Are We Seeing the End of an Era for Robo Advisors?

After failing to replace human financial advisors and DIY investment platforms, robo advisors are finally becoming a major source of disruption in the personal finance and financial services industry. Over the last year, the three largest robo advisor platforms, Vanguard’s Personal Advisory Service, Wealthfront, and Schwab Intelligent Portfolios, reached and subsequently exceeded $200 million in assets under management.

Alas, just as robo advisors were beginning to build some industry-wide momentum, COVID-19 arrived and radically changed the global investing landscape. Over the last 6 months, the short to medium-term efficacy of robo advisor platforms has been repeatedly undermined by widespread job losses, unconventional monetary policy, and protracted volatility in key equity markets. Concerned by the possibility of further losses, a significant number of investors have begun withdrawing from robo advisor portfolios in favour of low risk assets like bonds or fixed-interest accounts.

Despite these bumps in the road, robo advisors still have a valuable role as an accessible and highly affordable investing and investment advisement platform. The largest robo advisor in Canada is Wealthsimple. Boasting a streamlined onboarding process and a low-cost fee structure, it’s no surprise that Wealthsimple is the Canadian leader in automated investment services.

What Is a Robo Advisor?

Despite what the name suggests, robo advisors are not robots. Put simply, a robo advisor is an automated financial advisory service that uses input-driven algorithms to assist you with pre-configured personal finance tasks. While specific service offerings will vary between providers, most robo advisors offer portfolio generation and modelling, tax-loss harvesting resources, portfolio rebalancing, and limited wealth management support.

How Do Robo Advisors Work?

When you sign up with a robo advisor provider, you’ll be asked to answer several questions and set a range of investment outlook parameters. Once completed, this process will give your robo advisor a qualitative and quantitative idea of your risk attitude, preferred sector exposure, and expected investing time horizon.

Your robo advisor will then take this inputted data and process it using a complex mix of historic trend recognition software and sophisticated multivariate algorithms. At its most basic level, this information will allow your robo advisor to generate a suggested allocation model for your portfolio. Alternatively, if you’re looking for more customized advice, some robo advisors support additional advisement functions, including automatic rebalancing, pre-configured arbitrage, and user restricted market timing.

Why Are Investors Shunning Robo Advisors?

1. Pursuing Superior Returns

When you look at annualized returns between December 2017 and June 2020, the average performance of robo advisors leaves a lot to be desired. Specifically, the 2.5-year annualized return for the 20 largest robo advisors in Canada and the U.S. ranged from 0.81% at the low end to 4.71% at the high end. Even when you factor in the significant uptick in market volatility through the early months of 2020, this return range is disappointing. Comparatively, several major equities indices, including the S&P 500, grew by more than 20% over the same period.

2. Limited Advisement and Hedging Options

Robo advisor providers are able to charge very low management fees because their products require minimal human oversight for day-to-day operations. This is all well and good when financial markets are growing steadily and registering low intraday volatility. However, during periods of erratic market behavior, robo advisory services can be a stifling platform, especially if investors require professional human advice or more sophisticated hedging options.

3. Shift to More Active Management

During periods of elevated economic uncertainty, many investors simply feel more comfortable having their money overseen by a human. Nevertheless, it remains unclear whether a shift to more active investment management will be helpful given the ongoing and sure-to-be long-term impacts of COVID-19 upon the global economy.

What’s Behind the Boom in Index and Retail DIY Investing?

Despite significant short-term price contraction and prolonged market volatility, index investing has never been more popular. In addition to low management expenses, index investors now have access to an ever-increasing range of diversified sector-specific index investment products. Interestingly, the surge in index investing has also coincided with spiking interest in retail DIY investing. The uptick in DIY retail investing seems to be concentrated amongst millennials, many of whom are entering the market for the first time to scoop up distressed assets and under-valued equities.

Remember, as investment strategies go, both index and DIY retail investing give you a lot of control over your portfolio. This can be a real benefit if you have experience with investing and are fully aware of the potential pitfalls of trading in exceptional market conditions.

On the other hand, the current economic climate is a minefield for novice retail traders and overconfident index investors. As such, if you’d characterize yourself as an amateur investor, it’s probably worth thinking very carefully before pulling your money out of a low-cost, low-risk robo advisor investment portfolio.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes