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Robots are an ETF’s new best friend, but some need convincing

Robo-advisers build portfolios that are attuned to the client’s risk tolerance, goals and personal profile.

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It's time for exchange-traded funds to start wooing the robots. But the asset management industry isn't quite so sure.

Automated advice platforms -- known as robo advisers -- are poised to expand their investments in ETFs over the next five years, boosting their assets to more than $800-billion, according to a report by PricewaterhouseCoopers. Overall, digital advice is likely to grow to $1-trillion by 2020, a separate study by Aite Group showed.

Robos, which include independents such as Betterment LLC and Wealthfront Inc. as well as platforms from the likes of Vanguard Group Inc. and Charles Schwab Corp., currently oversee about $75-billion. PwC's prediction is based on growth rates from 2015 to 2016, while Aite used data submitted to regulators and interviews with large incumbents.

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"You're going to see a real acceleration," said Nigel Brashaw, PwC's global ETF practice leader. "Once you start seeing technology increasingly take hold, it's something that's not going to go backward."

But many asset managers consider these projections optimistic, with more than 75 per cent of those polled by PwC expecting robos to generate less than $100-billion for ETFs over the next five years.

Asset managers are aware of the robo-adviser trend, but only in "a superficial manner, like much of the general public," Aite senior analyst Javier Paz said in an interview.

Low Cost

Robos have found a natural partner in ETFs based on their shared emphasis on cost. Unlike a traditional adviser who might require hundreds of basis points a year to choose investments, robos use answers from a series of online questions and some sophisticated algorithms to provide the same service for little or no fee. This hands-off, cookie-cutter approach is cheap, and using low-cost ETFs to execute the strategy ensures that management fees won't eat into the savings.

Many ETF issuers and other asset managers are, however, ill-prepared for this shift. About 55 percent of those surveyed by PwC see robos sending less than $50-billion into ETFs, with participants from the European and Asian markets the most cautious in their expectations.

That wariness will end up being their loss, according to PwC. Those who resist the shift to automated advice and other digital technologies risk endangering their business and missing a huge opportunity, the accounting and auditing firm said in its report.

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Lurking Risks

About 17 million investors will use robo-advice by 2021, up from 1.8 million last year, with millennials most likely to sign on, according to Aite. That poses both a concentration and communication problem that robos, investors and regulators need to bear in mind.

Many of these investors could end up in the same ETFs. For example, all eight digital advisers considered by Aite own Vanguard Group's FTSE Emerging Markets ETF, better known by its ticker VWO. While that will invite more liquidity and more inflows, it also requires better regulatory oversight, Aite's Paz said.

Robo advisers could, however, take early action to counter another concern for investors -- what happens during a market selloff. After Britain voted to leave the European Union, Betterment halted trading to allow markets to stabilize. This move was communicated to financial advisers but not to retail users unless they called the firm, Aite said in the report.

"I see it as good business practice to let clients know when and why a robo platform may experience a trade suspension," Paz said. "This kind of communication should precede a major market event and not be the result of increased regulation."

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