Kathy
in Memos & Musings · 15 min read
Recently a robo advisor has been hugely flamed with their decision to liquidate KWEB, a China Tech ETF earlier this week at about over 70% from its highs. This is in response to the huge rebound on 16 March 2022 of more than over 30% since the last bottom. We see some comments that go along the lines of “KWEB should never have been bought.” or “KWEB should not have been sold.”
Last week, I sat together with one of my friends who was involved in this saga in a community sharing by this robo advisor over a zoom session to explain why they decided to sell away KWEB completely. (before the rebound took place)
I have no vested interest to speak for the customers or the robo advisor. The aim of this post is to be objective and to allow investors to see and understand things as they are.
By running through some of the comments posted, we felt that the primary issue is that there is a mismatch in expectations between what the investors expect and what the robos can realistically deliver.
A robo-advisor to some has been deemed as a know-it-all, hassle-free, zero-worries, almost sure-to-win proposition in the long term. If there are going to be any crashes, robo-advisors are assumed to be smart enough to anticipate early and do what they are supposed to do. The robo-advisor claims to have a robust system that is able to react promptly to protect much of their client’s capital before a crash happens. Because it is assumed that retail investors do not know any better and tend to react adversely especially during extreme market conditions, hence we have the robo-advisors to rely on to make rational decisions. Robos take emotions out of the picture and help investors in buying into ETFs diligently with a DCA approach. It is touted as the no-brainer way to do well over the long term.
And to be fair, this misconception is reasonable because if you look at it, most robo-advisors have been branding themselves as such in their marketing communications. It is not uncommon to see them using wordings such as “invest safely with xxx” or “invest smarter with xxx”. And it does not help that there is no lack of content creators who may know little about investing, flooding the marketplace with awesome reviews about these robos in exchange for some benefits. With such messaging and perceived expectations, it is only going to be a matter of time before things will turn nasty if not for the general bull markets we have been having in recent years since their launch.
It is not unreasonable for most laymen to understand by investing “safely” and “smartly” to mean to be free from huge drawdowns and to be able to rebalance their portfolio in an efficient manner to maximize returns.
The bigger problem is that this will not be the only isolated episode and if such expectations remain, more investors will be in for a rude awakening.
But before we go on to bash the robo-advisor further, let’s be objective and imagine this:
What if the rebound might only have happened when KWEB went further down to say 5-10 dollars? (which means a 90% decline from its highs) The markets can be impossibly irrational and remain so, longer than what we can stomach or prepare for.
If you are the one managing the investment, what would you have done? The sight of seeing your hard earned money “evaporating” day by day. Would it have come across to you to perhaps accept the losses and rather search for an alternative place to invest to recover from?
It is not unreasonable to believe that there would have been huge pressure piling on these robo-advisors by the investors to continue to be invested in something that is facing such huge drawdowns. Either the robo-advisors stop the bleeding, or the next likely scenario is that they are going to see a massive exodus of their Assets Under Management (AUM) which in that case they have nothing much to manage to help the investors to recover from. My point is that, in any case, would you have allowed the robo-advisor to continue to hold even if they held onto their conviction? The same scenario applies if today you have a human financial planner to do the investments for you. Would you demand to get out of this ETF or listen to your financial planner to stick to the original investment thesis?
The truth is everyone who got invested in KWEB or other China Tech stocks are caught in a situation where there is no best answer to it. If China aids Russia in their war efforts and faces secondary sanctions (which we highly doubt so) or if the rebound happened only at a much lower price or never did, the robo-advisor would have been the hero that saved your last bit of money by biting the bullet there and then. It is always easy in hindsight to blame whoever is managing your investments because you are judging the soundness of their decision purely from the eventual outcomes.
My point so far is that in investing, there is no such thing as “should have”, “would have” or “could have”. (Just like Laszo could have paid his 2 pizzas with cash instead of 10,000 BTC) IMHO, the investment thesis to invest in KWEB is a fair and legit one at the start. For the majority of these Chinese Tech companies, they are profit making and are fundamentally sound. It was the right and sound decision to include KWEB as one of the ETFs that is investable. No doubt it eventually led to an unfortunate bad outcome for the past several quarters.
But on the other hand, to capitulate only when KWEB retraced more than 70% from its high is something that investors would definitely not be able to grapple with understandably. Investors have been told to remain convicted and stay invested for the longest time, to dollar cost average (DCA) regularly and yet now the robo-advisor tries to intervene manually, contradicting what the investors have been sold to all along and are thus seeming to be “timing the market.”
Perhaps some investors might prefer that the robo-advisor stick to their guns and explain the rationale for holding on should it fall further. Some investors proposed that the robos should have an exit strategy which may liquidate some partial holdings earlier should an underlying ETF have fallen by more than 30-40%. It is still the same problem however. What if the ETF recovers immediately at the 40% mark? The robo-advisor will be pounded for liquidating partially as well. Hence there is no best approach until investors can fully understand returns in the context of risks as well. If you are agreeable to liquidating partially should the ETF decline by 40%, you must be equally agreeable to forgo the gains that might materialize should the ETF rebounds back up after that. There will also be the question of what percentage is reasonable. To some investors 25% drop is huge enough, let alone 40%. There is no way the robo-advisor can come up with a specific percentage to cut some losses that everyone can agree upon.
But what we do know is that when a fundamentally sound stock or ETF ever retraces more than 60%-80%, the chance of a rebound gets even much higher and when it happens, it is usually going to be a very violent one. Exiting at such a juncture and fully is a very risky maneuver that requires some serious explanation and accountability should the rebound happen. An investor who can still remain convicted at 70% drop is still likely to do so at 80% drop. (Partly also because there is nothing much left to lose) The only way to rebound is to remain invested and the long term odds are good because we are talking about some of the most profitable companies around in China!
And in the worst case scenario should there be secondary sanctions on China that causes KWEB to plunge further, the robo-advisor could have justified it as a known risk which has a low probability of happening. That is a lot more palatable than letting it all go by claiming that there are just too many “unknown unknowns” for the China markets as they did in the community sharing. They can pull out charts like the risk/impact matrix and will also not look as bad alongside the other robo-advisors who are in the same plight by holding onto the China stocks. When you are a robo or human advisor managing people’s money, it is alright to fail together but not when you are the only one.
The possibility to invest safely and smartly in an easy manner without much effort is too good to be true. As humans we love to hear that there is a quick fix to the things we struggle with and to have someone to do the heavy lifting for us at a low-cost can be so attractive. But as in all things in life, you get as much as what you pay for. (or sometimes less) It is important to be aware of what we sign up for and to acknowledge the pros and cons so that your investing journey with the robos can be a joyful one.
First off, robo-advisors certainly have their merits. Robos can be hassle-free by helping you to rebalance your portfolio allocation in line with your risk profile from time to time. The weightage of higher-risk equities are kept in check automatically so that you face lesser drawdowns when the markets become bad.
Next, for passive investors who neither have the disposition nor time to be involved in the markets, robo advisory is a great option for them to still earn a better return in the long run than just having the money idling in their bank savings account. While it may not be that difficult to try to construct a simple portfolio on your own with discount brokers, the truth is it still takes a little bit of time and effort. It is still better to get started somewhat in their investing journey than to have nothing going on at all. Frankly if not for the seamless process offered by the robos, many retail investors would probably never have dipped their toes into investing because it seems too difficult.
That said, it is equally important for investors to understand what to expect out of the robos. There are quite a number of points we can cover, but perhaps let us touch on three key ones that will address most of the common feedback on the ground. Note that the following points are not made in reference to any specific robo-advisors but are generally the case for the majority of them.
1. Understand how robos operate and what asset allocation really means
Robo advisors create a passive portfolio of ETFs that is deemed to be suitable for the investor purely on the basis of his risk tolerance (mainly this), investment time horizon and financial objectives. This is in fact pretty much the same manner a physical financial advisor is supposed to run through with their clients through a process commonly termed as fact-finding or know-your-client.
These are helpful information for the robo or human advisor to decide if you are able to stomach more equities (as opposed to bonds) with higher volatility that may only have meaningful results over the long term. The crafted portfolio will often be a bundle of low-cost ETFs (or unit trusts for some human financial advisors) which is supposed to be in line with your risk tolerance.
Individual stocks are almost never chosen because it gets tricky if that particular stock faces considerable drawdowns and too much work has to be done to justify why that “particular” stock was chosen. Should there be a broad market selloff, it is harder to fault a robo or human advisor as the portfolio is already vastly diversified within a geographical location or industry. It was a result of market-specific events on the broader scale, rather than anything to do with their stock picking abilities.
And once we are invested, these robo or human advisors have their own “proprietary” frameworks that are often merely trying to rebalance the portfolio according to your risk profile and actively reallocating so that it remains close to your target allocation. There isn’t exactly any magical “machine learning”, “Artificial Intelligence (A.I.)”, “high frequency trading (HFT) or any other “secret ingredient” to it however they wish to market it. There may indeed be exceptions, but for most cases there aren’t.
How it works is that for example, you have a balanced risk profile and the portfolio was initially allocated with say 50% equities and 50% bonds. After inception of the portfolio, the equities have greatly outperformed relative to the bonds. Needless to say, you will now have a greater weightage of equities in your portfolio as opposed to bonds now. But based on your risk profile, it should be a 50-50 allocation. What happens then is that in the rebalancing exercise, the robo will attempt to redeem some of the equities and buy into bonds so as to maintain the original allocation. Therefore should the equity markets decline later on, you will be facing lesser drawdowns and hence is befitting of your balanced risk profile.
Rebalancing seems a good idea in theory, but in practice it can go awry as well. If the underlying equities are not performing well and are facing a sustained downtrend, one would be doubling down on something that is going to go down further and selling on other things that are making money and still continuing their uptrend. This means that an investor is going against the momentum of the market and is essentially giving up some potential gains of a performing asset in order to buy into another asset that is going to continue to decline in the near term. The investor is caught in a double whammy situation where he enjoys less of the future upside and is made to suffer further with more downside pain. All for the purpose of “re-balancing” to be aligned to the risk profile. A more optimal way would be to re-allocate based on risk to reward using technical analysis but that is a topic for another day. (I know some of the investors by now will stop me right here and say that there is no way to predict where the markets are going. Yes, we cannot predict and we never try to. But we can make educated guesses with a higher than average probability by understanding market trends. You may google on how to read market trends to get a better idea. Or we may write something on this in the future too if there is enough interest.)
Which brings to my point that rebalancing your investment portfolio is merely an act of readjusting your portfolio allocation based on your risk profile and NOT an act of optimizing your portfolio returns based on risk-to-reward. (You can read this last sentence a few times to sink that into your head.) What is often only mentioned in mainstream media is that rebalancing helps to improve diversification and help to reduce your risks. An ideal scenario would be for example, an outperforming asset that has now been irrationally overpriced and sold in order to buy into another asset whose prices are beaten down for now that is poised to do well in the future as well.
But in practice, we do not usually get the above ideal scenario. On the flip side, returns can often be equally diluted for the purpose of being more diversified and having possible less drawdowns. While I can’t speak for all, in most cases, a robo-advisor buys or sells an asset for you for the sake of matching your risk profile. It is often less likely that because an asset was undervalued or overvalued, overbought or oversold. This means it is also possible to have a scenario where an undervalued asset that is still early in the uptrend to be sold prematurely because it has performed relatively well and to be bought into another one that is struggling and facing some further headwinds ahead.
Hence trying to meet the suggested asset allocation in your robo-advisory portfolio can be a double edged sword.
2. Robo-Advisors might not be timely enough
Another common feedback that investors who have invested for a few years in robo-advisors lament is that robo-advisors are slow to react to changing trends or market shocks such as Covid in 2020 and the recent China market correction. The ability to anticipate crashes or manage the portfolio well before things happen seems to be a wild claim as they put it.
It is likely that robo-advisors cannot be relied upon knowing what to do when faced with sudden market shocks or extraordinary events, which happen more often than we think they do. At the back end, in one way or another, the robos usually use technical indicators that are often lagging indicators in their decision making process. By the time the “signal” comes, it is no surprise that the market might have gone up or down considerably. Indicators help most when the trend takes a longer time to evolve and is less useful during quick rebounds or crashes. Such is the same for most investors who use technical analysis. It is in fact alright to have indicators that are lagging somewhat but it is not alright for some of these robos to plaster claims on their websites that purport to having such a “smart” algorithm that will help investors to take advantage of the market volatility in a speedy manner.
This is because robo-advisers often lack the human intuition to assess how grave a situation can be and cannot be relied on to make decisions quickly or reliably in a crisis. Imagine if today the headline news is the possibility of China invading Taiwan and knowing what happened to Russia, our investment thesis in KWEB can very well be invalidated in an instance which a robo-adviser will not be able to make sense out of it till it really reflects in the stock prices after a few weeks. Not all crashes are equal. There are some that we know logically will bounce back quickly in the near term, and there are some that we know it is not going to happen anytime soon. It is usually a human investor, if at all, that will be able to differentiate if a crash is a result of the deteriorating industry fundamentals or that it is a broad based crash due to external factors such as covid-19 which can be solvable eventually.
This said, we respect that the team behind the robo-advisor actually took a step forward and intervened manually to liquidate the holdings this time round. Typically the robos would be left alone to do what they should do. Perhaps they may have acknowledged somewhat that the robos cannot be relied upon in situations like this to make a call. While we may not be on the same page based on the assumptions they had, we are saying that the action for them to intervene manually is a correct one in such a situation.
3. Robo-Advisors may not necessarily be cost-efficient
Different robos charge differently but generally it is a percentage of the assets that you have with them. Typically the management fee can be between 0.4%-0.7%. But to be fair, what makes something cheap or expensive can only be understood in the context of the value added. For the most part, the underlying are very commonly known ETFs that they are allocating into which you can easily have access to with other brokers. What is left next is the automatic process of rebalancing on a regular basis which does not take a lot of effort actually to be done on your own. Do not confuse rebalancing with active management. The former is merely an automated exercise with passive indexing strategies to maintain the original asset allocation while the latter is more of taking advantage of short term opportunities and mitigating losses proactively. Robos for the most part are merely rebalancing.
Let us do the sums. If taking 0.5% management fee out of a 10k initial portfolio with 1k top up every month over 20 years, with compounding effect, it is at least about 30-40k fees to be paid and that is excluding the fees that the ETFs charge too. Some investors start with a bigger initial outlay or do bigger regular top ups. The amount paid in management fees can be very considerable indeed, all in the name of being hassle-free. So you have to decide for yourself as an investor if the price of such automation is acceptable for you.
These are some points that you may wish to take note of when having a robo-adviser in your investment journey. We would like to re-emphasize the fact that these are some general pointers for thought without specific reference to any robos and some of them might have an exception to what is usually the case.
For those investors who have been forced to sell off their KWEB holdings, not all is lost. After all, the only ones who get hurt on the roller coaster are the ones who jump off in the middle of the ride. If you are still bullish on China and especially its tech sector that KWEB is primarily focused on, you can always take your money and buy into KWEB with another broker. As an investor, you always have a choice with the plethora of discount brokers these days. The only thing is of course you would have missed out on the gains in between for now.
Understand that by appointing another party to manage your investments, they are essentially given the right to make some sort of discretionary investing decisions for you most of the time. This is what you signed up for. In the normal course of things over the long term, most ETFs selected by robo-advisors should stand a good chance of doing well. But in the short term, we never say never in the financial markets. Irrational exuberance happens from time to time and it is something that we believe is a challenge for robo-advisors to calm their investors down when things take a turn.
It is however worrying to read that some investors have commented on jumping ship to other robo-advisors in light of this saga. The same thing is going to play out eventually with other robo-advisors if they still do not understand and accept what a robo-advisor can or cannot do.
Perhaps the more important takeaway is to understand that everything is a business. There is no free lunch in the world. Investment trainers teach and charge a course fee so that the student can eventually learn to fish for themselves. The robo advisor or financial planner manages your portfolio in order to provide greater convenience in return for a wrap/management fee. That is all their value proposition.
But if you believe that you can do better, then you should learn to manage your own investments. The price you pay would be the cost of the time taken and financial mistakes to be made in order to get you to where you need to be. In one way or another, you will be spending some time or money in order to learn, purely with the hope of becoming better one day.
We welcome further comments or feedback below should there be areas that we may have overlooked and feel free to share this article to those whom you feel may benefit from it.
About Kathy
Co-Founder of The Joyful Investors and Manager of The Moneyball Portfolio. I graduated with a degree in Economics in National University of Singapore (NUS). My previous experience with traders at the Merrill Lynch enable me to realize many counter-intuitive truths about how the financial markets work and to uncover the challenges faced by many new investors. We believe that investing can be astoundingly simple and want to make financial education understandable for everyone.
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The information provided regarding any individual securities is not intended to be used to form any basis upon which an investment decision is to be made. The information contained in this document, including any data, projections and underlying assumptions are based upon certain assumptions and analysis of information available as at the date of this document and reflects prevailing conditions, all of which are accordingly subject to change at any time without notice and The Joyful Investors is under no obligation to notify you of any of these changes.
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View Comments
these sharings are so true. being their customer for the last few years, i have personally been through them and i wished i understood these earlier
never too late Sharon.
We always learn and become better. Nothing is wasted. Most importantly is we understand both the pros and cons of something. Glad this article help in some way.
Investing cannot be done well by robots. It is program by humans after all who can't do well usually too.
It's basically a fund with their own investment mandates, algorithm and can intervene when they feel necessary just like most of the funds. They are fund of Funds. Market is extremely hard to beat afterall.
Balanced piece of write up. Mentioned points are why I signed up for robos. But nothing short of disappointment as I learn more what they really do which I can otherwise do myself at a cheaper manner. Ever consider helping the community with lessons to get started on investing?
Agree with Jian Ming and David, It is more effective and as easy for regular investors to just DCA a world index. Don't be seduced by Roboadvisors' marketing.
It appears that the new strategy is to shift the focus away from the saga with retail folks, and court the high networth individuals with angel investing and other higher risk investments, likely for a higher fee and certainly for higher revenues
It will take a bit of time for this saga to come to pass. As a company you got to keep doing what you can do with different product lines or audience if one is affected temporary.
True that. Great article. These days I try to learn myself from your videos and read up more. Robos just a good starting platform for some i guess.
Robos do have their merits still as shared in the article. Most importantly is to find what suits the individual. All the best in your investing journey!
Thanks for this piece. Very fair one.
Good read. I have been thinking to be slowly moving to learn to DIY and away from robos. thanks for raising the awareness for us new to investing!
Good writeup on this whole saga.