As the popularity of so-called robo advisors has risen, the conventional wisdom that has pervaded the advisory profession is that the discipline of investment management will be “commoditized,” resulting in lower margins and an urgency to justify one’s value through non-investment activities. But a review of the historical performance of the robos over the last three years, a relatively short time period, shows that fear is unjustified.
If the robos were pitted against a fifth grader, consisting of a 60/40 cap-weighted index portfolio, Jeff Foxworthy would easily give the victory to the 10-year old.
Measuring the performance of the robos is no different than assessing any active manager – and virtually all robos engage in some degree of active management, in their deviations from the cap-weighted market and in their asset-allocation decisions. They should be judged over a full market cycle, since active managers typically claim their advantage is in their ability to protect against downside losses. But that would require going back to before the financial crisis, and there isn’t enough data to do that.
The farthest I could go back is three years, using data provided by Backend Benchmarking (BEB), which is when that service began tracking robos. BEB is a spinoff from New Jersey-based Condor Capital Wealth Management, a fee-only RIA. BEB does not receive any compensation from any of the robos it tracks and Condor does not use any robo technology in its operations.
Using the most recent data from BEB, of the 36 different robo providers it tracks, only 11 have a three-year track record. Of those 11, only two outperformed BEB’s benchmark. On average, the 11 robos underperformed BEB’s benchmark by 86 basis points, as shown below:
|
Acorns
|
-1.83
|
|
Betterment
|
-0.81
|
|
E*Trade
|
-0.02
|
|
FutureAdvisor
|
-1.60
|
|
Personal Capital
|
-2.40
|
|
Schwab
|
-1.25
|
|
SigFig
|
0.12
|
|
Vanguard
|
-0.12
|
|
Wealthfront
|
-0.68
|
|
WiseBanyan
|
0.01
|
| |
|
|
Average
|
-0.86
|
To put those nine of 11 robos (82%) that underperformed the BEB benchmark in perspective, consider the SPIVA scorecard that S&P uses to track active managers. As of the end of 2018, across all domestic funds, 81% of actively managed funds underperformed their benchmark on a rolling three-year basis (and that percentage goes up as the time period lengthens). With this admittedly small sample size, robo performance is closely tracking that of actively managed funds in general.
BEB uses a sound analytical framework to calculate its results. When it signs up for a robo, it uses a male, 50-year old investor who is in a high tax bracket with a moderate to aggressive willingness to take on risk. But it answers the risk-profile questions in such a way as to generate a 60/40 equity/fixed-income portfolio. That allows it to normalize its performance results across all robos (but it means that it cannot compare the efficacy of each robo’s initial asset allocation, since everyone starts at roughly 60/40).
Each quarter, BEB determines each robo’s asset allocation. It then assigns a benchmark to each robo using widely held, low cost, cap-weighted equity and fixed-income ETFs. It does not attempt to measure each robo’s performance based on its specific equity or fixed-income holdings; thus, a robo with value-oriented equity holdings would be measured using the same Vanguard equity ETF benchmark as a robo that was growth-oriented. This is eminently fair, although purists could argue that BEB does not adjust for risk.
Finally, BEB deducts 30 basis points from the performance of its benchmark to simulate the management fees that a typical robo charges. (All returns from the robos are measured net of fees.)
If BEB didn’t deduct those 30 basis points, all the robos would lose to the hypothetical fifth grader. That means that a self-directed investor who started with a 60/40 portfolio of Vanguard index funds, without the use of a robo, would beat all the robos.
I spoke with David Goldstone, a manager at BEB, who was more sanguine about the results. “The majority of providers perform as you would expect a low-cost, globally diversified ETF portfolio to perform,” he said. “They do pretty well.”
He attributed the underperformance – which he called a “small amount” – to BEB’s use of low-cost ETFs as its benchmark, as well as to the fact that some of the robos charge more than 30 basis points in advisory fees.
Our readers can draw their own conclusions about BEB’s results, but the key question is the nature of the competitive threat posed by robos.
Will robos compete with traditional advisors?
When robos were first introduced, there was a lot of concern that they would replace traditional advice with a low-cost model. That has not played out.
Robos have made very small inroads into the advisory profession. As of the end of Q2 of 2019, Goldstone estimated the AUM for robos to be $440 billion, but that includes approximately $200 billion in 401(k) assets. To calculate the robo’s market share, we can use the Washington, D.C.-based Investment Advisor Association (IAA). It reported that its members managed approximately $20 trillion in assets as of the end of 2018. Another way to calculate the denominator is that there are approximately $18 trillion in mutual fund and $4 trillion in ETF assets in the U.S.
That puts the robo’s market share at approximately 2% of U.S. assets.
Robos have found a niche between self-directed accounts and full-service traditional advisors, Goldstone said. They have expanded the advice market to mass-affluent investors, rather than stealing market share from traditional advisors. That is changing with hybrid models, he said, which combine human and digital advice.
For now, though, robos are appealing to those who don’t want a self-directed account and lack the minimum or don’t want a human advisor. Time will tell whether that’s a big enough niche to be a sustainable, addressable market for the 36 firms tracked by BEB, especially if the investment results don’t improve. Investors will soon discover that 86 basis points annually is too much of a performance sacrifice, and will revert to self-directed accounts. But they will do so with the reinforced knowledge that a low-cost, diversified, cap-weighted index is likely to outperform the vast majority of self-directed investors. Or they will recognize that, for those 86 basis points, they could get a human advisor.
The good news for traditional advisors is that they can make a credible argument, based on these preliminary results, that investors will get decidedly poor investment results from robos, particularly if they use a robo that charges 30 basis points or more in fees or does not use low-cost, cap-weighted index funds.
That’s a pretty strong argument for advisors who only provide investment management, but it’s also a strong argument for low-cost indexing. The greater challenge for those investment-only advisors will be to demonstrate that their own performance justifies their fees versus a cap-weighted benchmark.
For full-service advisors, these results provide stronger justification for their services. It makes it easier for them to justify financial planning, tax and estate planning, and other services, by arguing that, for 30 basis points, you get poor performance without anything else. Why not pay 100 basis points and get at least as good performance as the average robo, plus all the other services?
While BEB is providing a valuable service by providing transparency to robo advice, that transparency does not exist across the advisory profession. Goldstone doubts that human advisors do any better than the robos, and said that part of his company’s mission is to provide thatf transparency so that investors can measure traditional RIA performance in a similar way to how BEB measures the robos. It will be interesting to see what new services BEB offers.
Robo performance has been underwhelming, as would be expected from a universe of actively managed portfolios. That is based on a limited data set over a relatively short time period. But if this trend continues, the competitive threat that traditional advisors face from robos will weaken. The value statement that most RIAs offer will strengthen. But, at the same time, the performance advantage of low-cost, cap-weighted funds will become more obvious.
More Active Management Topics >
