Robo Advisors

Jason McMillen |

Robo is Here

If you could simply put economic forecasts, interest rates, inflation rates, valuation metrics, etc. into a computer and spit out future asset returns, within an acceptable risk level of tolerance, I could be replaced with a “robo advisor”.   Artificial Intelligence (AI) programs could buy and sell securities based on the most up-to-date statistics.  That has not happened, en masse, at least not yet.  We have all the tools through Morningstar, eMoney, Riskalyze, TD Ameritrade, etc.., to operate as a robo advisor.  These vendors of ours will, and already do, offer some kind of robo solution. 


Smartest Guys in the Room

Morgan Stanley sold a 21% stake to a Japanese firm on September 28, 2008, a few weeks after Lehman failed.  They didn’t get a great price for those shares.  It was unsure at the time if they would survive while waiting for wire transfer to come through…. No joke.  The Fed gave them an additional $107 billion to survive.  Merrill Lynch, UBS and others are back out there with huge advertising budgets trying to convince investors how smart they are.  Are you going to rely on their robots for advice given that these firms lost their gluteal muscles in the “Tech Wreck” and then the “Housing Bubble”.  These firms make product to sell to investors.  They are conflicted.  I worked at Morgan Stanley from 2001 to 2005, and Smith Barney from 1996 to 1998, a name that many new investors might not know.  My point is, I have been in that game.


…Wealthfront has now decided to invest 20% of its investors’ funds into an internal “risk parity” fund, which in turn is invested mostly in complex derivatives known as total return swaps.  The fees associated with the old strategy averaged out at 0.09%; the new strategy, by contrast, carries a fixed fee of 0.50%, all of which goes directly to Wealthfront, plus the costs associated with buying the swaps.  -- Wired Magazine, March 20, 2018


Robos vs. Humans

The economics and finance discipline have been under fire as new ideas and research have generally demonstrated that most investors behave irrationally, especially during periods of extreme market turbulence and uncertainty.  (See my blog Biases & Heuristics, December 6, 2018).  If your robo advisor said to buy stocks or bonds after they have dropped significantly, would you have any more confidence in the robo advisor than a human advisor giving the same advice?  Auto-rebalancing, which I DO NOT do, is the same idea.  I do not do it because if stocks are rising significantly, I do not want to buy high when I feel and believe, that if I am patient, I can buy lower.   Just because the price of collectible car or a downtown condo has risen significantly doesn’t mean you want to buy it (a momentum strategy), or just because it has fallen significantly (a deep value strategy), doesn’t mean you want to buy it.  Other factors may be at play, and often are.  Discretion is advised.  How does the robo decide and advise?    


Markets are Unpredictable

2018 is a perfect year to demonstrate that even though economic growth was good, employment conditions were strong, valuations were reasonable, things didn’t quite work out the way an algorithm might predict.  Why?  Because things were at play that may or may not have significance in the future, such as rising interest rates, politics or trade policy.  Sometime these things matter, other times they don’t.  Last year, they did matter. 


Mouse Traps 

Technology may augment good advice, improve decision making, but it still takes a human to explain financial markets to another human, from my experience.  While Mad Men and Women on 5th Avenue design marketing campaigns for deep pocketed financial services firm to convince investors that their mouse trap will work better than the next, there is a reason why a spring-loaded mouse trap is still the most common and least expensive way to rid yourself of those buggers without deploying full-on chemical warfare.  My best advice is to remind people that Wall Street is great at making products and convincing people that they need them – an axiom that is part of my core investment philosophy.  (R.I.P. John Bogle)       


 “Wealthfront built its business on helping people get into simple, low-cost investments. Now it’s putting some clients into a strategy favored by hedge funds.” --  Bloomberg, May 11, 2018       

Human Touch 

The biggest robo advisors are Vanguard, Schwab, Betterment and Wealthfront.  Early on, you simply answered a questionnaire, completed a simplified financial plan, received an asset allocation and the trades were done.  It was about as generic as you can imagine.  Over time, they have introduced a “human touch”, finding that it helped them compete for and retain clients.  The robo advisor is another mouse trap to capture assets and is looking more and more like traditional financial services as it evolves.  John Stein, CEO of Betterment, said, “We also give a lot of advice about staying the course…”  (Barron’s, July 28, 2018).  Sound familiar?


Hi-Def Now or Wait?

I think our clients know the level of customization, objective and independent advice we provide, as well as the flexibility we offer.  If I could build a robot to do what I do, of course, I would do it.  Ultimately, we want you to have a good online experience, but we have not found one solution, one vendor, or a combination, to do what we think is necessary for our clients, at a price we think is reasonable.  Who wants to pay $7,000 for a 56-inch HDTV?  Well, some people did in 1999.  Now you can go to Costco and get a Vizio 55-inch with Ultra-HD for $379.  The robo advisor is here today, but is it objective and independent?  Or is the robo just another asset collection device for the Wall Street firms with the deep pockets, or those upstarts that took venture capital and private equity money from those Wall Street firms?  And when another “Tech Wreck” or “Housing Bubble” comes around, will your robo join in the party, or suggest the prudence may be appropriate?