Dan Hallett from HighView Financial Group recently wrote an interesting article with the above subject on the HighView Blog, which appeared in the Globe & Mail. We thank Dan for expressing his views, particularly on the future for Robo-Advisors and highlighting the potential benefits of working with one, including:
- The ability to overcome the feeling of intimidation in some cases of having to be face-to-face with someone to obtain advice;
- An opportunity to leverage the power of user-friendly technology;
- Ability to keep costs low; and
- An opportunity to work with an advisor who is a fiduciary and is obligated to act in their client’s best interest (unlike the vast majority of those who call themselves “financial advisors” but do not have a fiduciary obligation).
The blog also mentions certain drawbacks of Robo-Advisors currently operating in Canada. While we fully respect Dan’s views in the article, as a service provider in the Canadian Robo-Advice space (although we would’ve preferred to be referred to as an online advisor by the media), we disagree with some of the comments made and would like to provide clarification.
- “None that I’m aware of actually structures portfolios based on indexing’s underlying theory…. By failing to take full advantage of indexing’s appeal, Robo-Advisors are missing an opportunity to maximize their cost advantage over incumbents.”
We agree that the basic idea of indexing is to obtain the broadest exposure possible at the lowest available cost. However, we don’t think that means Robo-Advisors have to necessarily be closet indexers. Every business looks at different ways to bring value to its clients. While we believe indexing is a very cost-effective way to gain a broad exposure to various segments of the market, we also believe there is value in using actively managed strategies within a portfolio structure. The key is to find great products without any biases, which have consistently demonstrated the ability to bring value to investors over time at a reasonable cost.
We agree minimizing cost is an important element of portfolio construction, but we also consistently state that it is not the only objective. A well-constructed portfolio should optimize the three key parameters – return objectives, risk and cost, all aligned with the client’s needs.
Maximizing technology and cost advantages over incumbents might be a great way to get started in business, but in an environment of constant fee compression (which is only set to exacerbate with the implementation of CRM2), cost increases, and rapid technology evolution, a cost/technology-focused strategy may not get Robo-Advisors very far.
For long-term success, Robo-Advisors need to find a way to evolve with the needs of the client and think beyond simply offering closet indexing strategies by providing other value-added services and continuing to leverage technology to improve the client experience.
- “This is a good example of a market naturally establishing a pricing floor for basic investment advice – i.e. 35 basis points (0.35%) per year of the value of client portfolios plus tax and product fees.”
We are not sure the market has established a pricing floor for basic investment advice yet. Robo-Advice is relatively new to Canada and most firms start at 0.50% to 0.60% of assets under management at the highest marginal tier. Given most of the early adopters of Robo-Advice may only allocate a small amount of their savings to begin with just to try out a new experience, Robo-Advisors still have to cover their operational and technology costs, which may not permit these businesses to operate at 0.35% per cent fee across the board.
As Dan mentioned, Portfolio Managers (the category under which most Robo-Advisors are registered), unlike most other financial advisors in Canada, have a fiduciary obligation to act in the best interest of their clients. This obligation brings with it additional costs of regulatory compliance as well.
Hence, most Robo-Advisors operate with a tiered structure where fees drop for larger portfolio sizes. That being said, it may be a stretch to say 0.35% is a floor that the market has already set. We think this is yet to be tested.
- “Robo-Advisors resist simpler structures due to the challenge of convincing investors to pay ongoing fees to buy, hold and rebalance two or three ETFs. It’s an easier sell to propose a more complex structure that looks more difficult to replicate and maintain. And yet simpler structures offer good value – i.e. low maintenance, low cost and – most importantly – in the embedded discipline that so few investors exhibit on their own.”
We fully agree, simpler structures offer good value, and hence our approach has been to construct portfolios with a simple asset allocation structure, aligning return and risk objectives to our client needs, while minimizing costs. Cost associated with ongoing rebalances is also a significant parameter we take into consideration in setting tolerance ranges for rebalances.
However, we believe Dan’s comment about it being an ’easier sell to propose a more complex structure’ is completely inaccurate. Having lived in the advisory industry for a long time now, we know it is NEVER an easier sell to propose a more complex structure that looks more difficult to replicate and maintain – especially to less sophisticated investors. In the online world, where advisors look to serve a segment of the market that has mostly been ignored by the traditional advisors, one quickly realizes there is nothing that can replace simplicity!
- “Accordingly, Robo-designed portfolios are more costly and less efficient than they could be. And just about every one I’m aware of employs sub-optimal rebalancing.”
While there is always an opportunity to be more efficient and less costly in everything we do, including how portfolios are constructed, we have to operate within the confines of available products to Canadian investors, tax efficiencies, trading costs, including spreads, currency conversion fees, etc. Hence, while it may appear at the surface that certain products selected are more expensive than a potential alternative, there are underlying reasons for doing so. As we repeatedly say, constructing portfolios is an art as much as it’s a science and is not only about minimizing costs; it’s about optimizing return, risk and cost parameters using what we believe are the most efficient investment products suitable for our clients.
Regarding the comment on sub-optimal rebalancing, we’re not sure it’s a fair statement for two reasons: i) there is no explanation of what is optimal; and ii) there is no one proven methodology for rebalancing. We believe rebalancing portfolios is more than simply a science, and needs to take into account a number of factors, including determining reasonable drift thresholds for various asset classes, costs of rebalancing, tax considerations, etc. Hence, we don’t say we rebalance portfolios ‘automatically’ although it might sound like a very attractive proposition for marketing purposes. We do set rebalancing thresholds, but qualified and experienced portfolio managers review portfolios daily and initiate the rebalance trades when necessary.
Once again, we thank Dan for expressing his views on the evolving Robo-Advice industry. We are certain a number of the practices followed in the industry will be debated over time, which is a good thing for the end investors. As we all know, if investors win, we all win!
Invisor offers Canadian investors personalized investment management solutions at a fraction of the cost of traditional advisor models, without requiring any minimum investment amounts. Get started now to tell us a little about yourself and your goals, and we’ll find an investment solution just right for you.
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