There has been a lot of press lately on the roboadvisors, largely due to the fact that Schwab entered the market this week with their Intelligent Portfolio service that charges a 0% management fee (but invests in their own ETFs). If you haven’t been reading my blog since 2006, I have written many times on their development and in general I am very positive on the emergence of the robos (and the non-robos like Vanguard). I even mentioned a handful of the automated investment services in my new book Global Asset Allocation. There is a lot of misinformation so I thought I would make a few comments below.
I expect the large custodians like Schwab, Vanguard, and Fidelity to dominate this space eventually for a few reasons. They have their own ETFs (a huge cost benefit), and they already have massive scale, distribution, and AUM (anything with a T is pretty big). I likewise expect some of the big ETF shops (like Powershares, WisdomTree, or FirstTrust) to enter the space on their own at some point in some capacity – allocation ETFs or a full robo offering.
Despite the fact I expect the big sponsors to dominate, that doesn’t mean there isn’t room for 5+ automated advisors. Maybe even 10. After all the #5 ETF sponsor manages $50 billion and #30 manages $1 billion. Could there be 30 robos managing over $1b?
Despite the big opportunity for all parties, Schwab and Wealthfront quickly got into a catfight over some various specifics of how they invest and operate. (Wealthfront post here and Schwab’s response here Scott Bell’s comments here and Howard Lindzon’s here.) It is weird and somewhat embarrassing they are fighting so much since they are really on the same side and it should be a rising tide for both. So, in my mind they should be cheering each other on against the high fee crowd, but they’re not, which is a shame. Their concerns were two main (minor in my mind) points in the asset allocation process:
Cash Allocation
Wealthfront took Schwab to task over their cash allocations in their portfolios. I don’t mind cash as a strategic allocation, but I do agree with Wealthfront that Schwab earning revenues from the money market sweep accounts could bias their decision to include cash. There is just no need to do this – they could have used their short term gov bond ETF at 8 bps and still made the same amount as their money market spread. However, the moral outrage from Wealthfront comparing Schwab to Merrill is a little ridiculous considering Wealthfront used to charge 1.25% for access to “geniuses”. I applaud that they have pivoted to the new low fee structure, but was it simply because the old business model didn’t work, or that all of a sudden they got religion on how they view the investment world and did a 180?
Smart Beta Allocation
Wealthfront also talked about how Schwab uses smart beta investments, and include two quotes that “smart beta products are not smart investments” and “smart beta is stupid”. This is odd since Wealthfront itself does not track the global portfolio and likewise uses smart beta funds like dividend/value. They go as far to state that dividend stocks can be a bond substitute (which is crazy). I applaud Schwab for using smart beta funds – after all almost anything outperforms the market cap weighted portfolio.
So, I agree with Wealthfront on the cash issue and agree with Schwab on the smart beta issue. But again, to me it isn’t really the point – I think they should be cheering each other on. The irony is that the roboadvisors can debate endlessly about their allocations and which is superior, but in reality their asset allocations will likely be very similar and perform similarly as well. Our new book demonstrates that almost all allocations cluster quite closely, and the backtested returns of Wealthfront and Betterment are likewise pretty darn close.
So if the asset allocation is a commodity, then you should pay as little as possible for that. Lost in the debate is that there has never been a better time to be in control of your own investments and both offerings are killer. The competition between roboadvisors will create downward pressure on fees that will massively benefit the end investor.
We forget that the average mutual fund charges 1.25% and the average advisor 1.0%. The top quintile charges over 2% for both!! While Schwab and Wealthfront argue over basis points, there are shops that still manage many billions like The Mutual Fund Store, Edelman, and Fidelity Portfolio Advisory that charge over 1.5%…And not too long ago we lived in a world that was much, much more expensive than even that. Remember front-end loads and 12b-1 fees? They still exist.
And while most roboadvisors are solid on the fee front, there is an even better choice. A 0% management fee ETF is superior to all of the roboadvisors for three or perhaps four reasons. (There is only one of those in existence currently but I expect someone to copy our model within the next 6-12 months.) Below is why:
1. The ETF at 0.29% likely has the lowest total expense ratio versus the roboadvisors (Schwab is potentially the only competitor but not if you add in cash revenue from the money market sweep).
2. The ETF has superior tax treatment to the roboadisors. Both can tax harvest, but the ETF structure is unique in that it benefits from the creation/redemption structure.
3. The ETF can engage in short lending, and return all of the revenue to the fund. Vanguard does this and effectively offers ETFs that are expense ratio negative, meaning they pay you to own them. Think about that for a second – you are getting paid to own an ETF! Could the robos eventually do short lending? Maybe, but it is operationally challenging and not sure this works across separate accounts. (But they should look into it.)
4. You can track the audited exchange traded performance of the ETF, whereas none of the roboadvisors are GIPS certified or audited (to my knowledge). It is near impossible to find published performance since inception. (Again, they should look into it.)
I still think any of these automated options (asset allocation ETFs or robos) are great choices for the buy and hold crowd. Frankly the fees will be rounding errors compared to any of the behavioral mistakes people make. (Tactical is another solution but not the point of the post. Those that know me also know I am a trendfollower at heart, and publish my portfolio every year.)
Assuming you now have the allocation put to bed, what is the big value add of a roboadvisor outside of that? The argument starts to break down, especially when we get another big fat bear and you want someone to talk to.
And that is where the advisor comes in, and there are many thousands of great traditional advisors to choose from around the US. As far as online ones, only two major players come to mind and those are Vanguard (0.3%) and Personal Capital (closer to .9% in fees). Either the roboadvisors or low/no fee asset allocation ETFs allow advisors (and investors) to be freed up to do what they do best – service the client and not worry about the asset allocation. So an investor (individual or pro) can allocate to a core, 0% management fee ETF and move on to more important things.
In summary:
1. It is a a great time to be an investor!
2. The emergence of the roboadvisors and low cost cyberadvisors (advisor powered automated solutions like Vanguard) are a huge positive for investors and advisors alike.
3. While the roboadvisors scrap over basis points, they should be on the same side and focus their energy on the high fee competition.
4. Despite the positive benefits of a roboadvisor, they can’t compete with an asset allocation ETF.
5. Investors, and advisors can focus their attention on more important things now that a buy and hold allocation is a commodity. Go live and enjoy your life!
