Robo Advice Data for Q3 2017 Now Available for Advisors

by Ken Schapiro of BackEnd Benchmarking, 11/30/17

The Robo Report™ has opened accounts across the most prominent robo advisors and tracks performance across the portfolios. The portfolios are created by presenting the same investor type to robo advisors, seeking a moderate portfolio of 60% equities and 40% fixed income in the taxable accounts and the most aggressive portfolio available in the IRA accounts. By opening and tracking real accounts, BackEnd Benchmarking seeks to provide transparency in the robo advice industry.

Robo advice is continuing to take hold among advisors and investors. Over the last year alone T. Rowe Price, Zacks Advantage, TIAA, TD Ameritrade, Merrill Lynch, and Wells Fargo have all released digital advice products. Additionally, LPL and Cetera Financial Group both recently made a robo advice product available to their advisors to market to end clients. Although robo advice is continuing to gain traction, and low-cost digital advice products are being made increasingly available across institutions, investors choosing these options still make up a relatively small share of the advice market. A recent Investment News survey found only 4% of mass affluent and high-net-worth respondents reported using a robo advice tool. That being said, digital advice products are finding success with both older and higher-net-worth clients. Personal Capital, a service that offers a digital investment service paired with a traditional advisor, says 11% of their clients have over $1 million invested with them. Vanguard reports 85% of their Personal Advisor Services clients are over age 50, while Schwab reports that 53% of clients in their Intelligent Advisory Service are over age 55.

The steady stream of incumbent firms releasing automated advice tools is putting pressure on the independent robo advice firms. Incumbent players have multiple lines of business and opportunities to generate revenue outside of the management fee. For example, Schwab mandates a large cash portion in their portfolios. This cash is swept into an FDIC-insured account and helps generate revenue from lending activities. Additionally, revenue is generated on the Schwab ETFs held in the accounts. Furthermore, Schwab has a wide suite of traditional investment services at the ready if a client decides their needs are no longer being met with their robo or hybrid robo advice service. Independent robo advice firms do not have the same advantages of many incumbent players but they can build on their success as innovators.

As competition heats up, both independent and incumbent robo advisors are trying to differentiate themselves through increased features and market segmentation. Independent robos in particular are broadening their product offerings and services. Betterment introduced live advisors earlier this year and just recently introduced a charitable giving feature that helps their clients make tax-smart donations of appreciated stock. WiseBanyan recently shared with us their introduction of life insurance to their product offerings, while Wealthfront now offers loans secured by the client’s portfolio. Meanwhile, Stash announced they have plans to introduce the availability of traditional bank accounts alongside their client’s investments accounts. These three areas--insurance, banking, and lending--are all logical industries for robo advisors to expand into, and we anticipate seeing more product offerings in these categories in the future.

By far, the feature that we have seen introduced the most this year is access to socially responsible investment options. These are portfolios that take into account ethical, environmental, or other non-finance related variables when selecting investments. Socially responsible investing portfolios have sprung up at Motif, Hedgeable, TIAA, Betterment, and WealthSimple, and is anticipated as part of the upcoming Morgan Stanley offering. This is on top of robo advisors that specialize in this type of investing like Earthfolio and OpenInvest. As firms quickly adopt each other’s popular features it will be difficult to stay ahead of the curve.

We see robos mostly looking to differentiate themselves on features, services, and fees, not many in the industry are focusing on stock selection and market outperformance. As a vast majority of robo portfolios follow a passive, low-cost strategy, it is appropriate for performance to not be their focus. That said, we continue to see a wide dispersion of returns in our robo universe. Of the robo advisors we track, Betterment led the group of moderate taxable portfolios in year-over-year returns ending 9/30/2017 with a 11.97% net-of-fees return. Acorns trailed the group over the same period returning just 7.85%. This represents a more than 4% gap from the first to last place performer over the course of year, a significant difference.

Although we typically see very little trading activities in our portfolios there are a few portfolios that have made some sector bets and allocation changes. Acorns has made the most significant changes to our taxable portfolio over the last year. They reduced their significant allocation to small caps, reduced their large allocation to emerging markets, introduced international developed markets exposure, and significantly cut their REIT holding. The timing of their adjustments within market cap and international weightings were poor, resulting in lower performance. Wealthfront holds a dedicated position to the energy sector in our taxable portfolio. Energy has performed poorly this year and although this position has not done well it did provide them with an opportunity for tax loss harvesting which they executed. Hedgeable is one of the few robo’s which follows an active trading strategy and our IRA portfolio exhibits the most trading in our universe. The equity portion of this portfolio is heavily invested in the tech sector and outperformed the other equity portions of our other IRA portfolios in the 3rd quarter. Despite having very strong equity performance, Hedgeable maintained a large fixed income allocation compared to our other aggressive IRA portfolios in the 2nd and 3rd quarters this year. Strong equity returns in the markets means the fixed income allocation held back the overall returns resulting in the Hedgeable IRA finishing last for the quarter. So far this year it appears the portfolios making active allocation decisions are trailing their more passive peers.

In the portfolios that have shown the strongest performance this year we see a couple of trends. High allocations to international equities have helped these portfolios. Betterment and Schwab both hold nearly half of their equities in international and were the top two year-over-year performers among our taxable portfolios. Schwab is an interesting case as they mandate a large cash allocation in their portfolio and in times of strong equity market performance cash allocations can hold back returns. Despite this cash allocation Schwab has continued to perform well. This is in part due to their aggressive fixed income securities selection. Schwab has large fixed income allocations to high yield and international debt, two historically riskier asset classes. This has served them well this year but may ultimately lead to a more volatile portfolio in a bear market.

As robo advice continues to gain traction around the investment industry landscape, BackEnd Benchmarking looks forward to reporting on how the industry evolves. As companies try and stay ahead of the curve by continuing to bring new offerings to the table, we are excited to see continued innovation. One thing we know is that not all robos are created equal. Levels of service, performance, and even fees vary widely. Investors should do ample research before picking a provider. The 4Q Robo Report™ will have two-year performance numbers in many of our portfolios, and we are excited to present analysis of long-term performance and trends.

Robo Advice Data for Q3 2017 Now Available for Advisors

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