Online portfolio managers, or what many call robo-advisors, have seen wild success south of the border: they now boast more than $1.5 billion in AUM. Such managers automate certain jobs you’d expect an advisor to perform, and service costs are commensurately lower.
And they’re headed north.
The American front-runners, Wealthfront and Betterment, use a series of screens to ask clients questions to establish their risk profiles, investment timelines and expected investment returns. They then recommend ETF portfolios, with automatic rebalancing and tax-loss harvesting for accounts over a certain size. Wealthfront subscribers pay only the management fees for the underlying ETFs on the first $10,000 in investments; above that the fee is 0.25% of holdings, plus ETF management fees.
The offering initially struck a chord with fee-averse consumers, particularly tech-savvy Gen X and Y investors, says Robert Stammers, director of education at the CFA Institute in New York. “But it’s quickly becoming a mainstream service for those people that don’t have ready access to financial advice.”
Read: Man or machine?
And Stammers points out Vanguard recently launched a robo-advice pilot program in the U.S. “If [such services] become so mainstream that people with significant portfolios start using them, then they may become a threat,” he says. “It’s a little too early to tell.”
The Canadian market
Here at home, many companies have implemented online questionnaires. Perhaps the most comprehensive is BMO Investor Line’s adviceDirect, launched in 2012. It’s meant for DIYers who want to invest through an online brokerage, but need help with portfolio allocation and monitoring, as well as investment suggestions. Advice beyond investments is not part of the package.
The service — which required an exemption from IIROC and CSA — asks users to fill out an online know-your-client form. That’s followed by a qualifying phone call from a licensed investment specialist. The call is meant to ensure the client has chosen the correct portfolio type (income, balanced, growth or aggressive growth).
At that point, technology takes over: a portfolio optimizer compares existing client holdings against the investor’s profile to adjust asset allocation, risk and diversification. It then recommends selling or buying equities, fixed income, mutual funds and ETFs to address those issues. Clients then call investment specialists to discuss their options.
Fees at adviceDirect are higher than for its U.S. counterparts (from 0.5% to 1%, plus the cost of mutual funds and ETFs), in part because clients speak to licenced advisors.
Robo-advisor as complement, not competitor
But automation doesn’t have to be a threat to advisors – in fact, it can help them.
That’s the tack Horizons ETFs Management has taken. In partnership with Mark Yamada’s PUR Investing, it’s launched an ETF Model Portfolio Builder aimed at advisors, not clients.
The builder requests information about client risk profiles, and then generates pre-designed ETF portfolios for each person. Each portfolio has its own risk number, which corresponds to the maximum potential drawdown of the portfolio over a 12-month period (offering what Yamada says is 99% statistical probability).
For instance, a 10 portfolio would probably not lose more than 10% in any 12-month period. (Horizons and PUR cannot estimate the maximum upside.) To achieve the results suggested by the risk number, each portfolio has a target risk allocation, instead of a target asset allocation.
Risk allocation is better, says Yamada, “because you can never predict what returns are going to be, but risks are very persistent.” He points to the low variability of VIX on a daily basis as an example.
By monitoring risk, he says, the model portfolios can “see a catastrophe coming, and slow you down.” He adds the algorithms driving the portfolios will bail out of a given asset class a little earlier than its peak, and return to a bull market a little late.
Horizons has targeted advisors with this program, since it’s difficult for retail investors to determine their own risk tolerance, says president Howard Atkinson. Advisors conduct all KYC and must manually rebalance client portfolios (the model rebalances quarterly), and communicate the tax implications of such changes to clients.
Atkinson says even if advisors don’t replicate the model portfolios wholesale, the tool allows advisors to evaluate clients’ holdings against what the model suggests. The model populates the portfolio with Horizons ETFs. But since advisors are placing the funds, they can opt to replace some generic ETFs (e.g., an S&P 500 ETF) with another manufacturer’s version.
And, with CRM2 set to make clients more fee-sensitive, automated portfolio building can help advisors focus on offering value-added services and increasing the frequency of client contact. “Spending less time managing assets means more time gathering them,” adds Yamada.
Advisor-only automation aside, will client-targeted online portfolio management succeed here? Canada’s market is much smaller than the U.S., but Stammers counters upfront capital investment has already taken place. “I don’t think it would be that hard to adjust it for the Canadian market.”
There also are regulatory concerns. Carolyn Shaw-Rimmington, manager of public affairs for the OSC, says the organization is open to “innovative business models that can benefit investors.” But, she says, they must meet requirements that include:
- complying with know-your-client and suitability obligations;
- anti-money laundering requirements;
- addressing conflicts of interest;
- maintaining books and records and ensuring system integrity; and
- explaining to clients the nature of the services provided.
“For the provision of online advice, we have not yet been comfortable with any business models that do not also have a human element,” says Shaw-Rimmington. “When we assess online advice or dealing proposals it is critical that they establish to us how they will comply with their key obligations, which include: know-your-client and suitability obligations,” among other things.
Shawn Brayman, president and CEO of Toronto-based PlanPlus Inc., doesn’t believe that will put robo-advisors off for long. He views them as an inevitability. The first firms to launch “will have to jump through a few extra hoops,” but essentially the regulations require advisors to ask the standard KYC questions and follow the standard compliance checklist. That’s something Brayman says can be handled online.
“The key thing would be the [client] filtering at the front end,” he says. “You have to be prepared to kick clients out who don’t belong.”
Brayman’s firm uses psychometric testing to identify clients with unrealistic expectations. So a client whose answers to risk tolerance questions range from very aggressive to conservative would be flagged as inconsistent, rather than averaged to come out as balanced.
He contends this type of technology would be equally effective if consumers fill out the form themselves. Clients whose answers are deemed suspect might get a phone call from an advisor to probe further and try to provide perspective.
So, while robo-advice may pose a threat to conventional advisors, it can also forge opportunities. Says Stammers, “I see it as a way for large advisory shops to service a part of the population they weren’t servicing before and to do it in a way that’s profitable.”