Will Robos Kill The Portfolio Star?

November 6, 2017

Do you remember the advent of MTV? Why would you simply listen to music, when you could experience it with visual storytelling? Who can forget gathering around the (very large, thick) TV to watch the original walking dead of Michael Jackson’s Thriller? Or removing one’s glacier glasses to get a closer look at Duran Duran’s Rio? But it all started with the very first video: The Buggles’ ominously titled Video Killed the Radio Star. And the title made sense. While the 80s felt futuristic, they would be nothing compared to the 2000s, where we would still be watching these music videos, albeit on a much more futuristic TV. Or so we thought. Then the 90’s came, and MTV, sensing a waning interest in music videos, reinvigorated the franchise with reality shows such as the groundbreaking The Real World. Today, MTV is a hodgepodge of shows and music videos, as are most of its music entertainment competitors. But radio is still alive and doing well. Now, in investing, many are asking “will robo-advisors kill the portfolio star?”

Robo advisors vs. Portfolio ManagersWhile there are few similarities between the pop icons of the 80s and the stock market stars of present day, there is a supposedly similar seismic shift in the financial services industry. This shift is the advent of the Robo-advisor, and there has been much chatter about the revolutionizing of an industry. It was inevitable with the rising popularity of index funds, and the ongoing advancements in quantitative models used by asset management firms, that these two approaches would coalesce in one, human-replacing wealth management tool. As there is little human capital involved, these robo-advisers are relatively simple to implement and can be utilized extremely cheaply (as opposed to inexpensively, as that would imply there is not a cost for using them).

But like all things robo, there usually needs to be a human involved. After all, who do you think builds the robots? Recently, a colleague commented about the burgeoning self-driving car industry and the pace at which it evolving. He pointed out some scary scenarios that are hard to contemplate. “What happens if a dog is running across the road, and to avoid it, the algorithm would have to decide if should take out the dog, or swerve into oncoming traffic to an inevitable collision with a car?” “Now replace the dog with a child, and an oncoming car with a school bus.” He had a point. The human element is critical in situations like this. But what about your retirement portfolio? Surely the robot could handle asset allocation decisions and build portfolio models based on your risk tolerance, right?

Investment optionsThis report explores various investing options and some of their pros and cons. As your portfolio grows, options become available that may not have been when you first started investing. An investment plan and firm that worked for you when you were 30 may not be a good fit for you when you’re 50.

Download Investment Options Report

This is where your probability of success as an investor becomes more difficult to quantify. In a traditional investing scenario, there have been two possible teams of human interaction. The first team is you, the investor. The second team is the professional advisor or team assisting the investor. While we have had the opportunity to self-manage our investments essentially forever, the evidence seems to show that this has usually been a bad idea.

Quantitative Analysis of Investor Behavior (QAIB)Returns are for the period ending December 31, 2015. Average equity investor, average bond investor and average asset allocation investor performance results are calculated using data supplied by the Investment Company Institute. Investor returns are represented by the change in total mutual fund assets after excluding sales, redemptions and exchanges. This method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses and any other costs. After calculating investor returns in dollar terms, two percentages are calculated for the period examined: Total investor return rate and annualized investor return rate. Total return rate is determined by calculating the investor return dollars as a percentage of the net of the sales, redemptions and exchanges for each period.

We know that having just bought and held the S&P 500 index via a fund or ETF for decades should have produced excellent results, yet most do not experience the results according to the QAIB study. Why? We can only assume what factors played into the underperformance. Reasonably, however, one might assume that, market turbulence was too much to bear, and changes were made, or over-confidence prevailed, and changes were made.

Our Chief Investment Officer, John Buckingham was recently interviewed about his experience in the industry starting back in 1987, which included Black Monday. He is one of the most well-known stock pickers of the last 4 decades, and attributes much of his success1 to “talking them off the ledge” at various points of doubt in their investing career. The value that a seasoned veteran brings in keeping one focused on their goals is not easy to quantify, but hard to discount. There is much wisdom gained in weathering many corrections and bear markets. By comparison, the robo-advisors, most of which have been around five years or less, are the awkward interns of the investment industry. There have been no bear market tests to make sure the algorithm can adjust to the financial version of the dog or the school bus. There is no sage advice. There is just the hope that the robo-advisors can fulfill the promise of a cheap, human-free ride to our investing goals. Even though we could have owned an index fund or target-date fund with little human interaction before, and history shows this wasn’t successful, surely this time, with this technology, we can be strong enough to ride through the inevitable gut-testing market drops and come out ahead in the end.

Yes, the novelty of robo-advisors has garnered much interest. But we believe they are unlikely to be any more successful than other self-serve options in replacing the context and experience provided by human portfolio management.

Investment optionsThis report explores various investing options and some of their pros and cons. As your portfolio grows, options become available that may not have been when you first started investing. An investment plan and firm that worked for you when you were 30 may not be a good fit for you when you’re 50.

Download Investment Options Report

1On an annualized basis, the Prudent Speculator strategy has returned 17.80% net of fees since inception, while the S&P 500 returned 11.33% from 03.10.1977 through 09.30.2017. Please visit https://www.afamcapital.com/investment-solutions/ for additional information.

No guarantee of investment performance or dividend payment is being provided and no inference to the contrary should be made.

Investing involves risk, principal loss is possible, and there can be no assurance that investment objectives will be achieved. The information presented herein is for discussion and illustrative purposes only and does not constitute investment advice. It is not a recommendation or an offer or solicitation to buy or sell any securities.

The S&P 500 Index is a broad market sample based on the market capitalization of 500 large companies having common stock listed on the NYSE or NASDAQ. It is not possible to invest directly in an index.

Nothing presented herein is, or is intended to constitute, investment advice, nor sales material, and no investment decision should be made based on any information provided herein. The information provided herein is educational in nature, is not individualized, and is not intended to serve as the primary basis for your retirement, investment, or tax-planning decisions.

Information provided reflects AFAM’s views as of a particular time. Such views are subject to change at any point and AFAM shall not be obligated to provide notice of any change. While AFAM has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of third party information presented herein.