As investment managers, it is part of our nature to think about the impact of evolving technology. How will innovative technologies affect our lives? Which companies will benefit? How can modern technologies enhance our capabilities as investment advisors to better serve our clients? Lately, Artificial Intelligence (AI) has been at the forefront of public consciousness, raising several questions: What are the pros and cons of AI use in the investment arena? AI applications can process enormous amount of data very quickly and accurately, some of which may be missed by human analysts who are not as efficient. The more comprehensively researched investment decisions produced with the assistance of AI should, in theory, be less risky, more successful, or some combination of the two. At a minimum, they should produce informed decisions more quickly. What other impacts can we expect AI to have on investment management? We cannot avoid the question of whether it makes our jobs as portfolio managers obsolete. Should we start honing new skill sets?
In attempting to answer these questions, we found ourselves comparing the present moment to the introduction of robo advisory services (first introduced in 2008), and how that innovation affected wealth management. Robo advisors are digital platforms that automatically invest for you after you answer a series of questions. There is typically little or no human contact with the investor or human intervention with the process. Based on the investor’s answers to the questions, the robo platform utilizes passive indexes to put together a diversified portfolio based on Modern Portfolio Theory. Robo advising is touted as a low-cost alternative to portfolios managed by mere mortals. While assets have migrated to these automated investment vehicles, how good are they?
On the plus side, these low-cost services are advantageous because they provide investment management to those who might not have utilized any advisor if the costs were higher. Since there are low minimums, robo advising is available to those with a small amount to invest. Thus, robo advising serves a worthwhile function in furnishing investment management to those who might not have gotten it otherwise. Since the average individual investor historically significantly underperforms the market, robo advising provides a positive service. For those investors that are both cost conscious and too emotional in their investing, robo advising is an appropriate strategy as it strips emotion out and is low cost.
However, one of the positives of robo advising – taking emotion out of investing – can also be one of the negatives of such computer-driven investment strategies. Intuitive investment managers can notice purely human nuances and information in their interactions with clients and apply these to the financial planning process. While a client may state they are not risk averse, their body language may signal they are fearful of market volatility. The first rule of investment management is “know your customer,” for only then can you recommend that most appropriate strategies. With a handful of questions answered on a machine, can robo advisers really know their customers as well as a human advisor? How can a robo advisor handle behavioral biases? What about knowing that your client is averse to investing in any company that tests their products on animals- can a robo advisor using ETFs avoid companies that do so? Can a robo advisor console a client who just lost her husband and tell her it will take care of coordinating with her attorney and accountant to retitle the assets and step up the cost basis where appropriate? Can a robo advisor run through different scenarios with a client, her family, and her other trusted advisors to find the best way for her/him to avoid the NY state estate cliff? We believe the answer to all these questions is a resounding “no.” Even if it were “yes,” who is going to coach the client and prevent them from pulling the plug once volatility strikes? In this regard, robo advising and AI have a lot in common: both lack of human interaction and are driven by algorithms. Robo advising has not replaced traditional investment management, as many warned it might, and we do not think AI will either.
Let us look at a few more examples of situations in which robo and/or AI inevitably falls short of a skilled human advisory partnership.
When a client loses a spouse or parent they may not want to sell or make any portfolio changes right away, but this might be what an AI-based algorithm suggests. Investment counseling is about achieving the best outcomes for each client based on their goals which necessitate a connection or bond with a client that a computer is unable to have. The fundamental building blocks of computing are 0s and 1s, or binary code, whereas the fundamental building blocks of long-term successful investment counseling include being a good listener, empathy, knowing what to ask and how to best achieve what a client truly needs.
Another example: when a client is about to retire, we sometimes do elaborate financial planning on their behalf. Often, however, they are more interested in knowing how clients in similar circumstances have fared. Put another way, their questions and concerns extend beyond the quantitative and become qualitative. Advisors who can relate, connect, and gain their clients’ confidence will outshine AI every day of the week. Grieving clients do not need a hug from their PC. Retiring clients want a firm handshake and to look into your eyes for reconfirmation.
While digital or AI programs and simple management may be a fine solution for some investors, they may be much less effective when it comes to more complex financial matters, goal-based financial planning, and what our industry refers to as “hand-holding.” While AI will not be useful on the human side of our business, using computer modelling and AI in our practices to help us research and generate better ideas, will be constructive and efficient. Harnessing evolving technology to improve our capabilities for our clients is essential and smart, but knowing its limitations is also critical.
As always, please call us when you have a question or concern. Unlike a robo advisor or whatever AI solution is incoming, you will receive a return phone call from your portfolio manager or another member of our team. We are here to listen, discuss and then recommend.
