Robo advisors, algorithmic trading & investment management: Raghu Kumar, Co-founders of RAIN Technologies
Wonders of fourth industrial revolution in financial markets
In the history of time, there have been three industrial revolutions while the fourth is still underway. We can define an industrial revolution as the introduction of technology to fundamentally and rapidly create a change in the way society undertakes an activity.
The first industrial revolution was the advent of the steam engine, the second was the age of science & mass production while the third was digital revolution, bringing internet & software on the cloud.
Now, that the fourth industrial revolution is underway, it involves using technology to fundamentally rethink how we approach money management via the financial markets. Essentially, with the advent of Robo advisories and algorithmic investing/trading, we can look for technology to completely manage our finances in a fully automated manner with no human intervention.
Understanding Robo advisors
Robo advisors are now as common as any other financial advisory product, both in India and around the world. Robo advisors currently manage $460 billion, and the industry is expected to grow to $1.2 trillion by 2024.
Traditionally, individuals had two options for money management: either do it yourself with an online/offline broker, or deal with a human financial advisor. Robo advisors provided a third option, drastically bringing down costs associated with the account opening and general maintenance charges while providing a turnkey solution for money management.
In a nutshell, a Robo advisory takes your information & buckets you into a group of similar individuals based on your risk tolerance, financial goals, and other inputs specified by you. Using pre-built algorithms, the Robo-advisory automatically takes trading and investing decisions on your behalf. Popular Robo-advisors in the US includes Betterment ($21 billion AUA) & Wealthfront ($13.6 billion AUA), while Scripbox (approx. $200 million AUA) and Kuvera (approx. $1.97 billion AUA) are popular choices in India.
Robo advisors come in different forms. In the US, there is generally a wider selection of Robo advisors in terms of what they invest into (stocks, bonds, futures, ETFs, etc) while in India, the leading players generally only invest in mutual funds.
Passive vs active investing and bringing algorithmic trading to the limelight
At face value, there seems to be a little downside when it comes to opting into a Robo advisory. Now, you have a fully automated, algorithmic solution for your investing and trading needs! You can specify a goal, enter your risk preferences, and voila - the machine does the magic!
Not so fast!
Robo advisors still fall into the ‘passive investing’ category, meaning, once the algorithm lumps you into a group with other users, it’s not going to ‘actively’ do much for you. Robo advisors club you into a group of thousands of other similar individuals, and it’s not geared to generate aggressive returns for the end-user.
What if you did want to potentially handily beat the index using an active investing approach but algorithmic in nature? Enter algorithmic trading!
Due to the advent of algorithmic, API-based trading, technology-enabled solutions providers (like Small case and RAINFUND) can have algorithms running on your account utilising an active investing philosophy. Simply put, you can opt to subscribe to active investing strategies, which are looking to generate aggressive risk-adjusted returns for you. Quite often, these strategies utilise intraday trading strategies, something a Robo advisory will never do!
In our opinion, one can look to opt in to an active investing or trading solution if they are looking to potentially generate aggressive returns on a risk-adjusted basis. You can consider investing a percentage of your investable assets into active strategies, and the rest into passive strategies. Anywhere between a 10:90 to a 30:70 active: passive ratio can do wonders as it provides you an instant hedge against the overall market movements as most passive strategies are geared to be correlated with the market at some level.
The bottom line:
The introduction of Robo advisors marked the onset of the fourth industrial revolution. The advent of new, cutting-edge technology has allowed individuals to opt into services, which dynamically & automatically manage their money for them at tremendously low costs. However, these Robo advisors have generally utilised a passive investing approach, looking to mimic an index or mutual fund’s return profile for their clients. With the introduction of API trading across India, users can opt for active investment solutions as well. This gives them an opportunity to aggressively beat a typical index or mutual fund return profile.
At the end of the day, you can't go wrong with either option, as long as you are actively participating in the current industrial revolution’s tide.