Abnormal Returns is on hiatus this week. That does not mean that we are content-free. As we have done in previous years we asked a panel of highly respected independent finance bloggers a series of (hopefully) provocative questions. Below you can see the blogger’s name, blog name and Twitter/StockTwits handle. We hope you enjoy these posts as we do. Feel free to jump in the comments with your own answers to the questions.
Question: The so-called robo-advisors, i.e. Wealthfront, Betterment, etc., have garnered a lot of hype (and VC money) in their pursuit of automated investment solutions. Will these firms become the new Charles Schwabs of the world or will automated portfolios simply be the way all advisors manage client accounts? (Answers in no particular order.)
The robo-advisors have a market, and it may well be a large one. Many of the current clients are not served, or not served well, by existing advisory businesses. Advisors should have special programs for young people, but most do not. Advisors who really learn about clients and develop programs that reflect their needs cannot imagine automating the process. For some people, this approach is much better than what they would do on their own.
While early on, robo-advisors framed themselves as the alternative to (and disruptor of) traditional advisors, increasingly the robo-advisors are realizing that they are no threat to real advisors and are actually more similar to the trading platforms and investment products that advisors (and direct consumers) use. And in reality, many advisors already use technology to do what robo-advisors do, including automated rebalancing and tax-loss harvesting and continuous portfolio monitoring. Nonetheless, the robo-advisor platforms are commoditizing the core cost to assemble a passive strategic continuously rebalanced portfolio, which will force both advisors and direct-to-consumer platforms to find ways to add value beyond (whether it’s effective active management, other financial planning services, or something else), and may even threaten traditional mutual funds and index ETFs as the building blocks of portfolio construction as transaction costs continue to decline.
Certainly, the reality is that technology is here to stay in the world of portfolio construction, and the robo-advisor is symbolic of that trend, though whether any of today’s robo-advisors are ultimately the long-term winners (or whether they have been overcapitalized with unrealistic growth expectations) remains to be seen once the dust settles after the next inevitable bear market.
Assuming they can figure out how to be profitable while providing adequate service as client assets grow, the robo-advisors (at least the ones that survive) will remain one alternative for investors.
I don’t think these firms will become the new Charles Schwabs of the world because eventually Vanguard or Charles Schwab will just roll out this type of service on their own or buy the robo-advisor with the largest market share. Robo-advisors are a positive for the industry, though. They offer a simple, low-cost option for investors that are just starting out or those that don’t have enough assets for traditional financial advisors. They won’t ever displace financial advisors but competition is good, especially for those that don’t offer a lot of value proposition for their annual fee.
I think the best case scenario for robo-advisors would be to take over the target date fund category in workplace retirement plans to offer an all-in-one solution for workers that don’t have the expertise to handle portfolio construction on their own.
Yes. An algo will do passive investing and do it well. If anyone learned anything in the past six years from the data is that Fama is right, and active portfolio managers are wrong. It will take some slick programming but eventually an algo will replace all the paper pushers at big financial firms like Fidelity.
On the plus side, robo-advisors offer a low-cost, tax aware implementation of simple allocation portfolios. Theirs is a convenient service (albeit one that investors could probably approximate for even less using low-cost Vanguard funds). The automated model works very well in a long, steady bull market (like the current one) where emotions aren’t getting in the way.
Robo-advisors claim that they will help you control your behavior during tough times, but that is much easier said than done. Betterment, for example, says that it will provide “additional returns” of 4.3% per year, 1.25% of which comes from “better behavior.” That is a large chunk of the value they propose to offer clients, which will be very hard to accomplish. I doubt that the emails, blog posts, and articles they publish during bear markets that say “don’t panic” will do the trick. To paraphrase Mike Tyson, “everyone has a plan until I hit them in the face.”
In their current form, their “risk tolerance” questionnaires are pretty basic and provide nowhere near as comprehensive a risk profile as would be determined by a good financial advisor. The bottom line is that robo-advisors (or whatever they morph into) will be good for the industry because they will drive costs lower for investors and provide great portfolio management technology. But I do not think they will replace good traditional financial advisors who know their clients intimately and can truly save them from themselves during bear markets. The best tools will be ones used by financial advisors rather than ones used to replace them.
The Millennials are the first generation to be born into a home with a computer, and because of this they see technology as a conduit — opposed to a barrier — to traditionally “heavy touch” endeavors like dating (pun intended) and finances. They don’t need to see, let alone interact with, an actual person when it comes to investing — a cool UI is sufficient — and robo-advisors will benefit greatly from this. Only time will tell if this leads to smarter investing and better returns for the end user. (Hint: It won’t.)
They’ll become the no-brainer way that ordinary individuals outsource their investment management. Not sure whether that analogy is Schwab or PIMCO or what. Stock picking is over, and RIA’s will raise minimums for taking on clients. If you’re looking to invest < $100k the question will be “Why would doing anything alternative beat a low cost algorithmic asset allocation program?” and that’ll turn out to be a pretty high bar for most. I tend to think this will make expected future returns for generic index products pretty low.
I predicted everything that would happen with the robo-advisors up until now when they first came about, including the fact that they would need to pivot at a certain point toward hiring human advisors to supplement their largely digital interfaces with clients. This is precisely what’s happened. Betterment has added live people and Personal Capital essentially has a warm-calling operation of junior guys out in Colorado working the phones to up-sell software users of the banking product into more of an asset management relationship. Wealthfront has the early lead thanks, I’m certain, to Adam Nash’s real credibility amongst the nouveau riche of the tech boom as well as his incredibly passionate take (and awesome slide presentations) about asset management done right. They’ll probably build a brand of it and keep their lead.
Betterment will likely sell out to Ameriprise before long and then Vanguard, Fidelity and Schwab will eventually dive into the space with their own offerings and put everyone else out of business. As for traditional advisors, they’ll all be using their own robo-software for smaller accounts inside of five years, likely provided by their custodian firms, who will build or buy a solution to provide it to their best customers – human advisors. The whole thing will soon lose its novelty as man and machine meld into one. No one’s going to be talking about robo advisors by 2020, because everyone’s practice is going to more automated and make use of the same technology.
As I showed in my recent review of this segment, the so-called Robo Advisors don’t do much (if anything) that an automated buy and hold portfolio doesn’t already do (a well informed Vanguard client, for instance, gets just about everything these firms offer without the extra fees). In fact, due to failures in risk profiling and a lack of true financial planning, I have a hard time seeing why anyone would pay to have a buy and hold portfolio managed on their behalf through such an oversimplified process. I think the Robo Advisor phenomenon is a positive industry disruption that will ultimately push down fees, push out weak advisors and create a necessary convergence between human advisors and automation, but will not replace the human ele
For many investors that understand the issues associated with “Trying Too Hard” , I imagine automated advisory will become common place. We already see algos it in search, dating, social interactions, security, recommendations, trading, and in the future…automated drivers. We have a fun saying around the office at Alpha Architect: Computers, Goooood; Humans, Baaaad. All that said, human beings like human beings. Stories trump evidence. Relationships matter. There will always be a need for human-to-human interaction when it comes to the investment advisory business. So robo-advisors will likely take huge market share, but not all of it.
The business proposition of robo-advisors is also perplexing. In the end, businesses need to create value and capture value. I think automated advisory will end up creating a TON of value for society and investors, but the businesses will be unable to capture much of the value they create. Buffett has a great quote on this simple business principle:
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”
There is little economic moat associated with automated advisory wealth advisors and replicating the algorithms is fairly straight forward (we know, because this is all we do). The larger RIA firms will be forced to lower their costs, get more efficient, and offer algorithmic adivsory services via their distribution pipes. The finance industry’s margins will compress and consumers will be better off. Finance businesses will be the loser.
Some combination. I think there will be at least one of the online-only firms that succeeds, but as with any rush to innovation that features a bunch of competitors, it’s probably foolish to try to pick the winner. (And I don’t expect that winner to be as big as Schwab.) Other investment organizations (including asset managers) will compete in the same way and so will advisors. Hopefully the result will be lower overall fees for clients. By the way, the biggest risk in all of this is the foundation of modern portfolio theory on which 99% of the applications rest. We’ll see whether future events make that all-in bet look like a huge mistake.
Thanks to everyone for their participation. Stay tuned for another question tomorrow.