Has Anyone Checked On The Robo Advisors?

Herb Greenberg essentially asked that question on Twitter looking for information about how the robo advisors have held up through this bear market. Robo advisors automate investing for customers. People answer questions, the robo builds an asset allocation based on the information provided and then rebalances accounts automatically.

The funds used are typically the lowest cost indexed products an the management fees charges are also very low. There might be a human for customers to call but the implementation and management of portfolios can happen without human interaction. The first to market were Wealthfront and Betterment and since then many of the online brokerage firms have also rolled out some version of this service. 

Herb said this event should be a good test for the robos. One thing I don't understand about that is if a robo offers automation with strict rules for rebalancing then their customer portfolio will be down the full brunt of this event. That's ok. If they are supposed to be in the market fully invested, then on the occasions that markets go down then the robo portfolio would go down in corresponding fashion. I see no problem with that as long as that expectation is set for customers.  

A few years ago, to the surprise of everyone, Wealthfront put together a mutual fund targeting risk parity with symbol WFRPX and included it in some of their customer portfolios. 

 

Here you can see it compared to RPAR that we looked at yesterday since RPAR's inception. More on Wealthfront, it was acquired by UBS back in March. Other news came this week about Schwab (client holding) having to reimburse customers because it held too much in cash for its robo advisory clients. As best as I can tell, since their robo service is free, Schwab allegedly put cash in money market funds which are typically profit centers for brokerage firms. 

I obviously have no idea about intent or understanding but using something like SPDR Bloomberg 1-3 Month Treasury ETF (BIL) as a cash proxy probably would have prevented the problem and based on this chart, seems to be a reliable cash proxy.

I had two occasions this week to Tweet that robo advisors seem like a 1.0 version of something better to come. What that something is, I don't know but want to try to work through here. 

If you recall from last month, I hate target date funds. I think setting your retirement fund to someone else's automated glide path is a bad idea. There is some of that in how I view robo advisors. I am not a believer in static asset allocations. There are times to dial up or dial down equity exposure and for years, the fixed income exposure I've had on for clients looks nothing like an indexed bond fund/portfolio. And while Wealthfront apparently has/had room for alternatives, as we discussed yesterday, I'm not sure when the time will come for risk parity but it has been a long time since owning it was optimal. 

I've had good luck with other types of alternatives, Larry Swedroe has had good luck with other alternatives and I just had an email conversation with a buddy who is also a portfolio manager who has had good luck with alternatives. Recently, I've added in a little short term traditional fixed income exposure and at some point, it will make sense to dial up the fixed income exposure more while dialing down the exposure to alts. I wouldn't expect robo advisory models as they are now to capture that. And with respect to the fine Schwab paid for having too much cash, there are times where you do want more cash, or BIL, whatever, to manage sequence of return risk. 

Maybe the 2.0 version moves off the brokerage firm platforms and on to the blockchain, just kidding, but maybe the models are sold as subscriptions for the investors to implement themselves or maybe some sort of third party who can access customer accounts at brokerage firms which seems like it would avoid the cash balance issue that was problematic for Schwab.

Part of doing it yourself that is difficult is the overwhelming number of choices of funds. ETF.com shows 2944 ETFs and I prefer to be open to the possibility that traditional mutual funds can be part of the solution, I use a couple for clients and what about individual stocks? The typical person not wanting a lot of engagement but not wanting to hire a more traditional manager will reasonably glaze over at the prospect of sifting through 3000 ETFs. I think they might glaze over sifting through 1/10th of that number. 

There are 437 large cap domestic ETFs. This chart shows some of the largest, plainest vanilla ETFs. There are other plain vanillas too and they are all going to look like the ones charted. How much time is the typical investor going to spend choosing among this batch?

 

In the large cap domestic realm there are plenty of style ETFs (value versus growth) and factor ETFs too. I don't think the typical investor, meaning one that is minimally engaged, is going to try to guess on value versus growth. There can be serious dispersion between the two and guessing wrong could be costly. 

There are plenty of factor or fundamental large cap equity ETFs that investors could consider but there is a pretty serious error waiting to happen with that. No factor can always outperform simple market cap weighting. The worst thing to do would be to hop from factor to factor chasing the one that just worked. A less serious error would be giving up on a factor after an extended period. I am not against factor ETFs but anyone going down the road of a factor ETF should be prepared to stick with it.

This dynamic supports the idea that plain vanilla is simpler. Where many of them will all capture a similar effect with the most important decision being to be in equities in the first place, why not make it as simple as possible?

So could robo 2.0 offer a very abbreviated list of ETFs in each asset class to choose from as customers build their own portfolio after the robo 2.0 has done the sifting for them? Robo 2.0 could suggest asset allocations, make it visually simple with onscreen sliders for each asset type and give portfolio statistics for what ever mixes the customer is experimenting with. The could provide standard deviation and R-squared but give them less intimidating names. And the robos could also provide coaching about when or if to tweak asset allocations for as much as someone did want to engage. 

If a robo 2.0 is not affiliated with a fund company or a brokerage firm and does not custody assets then they can be agnostic about products chosen and there's no conflict in recommending cash. Customers would pay a subscription fee not based on assets. There could be tiers with add on services of advice for anyone so inclined, it could scale up as someone got older and needed more help. Our financial lives at 25 are whole lot simpler than at 55. 

A work in progress.