Robo-advisers — automated online investment managers based on algorithms — take a hands-off approach to the stock market one step further. By offering stock and bond investments governed by computerized rules rather than expensive labor, they can lower their fees. But can they beat the market?
Many think so. Researchers estimated $50 billion in assets were under robo-adviser management in 2014, an increase of 210 percent from 2014.
“The rich are already using robo-advisers, and that scares banks,” Bloomberg notes.
BMO, Charles Schwab, Vanguard and BlackRock are just a few financial institutions adding this automated management service.
For the most part, robo-advisers are programmed to mimic target-date mutual funds that hold a standard mix of assets — a mix that changes with investors’ ages and retirement goals. That means lower costs. Instead of the 1 percent management fee charged by a typical mutual fund, robo-advisers charge between 0.25 percent and 0.5 percent of assets.
However, by making the same investments only with more technology, robo-advisers and mutual funds are locked into the same range of returns. They can’t beat the stock market because they mirror the market. Fees are low, but options are few: mostly index and exchange-traded funds (ETFs).
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Also, autopilot portfolios can misjudge an investor’s appetite for risk, as a story in The New York Times recently pointed out.
Index funds and ETFs can be the start of a balanced, self-service portfolio, but they give few choices beyond stocks and bonds.
Meanwhile, institutional investors and high-net-worth individuals diversify with alternative investments in a range of assets, such as real estate, commodities, hedge funds, futures and derivatives contracts. While some ETFs track currency, commodity or real estate prices, they have the same limitations as other index funds — namely mirroring the market.
WHY ALTERNATIVES?
Alternative investments have a low correlation to the returns on investments in stocks and bonds. They can provide stability and downside protection during turbulent markets.
Alternative investments, such as private real estate deals, hedge funds and private equity, can also add value for investors who don’t have immediate liquidity needs.
“Many investors are looking to illiquid assets to insulate themselves from market volatility,” says BlackRock’s senior managing director Mark McCombe. “The ripple effect from recent events is causing investors to actively manage risk.”
More than half of BlackRock’s largest institutional investors say they will shift assets in 2016 to real estate and private credit.
THE VALUE OF USING AN RIA TO INVEST IN ALTERNATIVES
Some investors put money into alternative products on their own. However, many find the world of alternatives unfamiliar and confusing. Dabblers may not understand the language, and more importantly, the economics of these investment vehicles.
Registered investment advisers (RIAs) who understand alternatives can help clients navigate the waters, including the impact of taxes, commissions and fees. They gauge:
- What types of alternative strategies make sense for their clients?
- What is the asset manager’s track record?
- What are the deal’s terms and restrictions?
- What are the fees and expenses?
Alternative-savvy RIAs also understand that the fund manager is equally relevant to the strength and success of such investments. This is especially true in real estate, where they consider:
- How long has the manager been investing in this type of alternative?
- What is the frequency and transparency of the manger’s communication to its investors?
- How accessible is the manager for questions?
- Is the manager investing his or her own money in the fund?
THE BOTTOM LINE
While the robo-adviser may make financial advice a low-cost commodity, it has limitations. With alternative investments, a human adviser can add value to clients far in excess of what a robo-firm can provide, especially by adding alternatives. Because at the moment there is no widely available computer program or service that does it all.
