Robo-advisors are online investing platforms that allows you to invest in pre-set investment portfolios. They have revolutionised passive investing for many everyday investors.
The use of technology has enabled them to offer similar services to traditional advisors at low cost. This has been a boon for everyday investors for whom a traditional advisor may have been inaccessible due to large minimum investment requirements and high fees.
In this article, we will take a closer look under the hood and discuss the ways in which they can make money. We will also contrast their activities to that of traditional robo-advisors.
1. Management fees
The main way robo-advisors make money is through the management fee that they charge. This fee is usually charged as a percentage of AUM (assets under management). For Islamic robo-advisors this fee is usually between 0.85% – 0.5%.
This is more expensive than conventional robo-advisors who tend to charge fees in the 0.75% – 0.25% range. However they can afford to do this due to the larger customer bases they have and also because they can make money through other means not available to Islamic robo-advisors.
For example, conventional providers earn interest on the cash balances of investors. This could be quite lucrative if a robo-advisor has many clients as the combined cash balance could become quite significant.
However the fees of Islamic robo-advisors still compare favourably to the traditional advisors who charge around 1%. As the Islamic robo-advisors become more established, expect their fees to reduce. In fact, Wahed Invest recently announced a fee change that would make their fees cheaper for most investors. We covered that in more detail here.
2. Other service fees
Robo-advisors tend to charge other service fees related to various types of transactions. This could include a percentage of the amount involved on transactions such as wire transfers, withdrawals and expedited deposits.
This is an area where the main Islamic robo-advisors beat their traditional counterparts. None of the major players like Wahed, Sarwa or Simply Ethical charge separate fees for any transactions as this is all wrapped up in their management fee.
Many savvy robo-advisors cross-sell other financial products and services to their investors. This can include insurance, credit cards or mortgages that they market on behalf of their partners.
Islamic robo-advisors so far have not got down the partner route. Most of them cross-sell their other services. For Simply Ethical, their robo-advisory service is just one of many services they offer, which includes pensions and more active advisory products.
Wahed Invest have made some interesting moves since their inception. In 2019, they launched the Wahed FTSE USA Shariah ETF which is listed on the Nasdaq. This forms part of their core offering for US investors, enabling them to make additional money on the fund costs. It is also open for US public investors to invest through the stock market giving them another source of income.
They also recently announced the acquisition of Islamic digital bank Niyah which will allow them to funnel customers to their other offerings. In the first instance we would expect the focus to be on using Niyah to promote Wahed’s investment options, as Niyah’s current account will not be revenue generating.
However Niyah’s website states that they are working on an SME financing product which would be a great supplementary option to Wahed if they can get it done.
Expect additional products to be offered as these firms continue to mature and grow, which ultimately will be good for the community as we need more good quality investing options.
4. Payment for order flow (PFOF)
Monetising their order flow is another potential source of income for robo-advisors. As they process large amounts of trades on a regular basis, robo-advisors will bundle these together into large block orders. These orders are then executed once or twice a day. This presents an opportunity for them to get better terms as their order sizes are so large and saves them the cost of executing more trades.
Some robo-advisors also receive payment for this order flow from certain market makers. These marker makers want to get their hands on as many orders as they can as they make their money on the spread between the bid (buy) and ask (sell) price. This order data also has value to traders who engage in algorithmic trading. Having access to order data ahead of their competitors could be a major competitive advantage.
It is worth mentioning that this practice only seems to be allowed in the US.
There’s no indication that any Islamic robo-advisors have been engaging in this practice and is unlikely, given most of them have operations outside of the US.
It is also unlikely that Islamic robo-advisors would engage in this any time soon as PFOF is mostly only relevant for direct stock investing as opposed to investing in funds and pooled vehicles. Additionally, all the Islamic robo-advisors we know of, do not own the full back-end technical stack they would need to in order to do this.
Of course we expect Islamic robo-advisors to be bunching the orders together to save on trading costs which is a perfectly acceptable practice and different to PFOF.
Robo-advisors are a great low-cost low-effort investment option for everyday investors. We hope this article has given you additional insight in how they operate.
If you are interested in investing with Islamic robo-advisors, we have done deep dives on Wahed Invest, Sarwa and Simply Ethical. We also recently recorded a podcast with Aghaz Invest, a new roboadvisory option for US based investors. For more on these and other halal investment options head over to our halal investment comparison engine.
This article is part of a series where we look at how different investing providers make their money. Check out our most recent one on zero-fee brokers.