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Why Robo-Advisors Make Biased Recommendations... - Outside View by PersonalFN

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Why Robo-Advisors Make Biased Recommendations...
Apr 4, 2017

Robos are replacing humans in almost every field. The wealth management and financial services space too, is not consigned to oblivion - 'Robo-Investing' is a buzzword that's doing the rounds these days...

Supported by technology and algorithm backed systems, most robo-investing platforms offer online wealth management solutions buttressed with 'financial planning'. They make it appear as if you don't require a financial planner, or a financial guardian any longer to meet your long-term financial goals. But, how many robo-investing platforms really render unbiased advice to you, the investor?

Do they really put your interest at the fore taking into consideration all the quantitative and qualitative aspects (viz. your age, income, assets & liabilities, risk profile, asset allocation, amongst many others), that are pivotal to advisory and your financial planning?

We explored many robo-investing platforms, and discovered that many of them are sneakily putting their interest before the investors' financial wellbeing.

They're offering mutual fund schemes under 'Regular Plans' - that earn them attractive commissions vis-a-vis a 'Direct Plans' (that come with a lower expense ratio), which are effective wealth creators. This modus operandi is followed even for many other investment products. Therefore, the recommendations are not free from personal bias.

The Finance Ministry appointed Sumit Bose Committee highlighted the self-serving approach adopted by a majority of agents and distributors of financial products. According to the report, the mis-selling is prevalent at all stages of the product cycle: at the point of sale, post-sales, and/or even at both stages. SEBI has taken many corrective steps; but incidentally now (human backed) robo-investing platforms too are tricking investors. Transparency is non-existent, although they slickly facilitate investing.

Some of the schemes recommended are of course, star-rated; but you need to recognise that ratings subscribe to the "one size fits all" approach. And in reality, a mutual fund scheme could be right for one investor and (despite its sterling performance) be completely unsuitable for another. As a starting point, perhaps, investors may look at rating; but evaluating and picking mutual funds need to be done far more thoughtfully.

If you're relying on star-rated mutual fund schemes, try and assess the importance given to quantitative factors (viz. such as risk-return trade-off, performance across market cycles, average AUM (Assets Under Management), portfolio concentration, corpus size, portfolio turnover, and so on). You see, most ratings ignore the qualitative factors (viz. fund manager's experience, number of schemes to fund manager ratio, organisational structure, proportion of AUM performing, unique schemes, investment systems & processes, amongst a host of others), which in our opinion is of utmost importance. For a holistic approach, both quantitative and qualitative parameters are necessary.

Also, don't live under the impression that more the stars, more the returns. It is not necessary that 5-star rated fund will always earn you phenomenal returns. A robo-investing platform could be recommending a 5-star rated fund today; but remember these ratings often change - a 5-star rated fund could be 3-star or 2-star rated fund in a few months down the line. And this actually works in favour of many robo-investing platforms, because with change in ratings, they prompt you to churn your portfolio. Now outwardly, while this is appears good, it gives them an opportunity to earn more vide commissions.

So, it is imprudent to choose funds by their star ratings. In the interest of your long-term financial wellbeing, it is vital to delve deeper in understanding the methodology used for rating funds; because merely relying on star ratings cannot ensure winning mutual fund schemes for your portfolio, or a rock star like performance.

Besides, as an investor, you need to be cognisant of your risk profile, financial goals and accordingly allocate your investible surplus to various asset classes - equity, debt, gold - astutely to avoid going askew, in the interest of your long-term financial wellbeing.

Keep in mind: If a robo-investing platform claims to offer services for free, beware! There are no free lunches. Maybe the advisory is pocketing huge commissions from the funds they recommend.

We are of the view that, if commission are earned by robo-investing platforms / mutual fund distributor / investment advisors vide the advice rendered, they should be fairly and transparently disclosed to you, the investor. If the industry cannot practice this diligently, we vehemently believe, that a commission-driven model in mutual funds should be eliminated.

Similarly, confidentiality of your data has to be given paramount importance. The rise in phishing and cyber-attacks is a huge risk. Robo-investment platforms ought to be extra careful, by ensuring that all cyber safety measures are at their best.

Let us tell you that whenever PersonalFN launches its robo-investing platform, it will be devoid of commissions. Our recommendations will be powered by our in-depth research process, and we will encourage (offer) only 'Direct Plans'. We stand for credibility, integrity, and transparency -we will never compromise on that. Never! Likewise, we respect the privacy of our clients.

We always follow high fiduciary standards, and put your, the investor's, interest at fore. That's been our DNA, and shall always stay with us.

For superlative guidance to achieve your financial goals, you can reach out to our Certified Financial Guardian, the mark of Trust and Respect.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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