Robo-Advisors Face First Market Downturn Test

The recent stock market volatility represents the first test of robo-advisors in this type of environment. The growth of robo-advisors over the past several years has been significant. Even during the correction of 2011, they were not that prevalent. One of the unknowns about robo-advisors was how their portfolios would do in a bear market and more so would their clients stick with them. The current environment does not represent a definitive test and there have been no reports of significant departures of clients.

At some point, however, we will have a prolonged bear market and this will provide a far better barometer of how sticky the relationships between clients and robo-advisors truly are.

Wealthfront was active on Twitter, Inc. (TWTR) and other social media platforms during the worst days of the recent downturn. It engaged with clients who expressed concerns about their accounts in the wake of the swift market drop. Wealthfront founder and CEO Adam Nash indicated in communications with clients via social media and e-mail have reinforced that markets go up and will also go down. FutureAdvisor, which recently agreed to be acquired by BlackRock, Inc. (BLK)., sent out personalized emails to clients and had advisors on staff ready to take phone calls as needed.

Many robo-advisor clients are millennials who grew up during the financial crisis and watched their parents weather the market turmoil as best they could. Some saw examples of panic, while others saw examples of a calm longer-term approach. It will be very telling to see how these younger investors react to a protracted downturn in the stock market. This generation is used to doing business online, but will this carry over to their investments? Will they be okay with e-mails or social media contact as a means to communicate with their financial advisor? Will they stay the course with their investment plan? This Baby Boomer can only speculate, but I would hope that these robo-advisor firms would do better than communicating with clients via social media and e-mail during a real market or economic crisis.

While the most recent market decline might not tell us much, the reaction of robo-advisor clients to market events like this and subsequent downturns will be telling. Traditional financial advisors provide hand-holding from a real live person during market declines.

“Robo-advisors are great in that they invest via a disciplined process and employ a strict set of rules," said Greg Curry, a fee-only financial advisor with Pillar Advisors in Louisville, Kentucky. "Problems arise when the human clients circumvent these rules and diverge from the Robo’s recommendations." 

"In a down market," Curry added, "many clients need hand holding and the value of interaction with a human financial advisor can be the difference between them sticking with a well-conceived financial plan and investment strategy and making moves that are detrimental to their financial future out of fear."

Contrary to what some experts predict, if robo-advisors do not see a mass exodus of clients during the next major bear market then traditional financial advisors might feel threatened. There may be a realization that many investors don’t feel the need for the human touch or at least they don’t feel the need to pay additional fees for it. Much will also depend upon the needs of the specific investor including the types of advice and services they require. Any level of complexity in areas like tax planning and retirement income planning would be tough to service via a robo-advisor relationship.

With the recent acquisition of Future Advisor by BlackRock and the acquisition of Learnvest by Northwestern Mutual Life earlier in 2015, a trend of more traditional financial services firms buying robo-advisors for their technology and/or their knowledge of millennials and other emerging investors seems to be developing.

Vanguard’s Personal Financial Advisor Services unit provides a combination of robo-advisor technology with access to a live financial advisor. It indicated that their requests for consultations with an advisor were up about 9% during the recent downturn. 

Charles Schwab Corp. (SCHW) offers an advisor version of its Intelligent Portfolios robo-advisor via its Schwab Institutional unit. Financial advisors who custody with Schwab Institutional can offer the platform, with some customization if desired, to their clients. Betterment and Fidelity Investments have an agreement that allows advisors who custody on Fidelity’s institutional platform access to Betterment’s technology and tools for use with their clients.

The question with advisor arrangements like those of Schwab and Fidelity is what level of hand-holding are these independent financial advisors willing to give clients working under these platforms? The objective of using this technology would seem to be to allow the advisor to service the investment needs of clients who for whatever reason want a “lite” version of the advisor’s services. Will they answer calls from these smaller clients who want some hand-holding? Will they limit communications to e-mails?

The idea of offering some version of a robo-advisor service seems to be gaining traction as a way for traditional advisors to provide a lower touch offering as a way to service younger, less affluent clients, while cultivating them as their target clients of the future as they advance in their careers and inherit wealth from their Baby Boomer parents.

One of the unknowns regarding robo-advisors is how their clients will react during a prolonged market slump. We saw a sample of the communication efforts of these firms during a recent market decline. Only time will tell how well these firms do on the communications front and how big an issue this is in terms of client retention.