In Disney’s classic 1940 film “Fantasia” one of the most memorable sequences is based on Goethe’s story of The Sorcerer’s Apprentice. Mickey Mouse, in the character of the apprentice, is told to fill a cauldron with water and has the bright idea that he can bring a broomstick to life to help him. Unfortunately Mickey forgets the spell that stops the broomstick, and chopping the broom into pieces with an axe just multiplies the problem. Soon all is chaos as the magician’s lair is flooded by the army of unstoppable automatons. The Sorcerer returns, order is restored, and the apprentice receives his punishment.
Our distrust of machines and automata seems to be instinctive, and so it is surprising that an increasing number of people allow robots to manage their wealth. Companies such as Nutmeg, Money on Toast, Wealth Horizon and Moneyfarm all use complex algorithms to manage their capital, but can these robo-advisers offer something that a human financial adviser cannot?
The primary reason for allowing others to manage our wealth is the ability to beat the market. If investing in the FTSE 100 for a cost of 0.09% per year (with Vanguard) beats the average hedge fund which is charging 1.4% per year then we have to question why the hedge fund fees are so high. In 2016 the HFRX hedge fund index was up just 2.5% whereas the FTSE 100 was up 14% which gives pause for thought. Nutmeg’s Portfolio 7 which “Aims for higher growth by accepting higher volatility” returned a healthy 14.3% from September 2015 to September 2016 and their riskiest fund has returned an average of 10.1% per year since 2012 which is respectable in this low-rate environment.
Cost is clearly another of the forces driving people towards robo-funds. Robo slots into the cheaper end of the cost continuum, above Vanguard’s giant funds with ultra-low management fees and below financial advisers which often charge 3% upfront and 0.5% to 1% ongoing fees. For example Nutmeg charges 0.95% per year for investments up to £25k dropping to 0.5% for investments above £100k. Getting rid of highly paid and highly skilled analysts slashes the biggest cost for asset managers and so if this model proves successful there is no way that funds run by human managers will be able to compete. However this would not necessarily be an extinction event for fund managers. Even robo-funds keep some humans around to tweak the algorithms, overlay a view, and to step in for events that computer models don’t understand, such as Brexit.
The thing that robo-funds will have difficulty with is providing the human element. Some people simply like a friendly and familiar face when they discuss their finances. It will be difficult to maintain brand loyalty when all that the brand provides is an app and an algorithm. However the same arguments were made about the rise of “impersonal” supermarkets in the 1960s. Cost and performance are going to determine whether we will see the rise of the robots or humans will gain the upper hand.