Investing on autopilot has been all the rage over the last several years, with so-called robo advisors attracting billions of dollars worth of assets in both the U.S. and Canada.
But the rise of robos and their low-cost investment approach has largely overlapped with an unusually long period of smooth sailing in financial markets. A recession like the one that roiled global markets in 2008 and 2009 would be a first for the newbie industry.
A prolonged downturn would be “a huge test” for the sector, said Benjamin Felix, associate portfolio manager at Ottawa-based PWL Capital. “These robo advisors business models are largely untested through a real bear market.”
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The recent bout of volatility in the world’s major stock indexes has sparked much speculation about the impending end to the current decade-long bull run in stocks.
“Markets are vulnerable to fears that a downturn is near, even as we see the actual risk of a U.S. recession as low in 2019,” reads a recent report by investment behemoth BlackRock.
Felix hastens to say he has “no idea” whether financial markets are actually in for a crash. Recessions don’t necessarily hit when people expect them to.
Still, when the market does turn, robo advisors will be in uncharted territory, Felix said.
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It’s not about returns, it’s about fear
The test won’t be so much about robo advisors’ investment performance.
Robos generally invest in so-called exchange-traded funds (ETFs), which mirror a market index like the S&P 500, a commodity, bonds or group of assets. And there is plenty of research to show that pegging your fortunes to the ups and downs of the market is better than putting your money in the hands of a human picking investments for you.
This seems to hold true during recessions, as well. A 2014 study based on data from 16 countries between 1980 to 2010, for example, found that actively managed mutual funds unperformed investing on autopilot in 15 of those jurisdictions.
The real question, though, is whether small investors using robo advisors will have the nerve to ride out a financial downturn without pulling the funds, which is generally a money-losing knee-jerk reaction.
While humans have a poor track record of beating the market over the long term, the value of having a flesh-and-bone advisor is, in part, having someone who can talk you out of pressing the eject button in a panic, Felix said.
A recent paper by investment giant Vanguard estimated that advisors can increase clients returns by 1.5 percentage points simply by helping them “stick to their financial plans when their emotions run high.” That’s a significant contribution given that a balanced portfolio might earn yearly returns of five to six per cent.
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But will robo advisors, with their bare-bones advisory services, be able to assuage the anxieties of skittish clients?
At Wealthsimple, Canada’s largest robo advisor, Dave Nugent, head of investments, doesn’t sound concerned.
A bear market, he said, will be “our time to shine.”
Though Wealthsimple has only been around since 2014, it has seen its share of stock-market roller coasters, Nugent said. And the company has honed a strategy for helping clients stick to their long-term financial strategies and keep saving.
Every time there is a market correction, Wealthsimple sends out an email to all users encouraging them to keep calm and carry on.
The emails usually contain “an explanation of what’s causing the market to go down and why it doesn’t matter,” Nugent said.
But there is also more targeted communication for clients who have a track record of more frequent account logins during market dips, a behaviour that suggests a more nervous user, and those who have experienced larger losses — for example, because they started investing at the peak of the market.
In addition to the standard email, these clients also receive a more personalized message via the Wealthsimple app to help them understand why their portfolio might be down and why sticking with an investment plan pays off in the long term, Nugent said.
And if anyone still feels the need to talk to a real human being, they can always pick up the phone and make an appointment with a registered portfolio manager, he added.
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But Wealthsimple has only eight registered portfolio managers in Canada, where it has over 100,000 clients and more than $3 billion under management. Currently, users can get a phone appointment with a portfolio manager within a week, Nugent said.
It’s an open question whether the demand for phone advice would spike during a protracted market dive.
But a growing number of Wealthsimple users have their own personal financial advisor, anyways. The company has been ramping up its collaboration with independent financial advisors, including helping them to improve their communication with clients, Nugent said.
And, he added, most advisors wouldn’t be able to field every single call, if all their clients jumped on the line at the same time. Usually, he added, advisors will send a standard email and only call their most important clients.
“We’d run into the same challenges that a traditional advisor would as well.”
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