Editor’s note: This is the second article in a three-part series on online investment advisors. Part 1, published on Monday, introduced the players in the budding Canadian robo-advice industry. Part 3, which compares online services with traditional providers, will publish on Friday.
Robo-advice aims to simplify investing decisions. Yet choosing an online investment advisor isn't necessarily all that simple. Like Star Wars droids, they come in different forms and have different capabilities. Before clicking on the "Accept" button after filling out an account application and a questionnaire and committing yourself to a particular robo-advisor's portfolio, shop around. Here's what you need to check out:
Is online interaction a good fit for you? You don't need to be as plugged into the Internet as a typical teenager. But you should have a reasonable comfort level with online interaction and secure Internet access. More importantly, you need to have self-awareness of your investor personality. This includes knowing where you mentally draw the line between risk and return, why you are investing, and for how long. Knowing yourself is crucial, since your answers to an online questionnaire will be used to determine what you'll be investing in.
The questionnaire and the human factor: A well designed questionnaire should take you a long way toward finding a good investment fit, but perhaps not all the way. It should identify inconsistencies in responses, such as wanting equity-type returns but also being unwilling to tolerate shorter-term capital losses. Once these inconsistencies are identified, the robo-advisor needs to have a process in place to sort out what's realistic for you. Human intervention will be necessary. This will normally be accomplished via phone or email. Depending on the firm and your account size, you may have someone assigned to your account, or you may be connected to the next available representative. Ask about the robo-advisor firm's registration and the qualifications of its personnel. A portfolio-manager registration implies a higher level of proficiency and care than the standard applicable to most retail brokers and dealers.
The levels of advice: Regardless of how advice is communicated, know-your-client and suitability obligations apply. Though there's ongoing discussion in regulatory circles as to whether robo-advice deserves special treatment as a middle ground between self-directed and full service, that's currently not the case. Online investment advisors have the same responsibility as any other advisors for the decisions that investors make. They can be held liable if investors are able to select unsuitable portfolios.
The exception to this rule is a brokerage that makes clear that it's responsible only for order execution and does not hold itself out to be an advisor. The pioneering example of such a service for self-directed investors is Canadian Shareowner Investments Inc.'s Model Portfolio Service, launched in May 2014. Canadian Shareowner states in a disclaimer that it "does not provide investment advice or recommendations and investors are responsible for their own investment decisions." In other words, don't blame Shareowner if you make a poor choice.
If you need more than asset allocation and rebalancing, the current generation of robo-advice services will at best be only a partial solution. "As your wealth accumulates, think about whether you will want more complex services and diverse investment products than what can be provided by online advisors," the Investor Office of the Ontario Securities Commission recommends.
Most robo providers are advice-givers , serving the majority of investors who need and want advice, and are willing to leave portfolio construction to experts. They've received regulatory approval to act as discretionary portfolio managers. This means that once you choose a portfolio, the robo-advisor can make changes in the ETFs or mutual funds that the portfolios hold, without requiring your approval for each trade.
Asset allocation and rebalancing: One of the most valuable services of robo-advice is the convenience of periodic rebalancing. Based on your replies to questions seeking to determine your objectives, risk tolerance, time horizon and need for liquidity, robo-advisory services will place you in a suitable asset mix. This mix represents the "efficient frontier" for each portfolio, which is the best combination of risk and return. As with traditional asset-allocation services, robo-advisors rebalance as needed to maintain the strategic asset mix that's suitable for you.
Passive versus active holdings: Most robo-advisors rely exclusively on exchange-traded funds, while others use ETFs in combination with fee-based series of mutual funds that do not pay any embedded commissions to brokers or dealers. Canadian Shareowner, for instance, shuns active managers. It relies exclusively on ETFs that track either traditional market-cap-based indexes or "strategic beta" indexes that rely on rules-based quantitative screens. "Despite charging higher management fees, most active fund managers rarely beat the index, particularly over the long term," Shareowner says on its website.
Taking a different view while keeping a close eye on costs is Invisor Financial Inc. co-founder Pramod Udiaver, whose goal is to maximize risk-adjusted returns by using a combination of passively and actively managed funds. "We believe there is value in actively managed products," says Udiaver, a CFA charterholder and former vice-president and director of TD Asset Management Inc. "But we have to be very selective and ensure they fall within our overall selection criteria, including cost. It's still a challenge to find good F-class products."
Fees and expenses: With robo-advice, you should be able to keep your total ownership costs -- consisting of the fees and expenses of the underlying holdings, and what the robo-advisor charges for its services -- to a combined total of less than 1% a year. Fairly typical in its pricing is WealthBar, whose management-expense ratios (MERs) for its five ETF portfolios currently range from 0.29% to 0.35%. On top of that, WealthBar charges 0.6% a year for accounts from $5,000 to $150,000, with discounts applicable to larger accounts. This level of pricing is roughly half that of actively managed equity and balanced mutual funds that pay embedded advisor commissions. Count on robo-advisors to be talking up their cost advantage later this year, once new regulations take effect in July that will require brokers and dealers to disclose the dollar amounts of trailer fees and other direct compensation they receive from fund companies.
Conflicts of interest: Robo-advisors like Nest Wealth or Invisor, which have no affiliations with ETF or mutual-fund companies, are free of conflicts of interest in their portfolio selections. In contrast, BMO's SmartFolio, offered through BMO Nesbitt Burns Inc., which will rely exclusively or almost exclusively on BMO's extensive line-up of ETFs for its five model portfolios.
Elsewhere, proprietary ETFs play a minor role at Questrade, since it manages only eight ETFs, of which six are either currency-hedged U.S. sector or U.S. mid-cap mandates. Questrade's Portfolio IQ portfolios may use these ETFs when they want exposure to the U.S. market but not the U.S. currency.
And WealthSimple's portfolio components include a real-estate equity ETF and a North American dividend ETF managed by Purpose Investments, whose founder and CEO Som Seif is one of Wealthsimple's external advisors. The Purpose ETFs were picked by an independent investment committee and fill niches where there are no attractive alternatives in the market, says Wealthsimple CEO Michael Katchen.
Safe custody: Check on where your assets will be held. For example, assets managed for Nest Wealth Asset Management clients are held in their names at NBCN Inc., a brokerage firm that is a subsidiary of National Bank of Canada and a member of the Canadian Investor Protection Fund. Nest Wealth can access the account only to receive its monthly advisory fee, the Toronto-based company says.
