Was this Really the Market Test For Robos to Pass?
In the immediate aftermath of the recent market correction, robo advisors were quick to point out that a sharp downturn did not derail their business, despite such predictions from a number of industry critics.
But the reason why the scenario of panicked clients scrambling to dump robos did not come to pass is up for debate among those in the field.
Some chalk it up to educational efforts and proactive client outreach to ward off any concerns. Others suggest that today's online investor behaves differently, and the plethora of tech tools allowing for real-time control of investments reduces the fear factor. Yet for some a lingering concern is that the correction wasn't the big market test the fledgling industry has to prove itself against.
Both advisor tech platforms and automated advisors say they experienced normal call volumes and were far from being deluged with customer concerns when the market began its steep drop on Friday, echoing the experiences of human advisors.
That weekend after the Friday that saw the S&P 500 drop 3.2%, just 17% of users were online checking on their portfolios, says Dan Egan, Betterment's director of behavioral finance and investments, adding the activity tracked with traffic from previous weekends this past month. "We were not seeing any increase in log-ins," Egan says.
There was no need for additional resources, even though Betterment CEO Jon Stein noted at SourceMedia's InVest 2015 conference that the firm allots one customer service representative for every 10,000 clients. The platform now counts 105,000 customers, Egan says, adding the market's figures were nowhere close to triggering an internal reallocation plan at Betterment meant to protect its portfolios in a downturn. (SourceMedia is publisher of Financial Planning, On Wall Street and Bank Investment Consultant.)
"We have the opportunity to bury this myth that we're all going to collapse when the market hiccups," Egan says. "We can stop having the same old conversation."
Those surprised by the overall stability of robos through the correction may have misunderstood the robo client's propensity for autonomy, says Jarrad Harford, finance and economics chair at the University of Washington's Foster School of Business.
"If you consider the early adopter who's selected the use of a robo," Harford says, "it's someone who already has decided they need less person-to-person hand holding and are comfortable with the buy-and-hold approach. They are not going to pay for an active management style. They know that for them, the best reaction to a short-term blip like this is no reaction."
Modern technology and access to information has also eliminated many barriers to understanding the market and controlling one's portfolio, Harford adds; all automated advisors grant their users portfolio information and control from even a mobile phone, providing instant reassurance. Additionally a number of platforms posted blogs, sent clients email and responded on social media to any client concerns.
"When you know you have an ability to react if you want to, that can be hugely calming," Harford says. "Think about when you're sitting in a plane on the ground and there are mechanical issues, but you're not told what's going on. Not knowing drives you insane. By human nature we hate ambiguity and uncertainty."
There's also the generational aspect to consider in the profile of a robo client, says Meir Statman, behavioral economist and advisor to Wealthfront, and a finance professor at Santa Clara University's Leavey School of Business.
"People who sign up with robo advisors tend to be young people," says Statman, the author of What Investors Really Want. "Of their total wealth, most is in human capital. So if there was a recession and they were afraid of losing their job, then they would be more rattled. But their savings are small relative to their human capital. The typical clients of flesh and blood advisors tend to be older and retired, and their human capital is small but their portfolios are large, so they are more likely to be alarmed."
Betterment's Egan says the firm decided not to pepper its clients with emails about the market drop. From previous experience -- such as the taper tantrum of 2013 -- Egan says his firm learned to give the client information when asked. "We're not forcing the conversation and creating anxiety when they don't have it," he says.
Still, many investment platforms haven't been avoiding a conversation about a potential downturn in the market, says Joel Bruckenstein, a Financial Planning columnist and co-creator of the Technology Tools for Today conference series and technology guides for advisors.
"Investors have been conditioned for some time to expect a correction," Bruckenstein says. "In the large scheme of things, we are still in normal correction territory. Both advisors and robos have tried to educate their clients that this would happen at some point after such a long bull run."
Some stressed even before Friday's steep drop that their allocations weren't heavily exposed to Chinese equities -- concern over Chinas decision to devalue its currency was the main spark for the rapid stock market decline. The ETFs in Charles Schwab's robo offering had anywhere from 0.2% to 2.4% Hong Kong stock exposure depending on a client's risk level, the company noted in a post in early August.
The array of information available lends itself to another reason why the robo client didn't react the way critics expected them to, says Rob Foregger, co-founder of NextCapital, Personal Capital and EverBank.
"You have to consider how the service is sold in the first place," Foregger says. "Most of the robos are very transparent about how they sell their service. It's really not about driving alpha but about low-cost, passive, long-term investing."
The best robos are making this pitch in conjunction with offering a structured financial plan, setting expectations up front, he adds.
"When you have integrated planning connected to a portfolio, it is not just pushing alpha and not about the investment strategy du jour, it's about a long-term plan. That is something clients really like, and is beneficial to retention over time. It doesn't mean it will be perfect, but thats what a good advisor does, whether digitally focused or not."
But some in the industry didn't find much assurance hearing about low call volumes from clients. That is actually a problem, argues Aaron Klein, CEO of advisor tech provider Riskalyze.
"I would be concerned if I was a wealth manager," Klein says. "It means they dont have meaningful assets with me."
"It's interesting to ask what kind of money people are putting into robos right now," Klein continues. "People are putting play money into robos right now. I think that is what is one of the biggest factors why [the response from clients was so]. If a client of an advisor has $1 million and puts $10,000 into a robo, they will have an extremely high risk tolerance for it. They wouldn't want to lose it, but it's a nominal amount of money. They're not stressed over it."
(According to a study by MyPrivateBanking Research, the average AUM per client among Personal Capital, Betterment and Wealthfront is $104,000.)
The idea that educational efforts and proactive communication are enough to change investor behavior is wishful thinking, Klein says.
"All the good people in this industry can stand up and say, 'Stop opening statements, stop watching CNBC, be a long-term investor,' until they are blue in the face, but we see study after study that when there is a meaningful amount of money, investors are incapable of doing that.
"When investors care, they are going to watch the markets. When you dont put risk first and are invested in the wrong portfolio, you're going to blow out of the portfolio when volatility actually hits."
That's why Klein says it's too early for the robo industry to claim it came out of the correction unscathed.
"This is probably not the time for robos to hang up the 'Mission Accomplished' banner and call it a day. They dodged a huge bullet with the way the market actually ended up... I just dont think we've seen the impact of what a true sustained downturn will do when you have not prepared your clients to understand the concept of risk."
Statman says the correction is a moment for robos to reflect with their clients about risk. "They can say, 'Look we did a fire drill here, we told you days like these would arrive. We're not shocked the market went down, and we did our best to educate and advise you about that.'"
But he disagreed with Klein's assessment. "Robo advisors adopted a passive index strategy from the beginning in actions and education. They were never expected to do any market timing. Young people have gotten to the point where they know they are better off with a passive index strategy at low cost, which is what robos provide. They've gotten what they were promised."
Time, says David Lyon of digital practice management application Oranj, is needed for the robo industry to understand the correction's impact.
"It is hard to say the effect of a short-term market correction on robo advisors AUM," he says. "Everyone is certainly watching for assets to flow out as the robos could be short-handed in these situations. If a large outflow situation did occur we would not know this until the firm reported it on their ADV."
Lyon doesn't believe that there will be a mass exodus from robos because of a market correction. "But over time these market corrections, along with other investor needs, will bring attention to inefficiencies of robo advisors."
The true test for robos to beat is to be able to handle a cyclical sideways or down market, says Dean Cook, president at FTJ FundChoice, a turnkey asset management program provider.
"I dont believe we can address failure or success after a one-day drop in the market," Cook says. "If all you are offering is a strategic asset allocation portfolio, you are going to have extended periods of time where you earn nothing or lose money in your portfolio. Without human intervention, many investors will lose patience or confidence in a system that is not working in the short-term."
"Its not just robos that reported normal call volume," he adds. "A number of human advisors said they didnt get a rush of calls either, despite the market... It's not a question of call volume, but rather whether investors remained disciplined or panicked after the call was over."