Robo Advisors: quantitative methods inside the robots

Mikhail Beketov,Manuel Wittke,Kevin Lehmann

doi:10.1057/s41260-018-0092-9

Abstract

Robo Advisors (RAs) are perhaps the most important disruptive trend in wealth and asset management today. There is an immense amount of information about RA systems, but still little is known about the core portfolio optimization and asset allocation methods applied within such systems. Thus, to date, there is no comprehensive analysis of the methods used in RAs, their occurrences in these systems, the respective volumes of assets under management (AuM), and the future methodological prospects of the RAs. We analyzed 219 existing RAs worldwide and showed that Modern Portfolio Theory remains the main framework used in RAs. The current trend is to improve and augment this framework rather than applying and developing entirely new approaches. However, we also revealed that the AuM volumes tend to be higher for the systems applying newer and more sophisticated methods. In general, there is a clear gap between the predominant methods applied in RAs and new methodological developments. In the future, as the RA services mature, we can expect that the RAs system will adopt many of the new approaches since they promise good performance and have certain marketing potential.

Highlights

Robo Advisors (RAs) are widely recognized as one of the most important disruptive trends in asset and wealth management industry
There is an immense amount of information about RA systems, but still little is known about the core portfolio optimization and asset allocation methods applied within such systems
Our analyses based on the selected 28 RAs (Table 1) show that a typical RA’s workflow can be described as follows: preselection of ETFs, identification of the client’s risk profile and investment goals with online questionnaires, portfolio optimization based on the improved Modern Portfolio Theory approach (Markowitz 1952, 1959), threshold-based rebalancing, and performance monitoring through the web page or a smartphone app

Summary

Introduction

Robo Advisors (RAs) are widely recognized as one of the most important disruptive trends in asset and wealth management industry. Different forecasts predict that RAs will globally manage between $0.8 and $8.1 trillion by 2020, which is 1–10% of the total global assets under management (Statista 2017; BI Intelligence 2017). In 2017, the global assets under management (AuM) by RAs comprised approximately $226 billion, and the number of users exceeded 12 million (Statista 2017). The reasons for the current success of RAs and the remarkably optimistic forecasts are diverse. In line with previous research by Deloitte (2016a) and BI Intelligence (2017), the main reasons can be condensed to (i) a new generation of clients, (ii) the advantages of RAs over traditional financial advisors, and (iii) the large-scale financial processes such as the concentration of global wealth and the adoption of RAs in Asia

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