Performance of Betterment, Wealthfront and Other Robo-Advisors during Brexit
The performance of robo-advisors, including Betterment and Wealthfront, during significant market events like the Brexit referendum provides an interesting lens into their market strategies and the compromises that come with them. This analysis evaluates the short-term and long-term performance of these platforms during the market volatility triggered by the Brexit vote, and discusses the implications of their approach to downside protection.
Introduction to Robo-Advisors and Market Timing
Robo-advisors, such as Betterment and Wealthfront, have become increasingly popular due to their automated, low-cost, and accessible investment management services. These platforms typically aim to replicate the performance of passive index funds and strategic asset allocation, seeking to minimize human bias and reduce fees. However, their rigid, passive strategies can be scrutinized when markets experience significant volatility, as seen during the Brexit referendum. The question arises: do these robo-advisors engage in market timing or do they have a structured strategy to manage risk?
Market Performance and Portfolio Strategies
During the Brexit event and subsequent days, traditional performance metrics such as daily performance become unreliable indicators of long-term success. This is especially true for robo-advisors that do not actively adjust their portfolios to time the market. Instead, they rely on predefined asset allocation strategies to maintain a steady investment approach. Wealthfront, for instance, focuses on rebalancing and tax loss harvesting to optimize returns over the long term.
While Betterment also emphasizes a hands-off, long-term perspective, it has faced criticism for not being sufficiently responsive to short-term market fluctuations. The challenge lies in balancing the need for strategic asset allocation with the potential need for tactical adjustments, which Betterment claims is not within their scope.
Other Robo-Advisors and Their Approach
Hedgeable is an example of a robo-advisor that does take a more active approach, allowing for strategic and tactical weight adjustments. By actively changing weightings based on market events, Hedgeable introduces a directional risk profile. However, this strategy may have underperformed if the UK had voted to remain in the EU, highlighting the uncertainty that comes with such active management.
Cost of Downside Protection
A critical aspect of evaluating the performance of robo-advisors is understanding the cost of downside protection they provide. For example, Betterment charges an annual fee of 0.25% for users with balances under $10,000, which can amount to a significant drag on returns over time. If a robo-advisor is offering downside protection through options or other derivative instruments, it is essential to consider the costs associated with such strategies. Without a crystal ball, it is challenging to determine the exact impact of these additional expenses on overall returns.
Day-by-Day Analysis and Market Bounces
A specific example is the market bounce on June 28, following the Brexit vote. During this day, the performance of robo-advisors can be examined to see how their pre-defined strategies fared compared to more actively managed portfolios. The returns on that day would likely have been similar to those of passive index funds, as the market would have largely converged after the initial shock.
Tax Loss Harvesting and Market Correlations
Tax loss harvesting, a strategy used by Betterment and Wealthfront to offset capital gains, can cushion the impact of short-term losses. However, it does not eliminate the risk of significant drawdowns. The caveat is that in times of crisis, market correlations often reach their peak, leading to heightened correlation among financial instruments. A well-diversified portfolio may be less affected by negative events, but this diversification can also result in underperformance in bull markets where stock performance trumps broader diversification.
Conclusion and Implications
Robo-advisors like Betterment and Wealthfront offer a valuable investment solution, but they come with trade-offs. The ability to offer downside protection while maintaining long-term strategic targets is a key challenge. While strategies like tax loss harvesting can mitigate short-term losses, they do not guarantee superior performance. The key takeaway is the importance of understanding the specific approach of robo-advisors and how it aligns with an investor's risk tolerance and investment goals.