How Robos Handled Their First Major Market Challenge

How Robos Handled Their First Major Market Challenge

Contrary to doomsday scenarios, Betterment and Wealthfront say recent market volatility isn't a death sentence for their business. 

Some advisors still see automated investment advisors as a passing fad and greet articles about the growing assets of "robo advisors" with canned skeptical remarks.

“They have never been through a downturn,” the skeptics say, pointing to the historic bull market run as being the reason for the algorithms’ success.

But on Friday the S&P 500 suffered its biggest daily percentage drop in nearly four years and the Dow confirmed it was experiencing a correction. And the robo advisors?

“I’m really sorry to disappoint, but if I wasn’t listening to this sort of financial media, I wouldn’t have noticed a change at all,” said Daniel Egan, the director of behavioral finance and investing at Betterment.

Egan said his company hasn’t noticed any uptick in negative indicators, such as client login rates or a slow down in signups or growth. He added the company has even some uptick from younger investors who have been waiting for a dip to buy at lower prices. The company said it didn't experience an increase in call volume, and a Wealthfront spokesperson said things weren't too exciting in their Palo Alto offices either. 

Customer reactions on social media were less rosy. 

Wealthfront was active on Twitter, reminding customers that though it can be difficult, it’s important to keep a long-term view and stay the course. The company also emailed customers a link to a blog post written by CEO Adam Nash titled, “What To Do in a Falling Market.”

“Wealthfront clients are predisposed to the fact that markets go up and markets go down and the best way to invest is to not panic during times of market volatility,” Nash said. “We make sure to communicate with them along the way whether via email or on social media to reinforce long term passive investing and ensure they have a clear understanding of what that strategy means.

A Different Approach

Betterment took a different approach. Customers that logged into their account would receive a targeted message and Betterment used Twitter to address customer service complaints, but otherwise the company has not done any outbound communication to customers regarding stock market 

“The more you monitor, the more you’re likely to see a loss,” Egan said, adding 83 percent of customers did not log in to check the status of their accounts after the slide started. His motto? “Don’t force it on the customer if they didn’t initiate the conversation, but be ready to have it.”

Aaron Klein, the CEO of Riskalyze, disagreed with this strategy and argued that it exposed a weakness of robo advisors. “This is the market where real advisors provide their value by helping their clients proactively understand risk,” Klein said.

Still, it was not the doomsday scenario that many robo skeptics predicted. Some investors found that algorithms performed better than do-it-yourself accounts. 

Egan said he couldn’t speak to overall performance as it varies from customer to customer, but said Betterment recommends every portfolio have at least a 10 percent allocation to bonds and the riskiest portfolio allowed is 90 percent stock, though the average is far less. Wealthfront sets the maximum allocation in U.S. stocks at 35 percent.

Both companies also pointed towards automatic tax-loss harvesting as a silver lining. In a blog post, Wealthfront said this service has generated 0.81 percent of alpha for clients in the first half of the year. 

“Uncle Sam will be taking a little less tax this year,” Egan said. “[It’s] a great thing that allows customers to make lemonade out of lemons.”

Financial advisors using Betterment Institutional to custody their clients assets were unfazed, saying the way they advise their clients prepares them for stock market dips. Sophia Bera from Gen Y Planning said Friday she hadn’t any clients contact her yet, and Brandon Marcott of Edify Financial Planning said it wouldn’t be any different if client assets were held with a traditional custodian. 

“It goes back to how you are advising and guiding your client to think about the market,” Marcott said. “The day to day, month to month, even year to year returns of their portfolio is not our focus. Now, if you are an adviser that focuses on protecting portfolios on days like yesterday, then yeah, Betterment wouldn't have done very well, and you would have some irritated clients.”

For this reason, Egan actually thinks that a new bear market could end up being an opportunity, rather than a death sentence, for robos.

“We never said you would beat the market, however, there are some managers out there whose promises of out-performance are being broken,” Egan said. “We are waiting to see how many people realize active management isn’t working for them and they want to try a low-cost, efficient solution.” 

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