The Financial Conduct Authority (FCA) and HM Treasury review into the financial ‘advice gap’ recommends an increasing role for robo-advice in the UK but doesn’t get to grips with the problem that automation could promote reckless conservatism among investors.
Released in early-March, the Financial Advice Market Review (FAMR) contains 28 recommendations designed to close the advice gap that has opened in Britain since investors were introduced to a new regime of paying for financial advice by the hour instead of by commission.
FAMR’s Recommendation 9 promotes automation to plug the advice gap but steps back from looking more closely under the hood at how robo-advisers work which is where there is the potential problem of reckless conservatism - investors choosing overly conservative investment strategies that won't meet their financial goals.
“It is clear to us that there are areas where intervention by regulators and Government could help the industry to develop new and more cost-effective ways of delivering advice and guidance to consumers, in particular, through more effective use of technology.” FAMR, p28.
The advice unit
The specific recommendations are building out the FCA’s Project Innovate research hub into an ‘Advice Unit’ to help firms develop robo-advice. The unit will produce a best practice test toolkit for robo-advisers and a guide for robo-advisers seeking authorisation to provide financial advice. It will also work with leading robo-advisers to “provide individual guidance and support to firms with propositions with a high potential impact on the advice gap.”
But what about the way in which robo-advisers give advice? As FAMR offers no recommendations about this and indeed specifically recommends against pre-approving specific robo-advisers, the suitability assessment regime set out in 2011 remains in place. Back then the regulator was worried about “firms adopting risk-profiling and asset-allocation tools to support, supplement or replace aspects of more traditional ‘know your customer’ approaches”.
What now that robo-advice is more than an ‘aspect’ of the advice process , increasingly end-to-end, leaving humans out of the loop entirely? The report suggests that advisers are already turning away investors with small savings pot because they are not commercially viable clients.
Can a robo-adviser tell me uncomfortable truths?
The danger is that automation will allow investors to choose overly conservative investment strategies, which has serious implications for the already inadequate looking pension pots of many Britons.
The guidance from 2011 adequately sets standards for robo-advisers to determine an investor’s Attitude to Risk and Capacity for Loss – two sides of the risk triangle – but leaves uncharted the third side of the triangle, which deals with helping investors understand their need to take risk.
In Britain, most investors need to take more risk to meet their financial goals than their ingrained attitude to take risk suggests and it has traditionally been the job of the adviser to, say, encourage them to invest in stocks or bonds rather than cash.
Solving ‘need to take risk’ is not an easy task and robo-advisers will have to innovate boldly to prevent reckless conservatism. Certainly, it should be top of the agenda for the FCA’s new Advice Unit otherwise the ‘advice gap’ may be replaced by a ‘savings gap’.