fund managers may employ extensive risk management strategies in order to protect the fund and investors. According to the Financial Times, “big hedge funds have some of the most sophisticated and exacting risk management practices anywhere in asset management.” Hedge fund managers that hold a large number of investment positions for short durations are likely to have a particularly comprehensive risk management system in place, and it has become usual for funds to have independent risk officers who assess and manage risks but are not otherwise involved in trading. A variety of different measurement techniques and models are used to estimate risk according to the fund’s leverage, liquidity and investment strategy.Non-normality of returns, volatility clustering and trends are not always accounted for by conventional risk measurement methodologies and so in addition to value at risk and similar measurements, funds may use integrated measures such as drawdowns .

In addition to assessing the market-related risks that may arise from an investment, investors commonly employ operational due diligence to assess the risk that error or fraud at a hedge fund might result in loss to the investor. Considerations will include the organization and management of operations at the hedge fund manager, whether the investment strategy is likely to be sustainable, and the fund’s ability to develop as a company.

Fees paid to hedge funds
Hedge fund management firms typically charge their funds both a management fee and a performance fee.

Management fees are calculated as a percentage of the fund’s net asset value and typically range from 1% to 4% per annum, with 2% being standard They are usually expressed as an annual percentage, but calculated and paid monthly or quarterly. Management fees for hedge funds are designed to cover the operating costs of the manager, whereas the performance fee provides the manager’s profits. However, due to economies of scale the management fee from larger funds can generate a significant part of a manager’s profits, and as a result some fees have been criticized by some public pension funds, such as CalPERS, for being too high

The performance fee is typically 20% of the fund’s profits during any year, though they range between 10% and 50%. Performance fees are intended to provide an incentive for a manager to generate profits.Performance fees have been criticized by Warren Buffett, who believes that because hedge funds share only the profits and not the losses, such fees create an incentive for high-risk investment management. Performance fee rates have fallen since the start of the credit crunch.

Almost all hedge fund performance fees include a “high water mark” (or “loss carryforward provision”), which means that the performance fee only applies to net profits (i.e., profits after losses in previous years have been recovered). This prevents managers from receiving fees for volatile performance, though a manager will sometimes close a fund that has suffered serious losses and start a new fund, rather than attempting to recover the losses over a number of years without performance fee.

Some performance fees include a “hurdle”, so that a fee is only paid on the fund’s performance in excess of a benchmark rate (e.g. LIBOR) or a fixed percentage. A “soft” hurdle means the performance fee is calculated on all the fund’s returns if the hurdle rate is cleared. A “hard” hurdle is calculated only on returns above the hurdle rate. A hurdle is intended to ensure that a manager is only rewarded if the fund generates returns in excess of the returns that the investor would have received if they had invested their money elsewhere.

Some hedge funds charge a redemption fee (or withdrawal fee) for early withdrawals during a specified period of time (typically a year) or when withdrawals exceed a predetermined percentage of the original investment. The purpose of the fee is to discourage short-term investing, reduce turnover and deter withdrawals after periods of poor performance. Unlike management fees and performance fees, redemption fees are usually kept by the fund.

Investment management

Investment management is the professional asset management of various securities (shares, bonds and other securities) and other assets (e.g., real estate) in order to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations, charities, educational establishments etc.) or private investors (both directly via investment contracts and more commonly via collective investment schemes e.g. mutual funds or exchange-traded funds).

The term asset management is often used to refer to the investment management of collective investments, while the more generic fund management may refer to all forms of institutional investment as well as investment management for private investors. Investment managers who specialize in advisory or discretionary management on behalf of (normally wealthy) private investors may often refer to their services as money management or portfolio management often within the context of so-called “private banking”.

The provision of investment management services includes elements of financial statement analysis, asset selection, stock selection, plan implementation and ongoing monitoring of investments. Coming under the remit of financial services many of the world’s largest companies are at least in part investment managers and employ millions of staff. It remains unclear if professional investment managers can reliably enhance risk adjusted returns by an amount that exceeds fees and expenses of investment management.

The term fund manager (or investment advisor in the United States) refers to both a firm that provides investment management services and an individual who directs fund management decisions.

According to a Boston Consulting Group study, the assets managed professionally for fees reached an all-time high of US$62.4 trillion in 2012, after remaining flat-lined since 2007.  Furthermore, these industry assets under management were expected to reach US$70.2 trillion at the end of 2013 as per a Cerulli Associates estimate.

The global investment management industry is highly concentrated in nature, in a universe of about 70,000 funds roughly 99.7% of the US fund flows in 2012 went into just 185 funds. Additionally, a majority of fund managers report that more than 50% of their inflows go to only three funds.

Investment managers and portfolio structures
At the heart of the investment management industry are the managers who invest and divest client investments.

A certified company investment advisor should conduct an assessment of each client’s individual needs and risk profile. The advisor then recommends appropriate investments.

Asset allocation
The different asset class definitions are widely debated, but four common divisions are stocks, bonds, real estate and commodities. The exercise of allocating funds among these assets (and among individual securities within each asset class) is what investment management firms are paid for. Asset classes exhibit different market dynamics, and different interaction effects; thus, the allocation of money among asset classes will have a significant effect on the performance of the fund. Some research suggests that allocation among asset classes has more predictive power than the choice of individual holdings in determining portfolio return. Arguably, the skill of a successful investment manager resides in constructing the asset allocation, and separate individual holdings, so as to outperform certain benchmarks (e.g., the peer group of competing funds, bond and stock indices).

Long-term returns
It is important to look at the evidence on the long-term returns to different assets, and to holding period returns (the returns that accrue on average over different lengths of investment). For example, over very long holding periods (e.g. 10+ years) in most countries, equities have generated higher returns than bonds, and bonds have generated higher returns than cash. According to financial theory, this is because equities are riskier (more volatile) than bonds which are themselves more risky than cash.

Against the background of the asset allocation, fund managers consider the degree of diversification that makes sense for a given client (given its risk preferences) and construct a list of planned holdings accordingly. The list will indicate what percentage of the fund should be invested in each particular stock or bond. The theory of portfolio diversification was originated by Markowitz (and many others). Effective diversification requires management of the correlation between the asset returns and the liability returns, issues internal to the portfolio (individual holdings volatility), and cross-correlations between the returns.

Investment services

  • Investment management – the term usually given to describe companies which run collective investment funds. Also refers to services provided by others, generally registered with the Securities and Exchange Commission as Registered Investment Advisors. Investment banking financial services focus on creating capital through client investments.
  • Hedge fund management – Hedge funds often employ the services of “prime brokerage” divisions at major investment banks to execute their trades.
  • Custody services – the safe-keeping and processing of the world’s securities trades and servicing the associated portfolios. Assets under custody in the world are approximately US$100 trillion.

New York City is the largest center of investment services, followed by London