The Sweet Spot Between Robo-Advice & The Dinosaurs

It took some painful contortions in the markets this year for many financial advisors to realize robo-advisors may not be as diversified and risk-managed as they claim.

At Blueprint Investment Partners, we believe there is a “sweet spot” between the rudimentary machinations of a robo-advisor and a more traditional asset allocation method. In fact, we’ve bet our business on it. But, this briefing isn’t meant to say, “I told you so.” Rather, we want to articulate a solution to a problem that many well-intentioned advisors are contemplating.

Financial advisors can get pinned between two sometimes-conflicting interests: On one side is client pressure for low fees and market-leading near-term performance, and on the other is their fiduciary duty to help investors actually achieve their long-term investment objectives. Does the advisor focus on short-term results — which keeps clients happy so long as a chart of their account performance keeps moving up and to the right — or do you focus on true diversification with risk management and long-term performance in mind?

This problem has driven some advisors to centralize or outsource their investment management, depending on their size and scale, either to a robo-advisor or an asset manager.

In our view, delegating or outsourcing investment management is one of the key tenets of being a top financial advisor. But, in doing so, we think too many advisors have neglected risk management due to the fact that robo-advisors aren’t always as truly diversified as they appear. We believe this is a mutation of the 60/40 problem we have been writing about for several years.

Let’s unpack this.

Robos: A ‘Fee-Reducing Stroke of Genius’ or a ‘Pig in Lipstick’

First of all, it is a net positive for retail investors that advisors are shifting their focus toward financial planning and relationship management instead of stock picking. This is where financial advisors add the most value and provide a service that cannot be automated away.

Another important aspect of the shift toward robos, and something that is closely aligned with the core values of Blueprint Investment Partners investing process, is that it can remove some of the emotional elements related to the markets.

And yet, while the move toward robo-advice looked like a fee-reducing stroke of genius in a post-2008 regime that saw markets move in a unidirectional manner, then 2020 came along. And it revealed a pig in lipstick by exposing the lack of diversification in these portfolios.

As a result, and now more than ever, financial advisors must own the narrative with their clients. Inherent in this statement is that advisors must be able to articulate what they are paid to do and how they add value. To do this, advisors need to explain why selecting the right investment process or outsourced investment partner is a strategic value add, as well as be able to articulate the vetting process in some detail. 

Finding the Right Balance Between Performance & Risk Management

The tectonic shift for advisors toward financial planning doesn’t mean neglecting investment management. The biggest challenge is finding an investing process or partner that can keep up with markets while also providing risk management.

In our view, robo-advisors aren’t well-suited for risk management. For the most part, they have made the conscious decision to stay close to standard, traditional orthodoxy when it comes to portfolio management.

We also don’t think an internal team of analysts can add enough value to justify their expense, except for very large advisory practices. 

Instead of those stark, unappealing options, here’s an alternative: a systematic and rules-based process that can provide a balance between performance and risk management.

If Not 60/40, Then What?

With short-term interest rates likely to be anchored at the lower bound for years to come, investors may be tempted to take on more credit or equity risk.

Financial advisors must not only be prepared for the tough conversations about return chasing, but also must be able to recommend substitutes — such as alternatives.

From the beginning, Blueprint Investment Partners has recognized the value of adding liquid alternatives to investment portfolios as a way to participate in the upside while diversifying risk factors and return drivers. We’re ardent believers that you must diversify not only your return sources but also your risk factors.

In Your Head, In Your Head, Zombie, Zombie, Zombie-ie-ie

Taking cues from The Cranberries, we’re reading a lot lately about zombie companies, or, “unprofitable and cash-poor firms that rely on financial markets to cover their costs.”

Estimates from the first quarter show that up to 18% of the Bloomberg Total Return Index fit this definition. In this vein, if your robo-advisor is buying the market, almost one out of five companies it selects may be on life support.

In addition to credit risk and adding more equity to hit your return bogey, we think the third in the unholy trinity of risk is buying zombies. This alone speaks to the need for humans and robots to coexist, or in the case of Blueprint Investment Partners, to have sensible rules that rely on mathematical objectivity to create a more discerning moat around what actually gets into a portfolio.

The Difference Between Right & Retail

OK, we’ve unpacked it.

At Blueprint Investment Partners, we get that what’s RIGHT (focusing on long-term goals by protecting a client’s account from drawdowns and volatility through diversification and risk management) doesn’t always jibe with what the retail investor is asking their financial advisor to do. It takes honest, tough, “what if? scenario” conversations about rate changes, drawdowns, and volatility to demonstrate the value of managing their accounts with an eye on diversification, not just short-term performance.

This is essentially the reason Blueprint Investment Partners exists: We think it’s possible to provide strategies that have both financial advisors and clients in mind, so that through education we can help set retail right.