Mid-year review of Aman Raina’s Robo Advisor portfolio

By Aman Raina, SageInvestors

Special to the Financial Independence Hub

Aman Raina

As we cross the mid-pole mark in 2017, it seems like a good time to check in on my Robo Portfolio that I created two and half years ago.  For those jumping on for the first time, I wanted to try to find out if this new type of investment service which was taking the industry by storm a few years ago does any better job of creating wealth for investors compared to the traditional methods of investing (i.e. Do-It-Yourself or having a professional manage your money on your behalf).

I chose one Robo Advisor company here in Canada and invested $5,000 of my own money. When I set up the account I answered a series of questions about my financial literacy and risk tolerance. ROBO took my responses and crafted a portfolio that it felt reflected my profile.

As I am pretty experienced with investing and have a long-term investment horizon, ROBO determined that a portfolio mix of 85 per cent stocks and 15 per cent bonds would work for me. From there ROBO carved out allocations to a variety of equity and bond assets using ETFs to provide the appropriate exposure.

The objective of this exercise is to observe and blog about the whole experience and share with you any unique insights about the service. Most importantly I wanted to see what kind of returns this type of portfolio can generate. My experiment is by no means scientific but I think there is a lot that we can learn about this service if we go beyond the slick websites and marketing to truly look underneath the hood to see how these portfolios are managed.

Performance still reasonable

When we last checked in with my ROBO portfolio in late January, it was chugging along rather nicely, generating somewhat decent returns. It appears to be continuing the trend. Since the start of the year, the ROBO portfolio is up 5.5 per cent. Since I set up the account, the portfolio is up 14.2 per cent. The portfolio is up $298.71 this year, of which $53.59 was in dividend payments. Again, pretty reasonable for me. When you look at portfolio breakdown most of the returns have come from US stocks, Foreign stocks, and Emerging Market stocks.

ROBO Portfolio - 6 month performance chart

ROBO Portfolio – 6 month performance chart

ROBO portfolio - Asset Allocation breakdown - July 3, 2017

ROBO portfolio – Asset Allocation breakdown – July 3, 2017

Asset Allocation: Breaking News! 

It all seems decent enough; however, shortly after I posted my report in February, the portfolio has gone through some changes.

Most notably the weightings on the  asset classes had significantly changed. The asset allocation of my ROBO portfolio has remained an 85/15 mix of stocks and bonds and the equity components have remained constant with some minor tweaks; however, the equity allocations have changed quite dramatically. The charts below shows the current model asset allocation of the portfolio as well as the asset allocation when I set up the account in January 2015.

Current model asset allocation of my ROBO portfolio

Current model asset allocation of my ROBO portfolio

Model asset allocation of my ROBO portfolio since inception. Canadian and US equity weightings have more than doubled since I opened my account.

Model asset allocation of my ROBO portfolio since inception. Canadian and US equity weightings have more than doubled since I opened my account.

Many things jump out when I see this:

  • The allocation to US stocks has more than doubled from 15 per cent to 32.5 per cent.
  • The allocation to Canadian stocks has also more than doubled from 10 per cent weighting in January 2015 to 22.5 per cent now.
  • The allocation to dividend stocks and real estate assets has been removed and reallocated to Canadian and US stocks.
  • The foreign stock and Emerging Market stock allocations have been slightly reduced.

The good news is that the cost structure of the portfolio is lower thanks to the removal of the Purpose Dividend (PHD) and Purpose Real Estate (PHR) ETFs. I never really understood why these ETFs were included, as they carried a higher cost due to their active management style and this was not in alignment with the whole passive investing strategy that the ROBO company was promoting.

Too much in North American stocks?

The bad news is 55 per cent of the money in the portfolio is being invested in essentially North American stocks, which to me seems much too high. These markets have had an incredible eight years of growth and are due for a major pullback at some point. Why has the ROBO has chosen to double down on these asset classes? Is my ROBO chasing returns? Is my ROBO trying to time the market?  If so, would that contradict the whole emphasis on asset allocation over stock selection?

Diversification usually means not putting all your eggs in one basket. In fact my ROBO puts it out there that diversification is a core element of its value proposition.

Yet here we have a portfolio that appears to be highly concentrated in two markets, one of which only represents 6 per cent of the value of the whole global equity market. Doesn’t look like diversification to me.

In my Behavioral Investing module of my Everyday Investing program, I discuss the concept of Geographical Bias, which is a type of behavioral bias that negatively impacts our portfolios. Investors tend to choose investments that are closer to our home for either familiarity and/or comfort/security often at the expense of ignoring lucrative opportunities in other parts of the world. It appears my ROBO is suffering from a case of Geographical Bias right now. Why is my ROBO hesitant to invest outside North America?

These events and decisions are quite puzzling to me because my understanding is that my ROBO is being run and guided by some highly educated academics who should know better about diversification. It doesn’t seem like they are practicing what they preach, which is a bit concerning.

I’m also a bit concerned about how much the asset allocation weightings have changed in just a few years. A core principle of investing by asset allocation is that once you set your weightings, you should essentially should set it and lock it in, meaning the weightings should not change materially and you should not be nibbling around the edges and tweaking the weightings. When one sector’s weighting strays way from its model weighting level, only then through rebalancing should assets be bought or sold accordingly. It doesn’t seem to be happening. Again my ROBO even highlights it in its value proposition:

Whenever I’ve checked in on the portfolio, it doesn’t seem like ROBO is on top of making sure the allocations are in line.

One of the value propositions of the Robo Advisor model is that it adopts a more passive investment strategy by not picking individual stocks but instead diversifying over broad assets classes over long periods with minimal tinkering. Heck even my ROBO says this on their website.

This may be true. The portfolio now is using ETFs that are passive oriented,  but based on the large change in weightings, it appears my ROBO is trying to pick countries and regions, which isn’t any better. It’s one thing to be passively investing, it’s another when you are frequently changing how much you are passively investing.

These elements really had my scratching my head. I didn’t understand the logic, so I did the obvious. I went off to see the Wizard.

I called my ROBO.

I figure why not. Apparently they also have humans there.

So I rang them up. Just to note, this is the first time I’ve spoken to a human being from my ROBO service since I opened up the account more than two years ago. I really haven’t had a reason to speak with them, but I thought given this major change, I thought I should hear their side of the story.

I asked why the equity portion of my portfolio is so concentrated in Canadian and US stocks. Below were the responses (paraphrased):

  • Based on my risk profile, the ROBO has determined that owning a growth oriented portfolio that is made up of an 85/15 ratio of stocks to bonds is appropriate for me.
  • The decision to allocate between US and Canadian stocks is driven by algorithms.
  • The portfolio is constantly being rebalanced.
  • I’ve done quite well in my US portion.
  • The ROBO prefers to have a heavier weighting in US and Canadian stocks than Foreign and Emerging Market stocks.

Here’s what I got out of the conversation:

  • Because I’m OK taking on risk and comfortable holding stocks, it’s no biggie to increase the weightings and hold more Canadian and US stocks, even if it represents more than half my portfolio.
  • The algorithms are saying go all-in North America.
  • You’re making money thanks to your heavy US weighting. What’s the problem? Everything is awesome!
  • I can now confirm my ROBO suffers from Geographical Bias

I didn’t challenge them on any of this. I just listened. This did not give me much comfort.

Digging a little deeper

As I was reviewing the portfolio another element jumped out. In the US equity component, there used to be one ETF that invested in the market. The Vanguard Total Stock Market ETF (Ticker: VTI) invested in pretty much every US stock. Now the ROBO has added another ETF, a Canadian-issued Vanguard Total Stock Market ETF (Ticker: VUS) which is essentially buys shares in the VTI ETF, except it also hedges away the currency risk. So for example if the US dollar were to decrease in value, the value of the US assets would decrease as well. Hedging away the currency exposure helps to preserve the value of the US assets. Because of the work required to hedge the currency risk, it carries higher costs to manage. The VTI carries a 0.04 per cent cost, while the VUS costs 0.16 per cent, quadruple the cost.

There are different schools of thought on hedging currencies, some say in the long run it doesn’t make a difference, while some say it’s good to do more for piece of mind. Clearly, my ROBO believes hedging is a good thing.

I also asked my ROBO the logic about owning two ETFs in the same asset class.

Here’s the response (paraphrased)

  • The ROBO likes to have options. Rather than focusing on holding one ETF to cover an asset class, they like to spread it around a few ETFs.
  • By doing it this way, I will get more exposure, more diverse investments which is healthy for my portfolio long term.

What? Both ETFs are investing in the SAME THING. It’s not like one ETF is invested in the S&P 500 and the other invested in the S&P Retail subindex. I’m not getting any more exposure. In a way, adding the VUS ETF comes across as a backdoor way of churning the portfolio, which is not a good thing and I’m paying more for it. The person didn’t even mention the currency hedging component feature of the VUS ETF, which surprised me as well.

Did I miss the memo?

One thing you can expect when investing with a Robo Advisor is that they will provide little in the way of any explanation of why they are buying or selling an ETF. There is no notification. You find out about it when you get your statements or when you log in online to check in on your portfolio. I think with messaging technology pervasive in our lives that it would seem like a logical feature to include.

Final Thoughts

I’m wondering if we’re now seeing the true colours of the ROBO service being revealed. Up until now, it’s been a quiet existence, which is the way it should be. The recent moves the ROBO has made and the rationale behind them are making me wonder what is going into those algorithms. Many of the elements behind the value proposition of ROBO services (diversification and low cost) are not exactly being modeled right now.

That said, so far with the markets setting records high’s on a daily basis, the ROBO portfolio has benefited from this new asset allocation. I think it’s a bit aggressive, but hey when I filled out the survey, that’s what my risk profile came out so the ROBO is thinking I should be OK with this. The reality is that at some point the markets are going to pull back and it could be painful. Will my ROBO portfolio be able to absorb that kind of shock and preserve my savings? This is the one missing piece we haven’t seen. How will these portfolios behave in a weak market It will be interesting to watch and see how ROBO plays it out. Stay tuned.

 Aman Raina, MBA is an Investment Coach and founder of Sage Investors, an independent practice specializing in investment coaching and portfolio analysis services. This blog was originally published on his website on July 15th and is reproduced  here with permission.

2 thoughts on “Mid-year review of Aman Raina’s Robo Advisor portfolio

  1. Very interesting results Aman. A “constantly rebalanced portfolio” is costly and unnecessary as is have ETF’s covering the same asset class. It makes me wonder whether they really have algorithms or they have somebody playing around with your portfolio.

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