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Robo-advice: a winner from market turbulence

Robo-advice: a winner from market turbulence

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By johnjames ·
March 04 2016

Robo-advice: a winner from market turbulence

As markets edge deeper into bear territory there's much speculation about what this will mean for robo-advice.

Robo-advice: a winner from market turbulence
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The pessimistic view is that robo will fail to thrive as investors back away from digital and algorithmic investing and put their trust in the hands of advisers.

This argument is too simplistic in that it discredits the role that advisers play in delivering robo-advice and also assumes a greater level of trust in humans vs machines.

While this may largely be the case, there are some segments of the market - millennials in particular - who are more likely to put their confidence in a technology-based solution. More important is the fact that robo-advice can actually help both advisers and investors when it comes to managing volatility.

Removing bias and managing risk

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True robo-advice platforms use highly sophisticated algorithms to construct and manage goal-based portfolios. These are not model portfolios but rather globally-diversified portfolios tailored to an investor's individual goals and risk appetite. The more sophisticated algorithms also consider factors such as cost, liquidity, turnover and tax efficiency.

Of course, professional advisers have done this independently of robo-advice for years, but now they have the technology to do it more efficiently and without bias.

This removal of behavioural bias is key to managing risk and is one area where machines will always have an advantage over humans.

One of the biases robo can help advisers and investors avoid is the so-called home bias where investors favour assets within their own market. This bias can limit diversification and, in a volatile environment, completely exposing an investor to just one market may not be the optimal way to meet their goal.

Robo-advice can further manage risk by automatically rebalancing portfolios on a daily basis and ensuring investors maintain an allocation within their risk profile.

A natural extension to rebalancing is the automated tax loss harvesting that robos can provide. By searching the portfolios for harvesting opportunities daily, the investor has the opportunity to gain additional tax alpha by writing down losses more frequently, and at the same time reinvesting in highly correlated assets to maintain the allocation they have chosen.

Optimising alpha generation

While neither an algorithm nor a human can construct a portfolio that's immune to market turbulence, if the platform has investors simply tracking a market index, then the portfolio is not going to be optimised for the current market or the investor. True robo-advice platforms construct globally-diversified portfolios that create alpha in the most optimal way for each investor.

Many of these platforms have turned to low-cost, tax-efficient and highly liquid ETFs to generate alpha, focusing on funds which have the highest risk-adjusted expected investor returns. Some also use active management to add additional alpha to a portfolio over the long term.

With these benefits and many others, it's clear robo-advice is not just a trade-off between advisers and technology. It's about giving advisers and institutions a platform to deliver sophisticated and tailored advice more efficiently.

In a bearish market where lower returns may have investors focused on cost and risk/return, this is more critical than ever.


 

john-james    John James is founder and chief executive of BetaSmartz.

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