The rise of robo-advisors

Julie Barker-Merz, president of BMO InvestorLine and head of direct investing for BMO, believes the services offered by robo-advisors and banks are complementary. "I do think there's a way for us to co-exist," she said. Still, the bank was the first of the Big Five to launch its own robo-advisor. BMO SmartFolio became available to the public in January following a test by its employees.

There are more than 200 robo-advisors in the United States and about a dozen here in Canada. But many of them are quite similar and the market is becoming very saturated in the U.S., said Jeff Schwantz, head of Morningstar's advisor and wealth-management solutions for North America.

Katchen said the same thing is starting to happen in Canada and predicts that many robo-advisors using "cookie-cutter" solutions could disappear over the next 24 months. He noted that Wealthsimple has its own brokerage and makes all of its trades instead of relying on a third party.

"At the end of the day, this is a scale business," Katchen explained. "And if you have too many players in the value chain that are each taking a cut at these very low-margin businesses, none of them are going to survive."

The conversation also turned to whether or not investors understand what they're investing in when they use a robo-advisor. Barker-Merz said many consumers don't know what ETFs are and mentioned that it's difficult to build trust and credibility with clients if they're confused. "That diminishes the power of a robo-advisor," she explained.

Katchen agreed that most clients don't know what ETFs are. But he said most clients don't care; what they do know is that they should be investing. "The one thing they don't have is time to actually think about it," he said, noting that they'd rather outsource their investment decisions.

Fees were also another topic of conversation. Schwantz noted that robo-advisors in the U.S. are facing strong competition from Charles Schwab, a discount brokerage and banking company, which doesn't charge advisory fees, account service fees or commissions. "It's been a race to the bottom and Schwab went to zero right away," he said. "It's hard to compete with free."

Barker-Merz said fees were a sensitive issue for them before launching SmartFolio because it charges less than BMO Nesbitt Burns, the bank's full-service investment advisory division. "It's a really important sales force for us," she said. "It's a very fine line trying to get right and make sure that we have everybody on board, understanding where it fits within our strategy."

Katchen added that investors will soon know the costs of investment management and advice due to phase two of the client-relationship model (CRM2) reforms. CRM2 will force investment brokers and dealers to provide an annual report disclosing investment fees and other charges. Fee disclosure will create visibility and transparency, which he believes will be good for both the industry as well as investors.

The issue of the regulatory landscape was also examined. In the time leading up to Wealthsimple's launch, Katchen said there were many conversations with regulators about the need for robo-advisors. He said a new model needed to exist where clients didn't meet face to face but were still given access to support and advice. It took many months of meeting and collaborating with regulators to get the model right.

The industry is still being ruled by concepts that were created 25 years ago, Barker-Merz said, adding that the regulators are doing the best they can with the pressures they're getting from consumers and the government.

What does the future hold for robo-advisors and the rest of the financial services industry?

Wealthsimple continues to plan to cater mainly to young investors. It has advisors and planners who can facilitate introductions and relationships for those who have additional planning and tax needs. Katchen believes Wealthsimple will evolve to where it can do more for various clients. And he predicts the robo-advisor industry will evolve to serve all the different segments. However, it's just not his company's area of focus right now.

As investors accumulate more assets, their needs will be greater and complexity will become more of a concern, said Barker-Merz. She said that Nesbitt Burns advisors will offer SmartFolio to children of some of their clients because they don't have those concerns just yet. While financial planning is an important piece of its wealth management solution, she said it's still too early to see how that complements its robo-advisor business.

Instead of trying to take market share away from competitors, Schwantz believes the financial services industry should focus on providing solutions that are more relevant to investors. Robo-advisors are attracting clients who haven't been investing with traditional advisors. There's an opportunity for robo-advisors to "go into the markets that aren't being served today."