How Do Robo Advisors Work - The ROP Model explained

The model (ROP model) developed as part of my master's thesis provides an overview of the structure of Robo Avisors. The three main components of the model are explained in this article.


ROP Model

The term ROP model describes a Robo Advisor model consisting of three components:

  • Risk profile of investors
  • Optimization of portfolios
  • Portfolio management

It is important to note that the determination of risk profiles and the optimization of portfolios are detached from each other.

Risk Profile of Investors

The creation of a thorough risk profile is mandatory from a regulatory point of view. The regulatory framework is based on laws and guidelines to which traditional asset managers are also subject. Robo advisors request relevant information for the creation of risk profiles with the help of online questionnaires. Investors must thus provide information about their personal situation, financial knowledge and financial experience. In addition, they must determine the objective of their investment. When an asset management contract is concluded between a robo advisor and an investor, the investment strategy is already contractually stipulated and targets are set on the basis of key figures, such as benchmarks.

Optimization of Portfolios

Detached from the determination of risk profiles, robo advisors select investment products from a defined investment universe. Portfolio optimization is used to create "efficient" portfolios based on investment products. Regulatory requirements stipulate that processes must be clearly defined and optimization algorithms must be continuously monitored.

Portfolio Management

By combining risk profiles and efficient portfolios, optimal target portfolios can finally be simulated for investors. Based on target portfolios, investors are invested in their own actual portfolios. If deviations between actual and target portfolios become too large, a "rebalancing" of investor portfolios takes place. 

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