by Ken Schapiro
The founder and publisher of The Robo Report explains what it covers and discusses trends in the robo industry.
There has been a proliferation of financial technology enhancements in the last several years, one of which has been the creation of robo-advisers. These algorithmic investment tools offered through name-brand investment companies, including Schwab and Vanguard, offer individual investors an automated way to invest with a low fee.
There previously has been no information available to the public as to the investment performance of these services, what investments they held, or what trades they made—aside from the small handful of firms that disclose model portfolio information on their websites. We thought it was time to do some research into these robo-advisers to better understand how they work for individual investors and to create transparency. We’ve published our findings for free in The Robo Report.
The technology used by robo-advisers is being implemented in different ways across the industry. Some services automate their entire investment process, from new client prospecting and onboarding to the investments made and subsequent management of the account. At these “pure robo-advisers,” clients do not have an adviser to help them make investment choices or answer questions and must rely on the technology and digital platform for advice. Other robo-advisers include, or offer for an additional fee, a live adviser to help clients with their investment needs. These solutions are often called “hybrid robo-advisers.” Some traditional firms are leveraging the technology seen in robo’s to help them increase efficiency and elevate their client engagement and communication while maintaining a more traditional advising relationship.
Trends in the Robo Industry
As we watch the robo industry, we see two trends: robo services adding an option to speak to a live adviser, and larger broker-dealers developing similar capabilities for their existing advisers or rolling out separate robo-advising platforms. We see both the internal development of these technologies as well as adoption through merger and acquisition activity. Over the past year, we have seen Ally Financial acquire TradeKing and rebrand the service to “Ally Invest Managed Portfolios”; JP Morgan Chase, Morgan Stanley and Wells Fargo all announcing robo offerings; Goldman Sachs rumored to be developing one; and Betterment, one of the largest robo-advisers, introducing services that include live advisers. Charles Schwab, which originally just had Schwab Intelligent Portfolios (a fully automated service) recently launched Schwab Intelligent Advisory, which will follow a hybrid robo model. Regardless of the implementation, we are seeing a consistent trend of robo-technology gaining traction across the industry. Investors will be seeing these tools in the investment space with greater frequency.
Over the time we have spent covering the robo-advising industry, we have found some key takeaways as to what these platforms provide to investors and advisers.
The first feature is automating client prospecting, onboarding and communication, which we believe is the largest component of what the technology offers. Some robo-advisers are implementing free tools or aggregation of their existing accounts to initially attract users. Robo-platforms walk customers through an automated questionnaire process at onboarding, resulting in a risk tolerance determination and a suggested asset allocation. At the end of the process, a customer may have an account opened, funding instructions completed, and an allocation based on risk tolerance ready to be implemented, often without any communication from a live adviser. The cost savings from decreased time and paperwork spent on onboarding can be passed on to the client.
The automation in communication does not stop there. After opening an account, regular updates can be generated automatically. Many of these robo-solutions will regularly send clients information specific to their account or other investment-related content. The same technology that allows robo’s to generate these automatic updates can also be used by traditional advisers seeking to efficiently increase their client engagement.
The second large takeaway we have from looking at these solutions is about the actual account management and strategies being implemented. For the most part, we do not see complicated, algorithmically driven strategies in the portfolios we have opened. After a sleek onboarding and account-opening process, we mostly see traditional, low-cost ETF (exchange-traded fund) strategies being implemented. Once these low-cost, well-diversified portfolios are put into place, we typically see very little trading activity.
The strategies spread the investments out across industries and global markets.
This type of strategy is appropriate for many individual investors and was gaining popularity well before robo-advisers. So the term “robo” does not typically mean an advanced or complex trading strategy; it more likely means an automated, low-cost solution to direct investors into an appropriately passive strategy.
Robo-advisers almost always offer automatic rebalancing and sometimes include tax-loss harvesting. Rebalancing helps accounts stay within their initial asset allocation and keep a portfolio from drifting too far from its intended allocations as assets grow at different rates. Tax-loss harvesting adds value under certain market and funding conditions; however, given recent market conditions, we have seen it implemented very few times in our portfolios. Because of the upward trending markets since opening our accounts, there have not been many losses, realized or unrealized. We look forward to seeing how the tax-loss harvesting functionality works when market conditions change.
Our third large takeaway is that the specific portfolio holdings a robo-adviser buys for an investor is the most important driver of returns. With any manager, the asset allocation is usually the largest determinate of returns, not whether the funds are actively managed or indexed, and the robo portfolios are no different.
The Robo Report
When opening accounts, we sought to present the same risk profile to each robo-adviser. For the taxable accounts, we sought a moderate allocation of approximately 60% stocks and 40% bonds for an investor in a high tax bracket. As for the IRAs, our goal was to have the most aggressive (highest stock) allocation. Starting with a similar baseline allocation across the portfolios allows us to measure performance and compare how our funds are invested as equally as possible on an ongoing basis. Although the overall equity and bond allocations are very similar across accounts, the allocations making up the accounts can vary quite a bit.
Robo-advisers cited in the report include Acorns, Betterment, Ellevest, E*Trade (ETF and Hybrid), Fidelity Go, FutureAdvisor, Personal Capital, Schwab Intelligent Portfolios, SigFig, TD Ameritrade, TradeKing (Core and Momentum), Vanguard Personal Advisor and WiseBanyan. The most prominent, largest and well-known robo-advisers were chosen to participate in this study. Firms that requested to be excluded were not included.
Figure 1 shows an example of the allocation breakdown table displayed in The Robo Report. These allocation breakdowns are available for both IRA and taxable accounts and information is included on minimum investment per account and respective fees.
Within the equity portion of accounts, we see the allocation to international equity close to 10% and upward of 50% of total equity, depending on the adviser. Within international equities, some portfolios have no exposure to emerging markets, while others have significant exposures.
On the fixed-income side, we see varying levels of risk, with some portfolios taking on large international bond or high-yield exposure, while others stay mostly within government and investment-grade corporates.
These allocation decisions are the primary drivers of performance. For example, in the first quarter international, especially emerging market, equities did quite well. SigFig’s large allocation to both an emerging market equity fund and an emerging market government bond fund helped propel the portfolio to top performer in the first quarter. Another example of how different these portfolios can be is the fixed-income portion of Schwab and Vanguard. Vanguard allocates all of their fixed income to municipal bonds, while Schwab has well over half of their fixed-income allocation in international or high-yield bond funds. The riskier assets that make up Schwab’s fixed-income assets, compared to the more conservative assets held at Vanguard, help explain Schwab’s higher-fixed income returns.
Figure 2 shows the taxable account performance net of fees for each of the robo-advisers tracked. During the first quarter of 2017, SigFig was the best-performing strategy, gaining 5.21%, while Acorns was the worst-performing strategy, gaining 3.48%. Over the last year, Schwab Intelligent Portfolios is the best-performing robo-strategy, gaining 12.02%, while the lowest return was 8.14% from Acorns. With returns this divergent, it is important for investors to do their due diligence and make a considered decision when selecting a robo-adviser.
Figure 3 shows the best-performing taxable robo-adviser portfolios during full-year 2016, separated by equity, fixed income and total portfolio, further demonstrating how performance can change quarter to quarter and year to year. The portfolios haven’t been around long enough to determine a true long-term outperformer, and they have yet to be tested in a bear market.
The Robo Report also publishes information on the risk of the different strategies. It’s important for an investor to analyze risk in order to truly understand performance. Figure 4 shows risk measures for the portfolios tracked. Two different metrics: standard deviation and the Sharpe ratio. Standard deviation is a measure of volatility, while the Sharpe ratio is a measurement of risk-adjusted returns. A higher Sharpe ratio implies higher returns for each unit of risk.
Going forward, The Robo Report will continue to be published on a quarterly basis and will include performance data, portfolio makeup and robo news. Along with reporting performance on a quarterly basis, the Robo Report will show each portfolio’s structure and how it was invested, as well as contributors to/detractors from performance.
As the report evolves, we will continue to add important data points and facts for existing robo’s, while adding new robo-advisers to the study as appropriate. By providing a clearer look into robo-advisers, we hope that consumers can evaluate them properly and truly understand their differences.