A research paper which focuses on the impact of using a Robo advisors on traditional investment managers.. The Robo advisors are newly evolved technology that has given a collaboration between both finance and technology, this has created the concept Fin Tech across globe. The introduction of Robo advisors into the financial market has majorly affected the old and traditional investment advisors. According to the review of literature, it is been proven that Robo advisors charges a low fee than the traditional investment advisor. The data is collected from a primary source, which is mainly from Aditya Birla capital in Madurai. We have also found that the middle income investor invest into the instruments for the purpose of savings. The study has been limited to the middle income investor in Tamilnadu, India. As India is a growing economy where most of the country’s development is being contributed by the middle class households. Their average salary is one lakh rupees per month. The factors that affect the middle income investor’s investment pattern are their monthly household expenses, unexpected expenses that raises, other psychological factors. The other important reasons for the middle income investors to invest is tax benefit and some of them invest in order to create a regular secondary source of income, such middle income investors are most likely to invest in the fixed income instruments. In this type of situation, the Robo advisors are more helpful to create an investment pattern for the middle income households according to their objectives and expectation out of the investment in low fee charges.
A Portfolio is group of financial assets such as stocks ,bonds, Commodity,Currencies and cash equivalents, it also includes the fund counter parts including mutual ,exchange traded and closed funds. A portfolio can also consist of non publicly traded securities, like real estate ,art and private investment.Portfolio are directly held by investors and/or managed by financial professionals and money mangers.Investors should construct an investment portfolio in accordance with their risk tolerance and their investing objectives.Investors can also have multiple portfolio for various
purpose. It all depends once objective as an investor.
Portfolio Management-Portfolio Management is the art and science of making decision about investment mix and policy, matching investments to objectives ,asset allocation for individuals and institution and balancing risk against performance.Portfolio Management is all about determining strengths , weakness , opportunity along with threats in choice of debt vs equity, domestic vs international, growth vs safety and many other trade offs encountered in attempt to maximise the return at given appetite of risk.
Portfolio Approach-Evaluating individual securities in relation to their contribution to the investment characteristics of the whole portfolio.
Steps in Portfolio Management process-
Step 1: Planning step- this includes a return planning document that describes the clients investment objectives and the constraints that apply to the clients portfolio. This known as investment policy statement(IPS). IPS may state a benchmark such as a particular rate of return or the performance of a market index that can be used to assess the investment performance.The IPS should be reviewed and updated regularly-whenever there is a major change in clients objective constraints or circumstance occurs.Understanding the clients needs further includes their specification with respect to taxation ,liquidity, legal aspects etc.
Step 2: The Execution step-This step involves constructing a suitable portfolio based on the IPS. This step consists of Asset allocation,Security analysis, and Portfolio constructions.
Asset allocation involves assessing the risk and return characteristic of Available investments, Economic and Capital market expectations along with distribution between various asset classes.
Asset allocation consist of two approaches which are:
a. Top- Down Approach(This investment analysis includes examining of economic growth, monetary policy by central bank and bond prices and yields)
b. Bottom-Up Approach(This involves analysis of a particular companies Financial ratios, Earnings, Revenue, Sales Growth, Financial analysis, Cash flow, Management performance and the company’s Products and Market share.)
Security Analysis- Analysts uses their detailed knowledge about individual industry and specific companies to arrive at a investment selection decision. Analyst assess the expected level and risk of cash flows that each security will produce.
Portfolio Construction- It is based on Target asset allocation , Security analysis, Clients requirements based on the IPS. Portfolio Management should ensure the risk in the portfolio is consistent with the risk level as mentioned in the IPS. Portfolio construction phase also involves trading.
Step 3: The feedback :helps the portfolio manger rebalancing the portfolio arising out of change in market conditions or the circumstance of the client .
Types of Financial Instrument:
1. Shares- This is a unit used as mutual funds , limited partnership, and real estate investment trust. The owner of shares in the corporation is a shareholder of a corporation. The risk involved and the return from investing in the shares are high.
2. Bonds-This is an instrument of indebtedness of the bond issuer to the holder.The common types of bonds include municipal bonds and corporate company. Most bonds pay fixed rate of interest income that is also backed by a promise from the issuer.
3. Cash Equivalents-These are the most liquid current asset found on a business balance sheet. These are short term commitments (It carries an significant risk of changes in the asset value).
4. Properties and Commodities-These include agricultural products, energy sources and metals. These helps in reducing the overall portfolio risk and return.
5. Pooled investments
5a. Mutual Funds- It is a common pool of money into which investors put their contributions to be invested in accordance with a stated objectives. This involves Market risk,
Inflation risk, Credit Risk, Interest rate risk.
5b. Exchange traded funds- An ETF holds assets such as stocks, commodities, or bonds and generally operates with an arbitrage mechanism design to keep it trading close to it net asset value although deviations can occur occasionally.
5c. Separated Managed Accounts-This is fund management service for institutions or individual investors with substantial assets (Large minimum investment) . The assets are managed as per the investors objectives,Risk tolerance and tax situations.
5d. Hedge funds – These funds help in covering the risk to which the primary portfolio is exposed to or other market risks.
5e. Buyout & Venture Capital Funds – Buyout funds typically buys all the shares of a public company and convert them to private company.
Venture Capitalist invest in start ups and play an active role in the management of the company where they have invested . These investors bear a high level of risk.
Diversification is the process of allocating capital in away that reduces the exposure to anyone particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in variety of assets. It helps to avoid disasters investment outcome.This approach helps to reduce the risk without necessarily decreasing the expected rate of return which means it provides equivalent expected return with lower over all volatility.
Equally weighted portfolio return and randomly selected security returns are the same but with standard deviation is far lesser in an equally weighted portfolio.This is due to the portfolio correlation and interaction between different securities in the portfolio.
Diversification Ratio = Standard Deviation of Equally weighted portfolio /
Standard deviation of randomly Selected Security
Portfolio help to avoid the effect of downside risk associated with investing in a single security .
Selection of optimal portfolio are done by examining additional combination the same set of shares in different proportions and then observe the risk return trade -off for each of those combinations and then select the portfolio based on the best combination of the risk and return.
However, Portfolio diversification not necessarily offers down side protection because in diversification approach the decision is based on co-movements, and co- relations that is derived out of the past data and these historical co-movements patterns are bound to change and also in times of severe market turmoil the investor does not experience the expected risk return projected through diversification approach.
Types of investment Clients
The investment clients are broadly classified into two types :
• Individual Investor:(the below are listed in the order of importance of purpose for allocation of the individuals capital)
a. Life Insurance
b. Health Insurance
c.Emergency reserve funds
d. Investment towards goals
• Institutional Investors
a. Defined Benefit Pension plans
b. Endowments & Foundation
d. Insurance company
e. Investment Companies
f. Sovereign Wealth funds
Valuation of Stocks
There are three methods in the valuation of stock namely:
1. Income approach – It is based on the theory that the value of a business is equal to the present value of its projected future benefits.The method used to value the stocks in this approach is the dividend discount model in which the value of the company stock price is based on the theory that its stock is worth the sum of all its future dividend payments , discounted back to their present value. The equation used in this model is known as gordon growth model.
Value of Stock = Expected Dividend Per share / ( Cost of Capital Equity-Dividend growth rate)
Which is represented as,
• Value of Stock = D / (r – g)
• PV of High Growth Dividends = D1 /(1+r)^1 + D2 / (1+r)^2 + …..+ Dn /(1+r)^n
• PV of Stable Growth Dividends = Dn / (r – g)
2. Market Approach – It is a method of determine appraisal value of an asset, based on the selling price of a similar item. It is in fact a business valuation method that can be used to calculate the value of property or can also be used as a valuation process for a closely held business. It involves public company comparable and precedent transaction. Some of the most commonly used multiples for comparison are as follows.
• Price to Earnings
• Enterprise value/ EBITDA
• Return on Equity
• Return on Asset
• Price to Book value
3. Asset Approach – An asset based approach is type of business valuation that focuses on a company’s net asset value or the fair market value, of its total assets minus its liabilities to determine what it would cost to recreate the business it is subjective as to which of the company’s asset and liabilities to include in the valuation and how to measure the worth of each.
Apart from the above mentioned valuation that helps in determining the value of the stock in order to help the investor in making the investment decisions, there are a few physiological factors that may majorly influence the investors behaviour or decision irrespective of the actual stock market situation or the asset value.
Physiological Factors- It means Thoughts, Feelings, and others cognitive characteristics that influence the behaviour, attitude, and functions of the persons mind. The physiological factors that describe the individual investor behaviour will depend on the person’s personality and his characteristic. The below mentioned are few physiological factors that may influence the investor behaviour
a. Over confidence
c. Fear of Loss
d. Hurt Behaviour
e. Cognitive bias
There are a few economic factors that can affect an investors decision making or behaviour:
1. Overall Performance of the company- It means the analysis of the company’s performance by evaluating its
a. Financial Performance
b. Market Performance
c. Shareholder Value
2. Price Movement Information- Price fluctuations affect the pattern of investing. It is said that volatility in prices and manipulation is the main cause of worry for retail investors.
3. Risk Aversion- Investors have different capacity to bear risk hence have different types of investment and individual who expects to generate higher return will invest in the securities with high risk whereas, risk avoiding investors will invest in securities with lower risk. It is suggested that risk tolerance level decreases with the increase int age of the investor.
4. Risk -Taking Capacity- Investors invest in volatile investments in order to get higher profits than average.
5. Profitability- When investor invest their money, their main purpose is to earn profit on it. They do not hesitate to invest on risky securities because they think that high risk can give them higher return. Level of annual earnings/ income and their savings affect the decision making of an investor.
Functions of Traditional Portfolio Manager
Portfolio manager is an individual who develops and implements investment strategies for individual or institutional investors. Usually, Portfolio manager positions are in line with hedge funds, pension plans and private investment firms or as part of an investment department of an insurance or mutual fund company.
In most cases, a portfolio manager follows a pre-determined for investment dictated by an investment policy statement to achieve a clients objective. The traditional portfolio management requires basic knowledge and understanding in field of the financial investment.
Roles and Responsibilities of a Portfolio Manager:
• A Portfolio manager is responsible for making and individual aware of the various investment tools available in the market
• A Portfolio manager is responsible designing customised investment solutions for the clients
• A Portfolio manager must keep himself updated with the latest changes in the financial market
• A Portfolio manager ought to be unbiased and tough professional
• A Portfolio manager needs to be good decision maker along with communicating with their clients on a regular basis in order to meet the set financial goals of the client
• Do not forge or sign on behalf of your clients.
• Independence and Objectivity – Members and Candidates must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities. Members and Candidates must not offer, solicit, or accept any gift, benefit, compensation, or consideration that reasonably could be expected to compromise their own or another’s independence and objectivity.
Robo Advisors: An online application that provides automated financial guidance and services.
Robo-advisors (robo-advisers) are digital platforms that provide automated, algorithm-driven financial services with little to no human supervision. A typical robo-advisor collects information from clients about their financial situation and future goals through an online survey, and then uses the data to offer advice and/or automatically invest client assets.
History of Robo Advisors:
The first robo-advisors were launched in 2008 during the financial crisis . In 2010, Jon Stein, a 30-year old entrepreneur, launched for easing way of selecting the portfolio, and roboadvisors increased in popularity. The first robo-advisers were used as online interface to manage and balance client’s assets by financial managers. Robo-adviser technology was not new to this field, as this kind of software has been in use by financial advisers and managers since early 2000’s. But they were made publicly available in 2008 for the first to general public who were in dire need to manage their assets personally. By the end of 2015, robo-advisers from almost 100 companies around the globe were managing $60 billion assets of clients and it is estimated that it will hit $2 trillion by the end of 2020.In June 2016, robo-advisor Wealth front announced a partnership with the Nevada state front to offer a 529 plan for college savings. In 2017, Betterment raised $70 million of financing and Personal Capital raised $40 million of financing.
In 2016, Hong Kong based 8 Securities launched one of Asia’s first robo-advisors. In 2017, Singapore based Stash-away received a capital markets services license from the Monetary Authority of Singapore.
While robo-advisors are most common in the United States, they are also present in Europe,Australia, India, Canada, and Asia In Canada, BMO SmartFolio and Wealthsimple are examples of robo-advisors.
Mechanism of Robo Advisors;
The tools they employ to manage client portfolios differ little from the portfolio management software already widely used in the profession. The main difference is in distribution channel. Until recently, portfolio management was almost exclusively conducted through human advisors and sold in a bundle with other services. Now, consumers can access the portfolio management tools directly, in the same way that they have obtained access to brokerage houses like Charles Schwab and stock trading services with the advent of the Internet. Roboadvisors are extending into new business avenues.
The customer acquisition costs and time constraints faced by traditional human advisors have left many middle-class investors who are underadvised to get a better advice to invest in the portfolio with help of the robo advisors easily. The average financial planner has a minimum investment amount of $50,000,while minimum investment amounts for robo-advisors start as low as $500 in the United States and as low as £1 in the United Kingdom. In addition to having lower minimums on investable assets compared to traditional human advisors, robo-advisors charge fees ranging from 0.2% to 1.0% of Assets Under Management while traditional financial planners charged average fees of 1.35% of Assets Under Management according to a survey conducted by AdvisoryHQ News.
In the United States, robo-advisors should be registered investment advisors, which are regulated be Security and Exchange Commission (SEC). In the United Kingdom they are regulated by the Financial Conduct Authority.
Assets Managed under Robo Advisors:
As of October 2017, robo-advisors had $224 billion in assets under management.
The following are the largest robo-advisors by assets under management:
Company Country AUM (millions of US$)
The Vanguard Group
Charles Schwab Corporation
Great Britain 751
Apart from B2C, there exists large B2B players that provide Robo-advisory platforms to Banks, Wealth Managers, Insurance firms and other professional players in the industry. They use sophisticated algorithms for goal based investing and efficient financial planning. Some firms capitalising on Machine Learning technology, provide more innovative building block complimenting the platform.
Benefits of Robo Advisory Services:
• Minimal human error -Leaving a “robot” to manage your money and investments might feel uncomfortable initially. But a lack of unintended errors that come with being human is one of its biggest benefits. There’s no panicking and selling off a stock too early and no messy emotions that can get in the way of long-term financial growth.
• Lower fees – The cost of an automated adviser is typically less than what you’d pay for a human one.
• No awkwardness – If you’ve ever been in the uncomfortable situation of not getting along with your financial adviser, you’ll appreciate this benefit. Turns out, robots don’t mind being fired when it’s not a suitable match.
Drawbacks of Robo Advisory Services:
• Automated advisers can’t get to know you- Even the most sophisticated computer algorithm is still an algorithm. It can’t sit down with you, it can’t explain things to you and it certainly can’t listen to your dreams about the future.
• Robo-advisors can’t handle complex portfolios- These advisers aren’t best for overly complicated portfolios. The rule of thumb is that assets of six figures or more need the human touch.
• You might find it difficult to lose control- You’re always in control of your finances technically, but you might not be ready to hand over the reigns of your portfolio to a robot. If you prefer a more hands-on approach to digital guidance, a robo-advisor might not be a great fit.
• You can’t auto manage employer retirement plans – This software can’t do much with retirement plans like 401(k)s, so putting any money in a robo-advisor for a plan like that won’t do you much good.
List of few popular as well as emerging robo advisory players in India.
• Angle Broking – ARQ
Middle Income Class in India:
An Annual Household Income of a family less than 90 Thousand INR in India is considered as Poor Class. Income Between 90–2 lacs per annum is in the Low income Group or Class. Between 2–5 lacs per annum is considered in the Middle Income Group. Between 5–10 lacs you are in the Upper Income Group Category.
Middle income investor’s major choices of Investment:
The middle income investor will be always having priority towards keeping the money as a cash and some will want to spend them on their needs but they also think about investing the money into many other wise investment plan. They also prioritise their money on the basis of their situation such as emergency, insurance, child’s higher educations etc.
Their Investment avenues are as follows:
1. Recurring Deposit : Very reliable source for building fund for emergency (Immediate action)
2. 2. Endowment Plan: Best plan which can give both returns and life insurance. But endowment plan is non linked with life insurance plan that offers the two- fold benefit of insurance and investment
3. Child Plan: This mainly focuses on the child’s higher education and other needs. Major future expenses such as Education and marriage . This plan can be also used as collateral loans for the Childs benefit.
4. Index fund: Best investment plan to the retirement life of the investors. The first best example is mutual fund. The index fund also include different types of companies.
5.SIP in Diversified Equity Mutual Fund: This investment plan helps building the wealth of the investor. It more diversified equity mutual fund but its more risky option than a index fund and also has equal amount of return at the same time.
...(download the rest of the essay above)