Many of today’s entrepreneurs target an industry or process and ask, “How can we disrupt the old model?” In the investment industry, the latest innovation to challenge the status quo is coming from businesses called robo-advisers.
Startup firms like Betterment, Wealthfront, Hedgeable, TradeKing Core and Motif Horizon have been joined by industry giants Vanguard, Schwab and Fidelity in offering platforms that provide low-cost, algorithm-based portfolio management run on computers.
The robos have evolved on the heels of the explosive growth of exchange-traded funds, which are essentially daily-traded mutual funds that facilitate a liquid, stock-like ability to invest in a diversified portfolio. Robo programs are generally structured to appeal to the younger, technology-savvy generation with smaller amounts of money to invest.
The fast-growing robo firms have attracted $20 billion in assets so far and are expected to triple in size to $60 billion by year-end. While the growth is impressive, it is still just a fraction of the estimated $18 trillion in total adviser-managed assets.
Plenty of projections are being made about the effect robo-advisers will have on the investment advisory industry, including some that are outlandish. Oxford University researchers proclaim, “In the next 10-20 years, 58% of financial advisors will be replaced by robots and artificial intelligence.” Conversely, one keen observer compared these predictions to statements that were once made about TurboTax putting accounting firms out of business.
Robo-advisers’ initial aim is to shake up the industry by targeting adviser fees. Their platforms claim annual costs of around 0.3 percent or less, or about one-quarter the cost many advisers charge. Yet those low fees might be misleading. Investors need to look through to additional fees charged by the ETFs that are used within robo-portfolios to assess overall cost of the program. Many ETFs charge around 0.4 percent annually or more. So disingenuously, the robo firms are succumbing to the same lack of full fee transparency that plagues many corners of the investment industry.
Equally important, if not more so than fees, will be the net-of-fee investment return and the level of risk inherent in robo-portfolios. There hasn’t been nearly enough time to assess the long-term performance results of robo programs. As far as portfolio risk characteristics, a recent Wall Street Journal article found wide variation among robo-firms in their asset-allocation strategies.
Recently, the Securities and Exchange Commission concluded that the rapid growth of robo advisers was worth issuing an “Investor Alert” cautioning investors to thoroughly investigate “automated investment tools” before signing up.
Robo-advisers might be a good starting place for busy, young investors who like the automated simplicity and low-cost benefit of these investment platforms. Robots are certainly a worthy alternative for clients of entrenched investment advisers who charge high fees for fund portfolios that have performed poorly over time.
In contrast, robotic investing will prove to be an inferior solution to investment advisers who have business-valuation skills and have the proper investor temperament to succeed for their clients. Advisers who deliver above-average investment performance, net of moderate fees, and who are able to navigate the market’s bouts of fear and greed, won’t have to worry about being replaced by a machine.•
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. He can be reached at 818-7827 or [email protected]