Are You Vulnerable to the Robo-Advisor Threat?

Beyond the pure efficiency of investment research and due diligence, though, the real value of adopting model portfolios comes from the ability for advisors, like robo-advisors, to leverage technology for continuous monitoring of portfolios, which simply isn't possible with the same manner of efficiency when every client has a different portfolio.

In fact, while Wealthfront makes the case that a great deal of its value proposition is tied to its ability to effectively implement its continuous-monitoring automatic-rebalancing and tax-loss harvesting, the reality is that the benefit isn't actually unique to robo-advisors at all. Technology-driven automatic rebalancing, systematic tax-loss harvesting and tax-aware asset location, have already been available to and implemented by advisors in the form of "intelligent" rebalancing software for a nearly decade now (at least, those advisors who have already implemented model portfolios).

However, actual advisor adoption of these robo-advisor-equivalent tools is still astonishingly low; the latest Financial Planning magazine Advisor Technology survey found that more than 60% of advisors still don't use any form of rebalancing software, a moderate improvement from the prior year's 69%. That slow adoption has left the door wide open to a challenge from robo-advisors.

In some cases, the blocking point is that the firm simply hasn't invested the time and money into rebalancing software. In other cases, the issue is that the firm's investment process is not systematized and is still different for every client, making efficiency with rebalancing software outright impossible. There are also cases where investment models might exist and the software may have been purchased, but it is not actually being used properly to allow for robo-advisor-like efficiency.

While robo-advisors have been hailed as a rising threat to traditional human advisors, the reality is that the robo-advisor's tools of the trade are not unique to robo-advisors. Those tools include systematic model portfolios that are continuously monitored using technology to take advantage of rebalancing opportunities and tax-loss harvesting, while being implemented with low-cost investments delivered in the form of the 'optimal' portfolio matched to the client's goals and risk tolerance. Instead, they're simply the outcome of an intersection between a systematic portfolio design process, along with the savvy use of technology to implement those strategies, with tools that already exist.

Accordingly, the reality of the advisory landscape is that many advisors already fully deliver the entire core value proposition of the robo-advisor, and have for years, by implementing a consistent range of model portfolios appropriate for client goals and based on their risk tolerance, implementing with "intelligent" rebalancing and trading tools that allow the portfolio to be continuously monitored, rebalanced as soon as it is appropriate to do so, and managed on a highly tax-sensitive basis proactive tax loss harvesting.

(I'd argue, however, that in today's tax environment, loss harvesting may be overvalued, or even harmful in some client circumstances!)

Ironically, the Wealthfront robo-advisor value proposition is remarkably similar to the benefits articulated by Morningstar researchers as the "gamma" that human advisors already bring to the table. 

Of course, this balance of generating gamma by implementing systematized portfolios while using heavily leveraged technology to automatically rebalance and loss harvest isn't meant to undermine any of the other value propositions that advisors bring to the table with their financial planning and wealth management services. In fact, it highlights the point that the primary difference in pricing between robo-advisors at 25 bps and the typical advisor at 1% AUM fee may be less about the idea that advisors cost more than robo-advisors. Instead, it may be more about the fact that traditional advisors deliver what robo-advisors more for a commensurate cost.

On the other hand, the robo-advisor trend is commoditizing the core management of a passive strategic diversified portfolio, forcing advisors to ensure that they meet the 'robo-advisor minimum standard' while bringing to the table additional value to clients.

Nonetheless, the reality is that even with the available tools, clearly not all advisors are delivering what robo-advisors do today. As noted earlier, only 40% of advisors are using some form of rebalancing software, and many others fail to systematize their investment process into model portfolios that would make rebalancing software feasible and effective in the first place. For those advisors, the robo-advisor is a dangerous and emerging threat, since the robos deliver similar or better solutions at a lower cost, while those advisors have limited capacity to deliver more value-adds since they're inefficiently delivering their existing investment portfolios.

The fact remains that in today's environment, nearly all of the solutions that robo-advisors implement can be done by human advisors as well, and have been doing so for nearly a decade. Robo-advisors do have some modest enhancements beyond today's technology-augmented human advisors. For example, Wealthfront doesn't just own a large-cap index fund, it actually buys each of the 500 stocks in the S&P 500 in appropriate weights so that it can systematically tax-loss-harvest at the individual stock level. In addition, both Betterment and Wealthfront also aggregate trades across all client accounts, since they also broker the transactions, so that they can do so without any transaction cost to clients.

However, the power for human advisors to compete with robo-advisors lies entirely in the hands of human advisors to systematize their practices and utilize available technology, to deliver virtually everything robo-advisors already do but with more gamma on top of it.