If robo advice existed in 1987, would those automated platforms have worked against market sentiment on Black Monday?
It’s a question that sparks debate in the industry, which still has doubts about how robos will perform during market shocks or in a steep decline.
Since most automated advice platforms don’t actively trade, they would have done little in the mass sell-off, says Don Riley, chief investment officer at Wiley Group in Conshohocken, Pennsylvania.
“Robos may have actually started to buy if stocks retreated quickly and appeared undervalued, as opposed to rushing for the exits as traders and investors did in 1987 because they got caught up in emotion,” Riley says.
That lack of emotion in rules-based automation would’ve prevented robos from engaging in drastic action, says Bill Winterberg, who runs industry blog fppad.com.
“They are programmed to rebalance and harvest losses, and buy similar replacements, when mathematically attractive,” Winterberg says. “Based on that formula, I don't see automated investment services exacerbating a market crash or increasing short-term market volatility.”
But Winterberg adds that software can’t control human fear and investors disregarding advice to hold or buy.
“Line up enough human investors, retail or institutional, with their finger on the sell button and you will have a market crash,” he says. “Human psychology will continue to determine stock market dynamics, not brute force emotionless software programs.”
However, United Capital CEO Joe Duran — whose RIA firm does offer hybrid advice — disagrees.
“Robos would have exacerbated the 1987 crash, because the people investing directly through them would have no one to go to,” Duran says. “Investors were less sophisticated, and less able to adapt to market turbulence. With robos, they wouldn't have had anyone to speak to in order to keep them calm and stop them from trading in advance.
Quote“Line up enough human investors, retail or institutional, with their finger on the sell button and you will have a market crash."
“And of course, the minute the sale goes in, it's programmed trading selling that occurs on the other side, too. It's not that different now than in 1987. We would have had a greater volume of selling.”
It’s hard to stop panicked investors from taking some action, says Anthony Stich, chief operating officer at technology services firm Advicent.
“Human intervention would still have occurred in this particular case, likely overriding any pre-determined robo advisor behavior.”
Though the market has experienced flash crashes due to high-speed trading, a number of protective technological measures have been added since 1987, says Riley, Wiley Group’s CIO.
“There are circuit breakers in place today that allow for temporary halts of trading in stocks and futures when markets or stocks fall by 5% in a certain time frame,” he says. “This allows investors, traders and directors of electronic trading platforms a chance to catch their breath and evaluate. This can help avoid a cascading selling situation.”
If advisors were armed with data and better client communication tools then, they would’ve been better prepared to ward off market panic, Advicent’s Stich says.
“Would clients with access to their client portal — along with better financial literacy — have reacted the same way? The answer is no,” he says. “Access to financial plan data within a client portal along with direct communication channels to their advisors would have quelled any concerns.”
In some ways, the growing share of assets in passive index funds is a real market threat now, says Sayer Martin, chief operations officer and co-chief technology officer at Orchestrate, a technology services provider.
“BlackRock and Vanguard together manage total assets on par with the GDP of China. So we are more at their mercy than ever before. Clearly, recent years have shown us that we're more vulnerable to at least short-term crashes and with a smaller number of large holders, momentum has been and will continue to be a powerful force in both directions.”
Still, investors are savvier because they have more information and they’ve been through two very substantial economic declines, Duran says.
“There’s nothing like a bear market to educate people about the risks of investing.”