After a client is onboarded, Lu suggested that further customization of their portfolio could be accomplished via a follow-up with a human advisor.
Suitability assessments like questionnaires should be tailored to the clients’ goals and the services offered by the advisor. The simpler the services, the fewer the inputs a robo-advisor would need to design an investment plan.
Digital advisors should also use algorithms designed using generally accepted investment theories, and investment professionals should be closely involved in the development and oversight of algorithms, says Lu.
“We believe that algorithms have to be flexible,” he notes. “The algorithm’s job is to deliver the spark, the investment perspective of a human office or CIO. If they have new insights or new research that alters their perspective, that should be reflected in the algorithm by way of an adjustment. It’s not a machine deciding what to aim for, it’s a machine that reflects a human assumption on market and portfolio behavior.”
Algorithms should also match advisors’ stated investment strategies and analyze investments for a number of factors including performance, transaction costs and management fees. If a third party develops the robo-advisor’s algorithm, the advisory firm should conduct “a robust” due diligence.
Robo-advisors must clearly disclose fees and other forms of compensation prior to the provision of services, as well as any risks clients may incur from investing in a portfolio or a security.
Disclosures should also be clear and easily available to the end client so that they are able to evaluate and compare the performance of a robo-advisor.
Robo-advisors could be a boon to advisors trying to comply with the U.S. Department of Labor’s fiduciary rulemaking, says Lu.
“There are natural things that digital advice providers can help with,” Lu says. “They can record all of the factors that went into a particular portfolio decision for a single client at the time that decision was made by the algorithm and why it made sense, and they can do it in a systematic way. Robo-advisors can be a solution to the disclosure and documentation concerns that the DOL rule has raised.”
Robo-advisors should also have policies and procedures in place concerning their trading practices, including controls to mitigate risks associated with trading and order handling. Those polices should include rules for the bundling of orders, fair allocation of trades to clients and the resolution of trading errors.