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Robo advisor-whitepaper

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Robo-advisor portfolios may be well diversified, they also contain construction gaps that should not be present in well-constructed portfolios.

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Robo advisor-whitepaper

  1. 1. Looking Beyond the Low-Cost Service W H I T E PA P E R ROBO-ADVISORS Robo-advisors are growing in popularity among millennials by providing a convenient, low cost, automated, algorithm-based investment platform to manage investment portfolios with initial investments as low as $1,000. While it is good news that millennials are starting to manage their wealth early, the growth of their wealth is highly dependent on comprehensive financial planning, not just on the portfolio put together by the robo-advisors. The strength of a portfolio can be measured by its key characteristics such as asset allocation, diversification, stock and bond risk, investment costs, and overall portfolio risk and efficiency. When we compare the portfolios from the top five robo-advisors to a benchmark portfolio with several decades of measurable performance, we find that while the robo-advisor portfolios are very well diversified, they also contain several gaps in key characteristics that should be present in well-managed portfolios. Here are the key gaps identified: • Large allocation of assets to emerging markets • Lack of small-cap and value tilts that earn superior returns over the long term • Higher credit risk in the bond portion of the robo-advised portfolios through exposure to junk bonds • Significant variations in asset allocation recommendations across os- tensibly similar risk profile offerings, particularly with respect to large allocations to either stocks or to cash • The above non-risk-adverse allocations reduce overall efficiency of the portfolio, which means the investors might not be getting the optimum return possible for the risks they are taking  
  2. 2. Robo-advisors are online wealth management platforms that provide auto- mated, algorithm-based portfolio management advice without the use of human financial planners. Robo-advisors have benefited greatly from the growing investor appetite for index-oriented investment products, such as index funds and ETFs. Robo-advisors are one of the largest growing segments in the wealth man- agement industry over the last few years. As of February 2016, they were reported to have more than $50 billion of assets under management (AUM) led by passive management industry veterans such as Vanguard and Schwab, as well as venture-backed technology startups like Betterment, Wealthfront and Personal Capital.1 Robo-advice platforms provide a quick and almost-exclusively-online route to investing in a portfolio, making them particularly enticing for millennials. Robo-advisors typically require initial investments as low as $1,000 – $10,000 and charge extremely low fees — on the order of 40 bps or less annually — while including both global stock and bond exposures, making them popular with cost-conscious investors. The convenience and low-cost nature of robo-platforms is difficult to dispute, but there has been little analysis as to the investment quality of their actual investment portfolios. How do these largely algorithm-based portfolios hold up when compared to more traditional wealth management firms’ portfolio construction methods? The purpose of this paper is to answer this question by comparing the structure of several popular robo-advisor portfolio recommendations to a well-defined benchmark portfolio. INTRODUCTION 1 Alessandra Malito and Ellie Zhu, “Top 5 robo-advisers by AUM,” InvestmentNews, February 25, 2016 ROBO-ADVISORS: Looking Beyond the Low-Cost Service 2
  3. 3. Robo-Advisor Selection The first step in evaluating robo-advisor portfolios is to create a sample set of firms from the robo-advisor universe. We focus on the top five service pro- viders in the U.S. as the appropriate sample set for the study (refer to Table 1 in the appendix). The primary criteria for choosing the sample set for the study are AUM, growth in AUM, number of years of service and brand name. Portfolio Analysis Tool We entered the portfolio asset allocation of each robo-advisor into a Portfolio Gap Analysis program that uses Morningstar databases for in-depth analysis. The Gap Analysis Program is designed to compare a specified portfolio to a benchmark portfolio and detect deficiencies as well as potential opportunities for improvement. The key characteristics of an evaluated portfolio include asset allocation, diversification, stock and bond risk, investment costs, port- folio risk and efficiency. Portfolio Selection Traditional advisors as well as robo-advisors provide a range of portfolios based on the risk preferences of investors, where the investor risk prefer- ence is typically characterized as conservative, moderate or aggressive. In this study, a moderate risk portfolio is used to evaluate whether the structure of the robo-advised portfolio is optimized to meet investors’ financial goals. We obtained the asset allocation details from each robo-advisor’s webpage, based on what each robo-advisor identified for an average, moderate-risk- profile investor who is investing for retirement (refer to Tables 2 to 7 in the appendix). The asset allocation details are similar to the allocations pre- sented by a study published by Market Watch.2 The robo-advisors use auto- mated programs with detailed questionnaires to help individuals self-select into a risk profile. There is a question as to how well the robo-advisors METHODOLOGY 2 Victor Reklaitis, “We asked 4 robo advisers and 4 human advisers for portfolios for the same investor,” Market Watch, May 2, 2015 ROBO-ADVISORS: Looking Beyond the Low Cost-Service 3
  4. 4. understand the financial situation of an investor in order to accurately determine the risk profile. This critical topic will be discussed in detail in a follow-up paper. Benchmark Selection Loring Ward’s model portfolio asset allocation recommendations for a moderate risk investor as of September 2016 were chosen as the benchmark for evaluating the portfolio recommendations of the five robo-advisors in this study. Loring Ward’s portfolios are globally diversified as well as spe- cifically tailored to the needs of their clients by financial advisors. They are constructed with DFA mutual funds with tilts towards small-cap and value securities. They embody an Asset Class Investing philosophy that is based on almost nine decades of data, analysis and research, insights from be- havioral finance and close relationships with leading academics, including Dr. Meir Statman and Nobel Laureate Dr. Harry S. Markowitz. Results The Portfolio Gap Analysis we performed of the portfolio recommendations developed by the top five robo-advisors reveals significant gaps with respect to the benchmark portfolio (see Table. 1). The first observation is that Vanguard and Schwab have gaps in two of the 10 key characteristics of the portfolios. Second, the newly established firms Wealthfront, Betterment and Personal Capital have four or five gaps in the portfolios. In the next section, the gaps observed for each key characteristic are discussed in detail. ROBO-ADVISORS: Looking Beyond the Low-Cost Service 4
  5. 5. Table 1 — Gaps in Robo-Advisor Portfolios with Respect to the Benchmark Portfolio Asset Allocation: One of the most important steps in efficient portfolio construction is setting the proper asset allocation. In a study conducted by academics Gary P. Brinson, L. Randolph Hood and Gilbert L. Beebower, asset allocation was found to account for 93.6% of the variation in portfolio return.3 The proper allocation must be determined with care and in context with each client’s investment goals and personal risk tolerance. Gaps in Moderate Portfolios of Robo-Advisors Vanguard Schwab Wealthfront Betterment Personal Capital Asset Allocation Global Diversification Stock Concentration Risk Stock Risk Analysis Bond Quality Bond Maturity Management Expenses Trading Costs Portfolio Efficiency Portfolio Risk Profile 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 3 Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower. “Determinants of Portfolio Performance.” Financial Analysts Journal 42.4 (1986) ROBO-ADVISORS: Looking Beyond the Low-Cost Service 5
  6. 6. The Betterment Portfolio has the biggest gap with respect to asset allocation, with 90% in stocks and just 10% in bonds for a moderate portfolio (see Fig. 1). The Schwab Portfolio has an unnecessarily large ‘cash-drag’ for our hypo- thetical investor, with nearly 8.5% of the money in cash. Fig. 1 — Asset Allocations in the Betterment and Schwab Intelligent Portfolios Have Significant Gaps Compared to the Benchmark Portfolio Global Diversification: On the general issue of global diversification there does not appear to be a gap in the robo-advisor portfolios, but it is important to note that robo-advisors have allocated more of their portfolios to emerg- ing markets as exhibited by Wealthfront in Fig. 2. Emerging markets have higher volatility due to currency risk, inflation risk, institutional risk, liquidi- ty risk and political risk. From Loring Ward’s capital market assumptions the Sharpe ratio, which is the ratio of an asset’s return over risk, is lesser for emerging markets compared to U.S. stocks and developed international stocks.4 This means even though investing in emerging markets could generate higher returns, it also increases the risk of each of these moderate portfolios. Hence it is recommended to allocate 6% or less to emerging market securities as observed in the benchmark portfolio. 10% 90% 8.5% 21.5% 5% 65% 2% 65% 33% Cash Bond Stock Other Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Lo Highest CreditQuality Duration Lowest Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth MSCI World Marke (MSCIAC World Ind Current Portfolio Recomm Portfolio Charles Schwab Portfolio Loring Ward Portfolio Gap Total Stocks 7,097 9,514 2,417 Top 10 Stocks 5.75% 7.59% 1.84% Cash Efficiency 0.08 0.99 0.91 Global Market Wealthfront Portfolio Loring Ward Portfolio Gap % Weight % Weight % Weight % Weight U.S. Core Equity 44 53 56 3 International Core Equity 43 33 38 5 Emerging Core Equity 13 14 6 8 Not Classified 0 0 0 0 4 “Asset Class Capital Market Assumptions Methodology,” Loring Ward Portfolio Strategy and Research ROBO-ADVISORS: Looking Beyond the Low-Cost Service 6 Schwab Intelligent Portfolio Betterment Loring Ward Portfolio
  7. 7. Fig. 2 — Global Diversification in Wealthfront’s Portfolio Compared to LW Portfolio Stock Concentration Risk: Stock concentration risk refers to undiversified company-specific risk. All the robo-advisors were very well diversified with the top 10 stocks accounting for less than 10% of the portfolio resulting in low stock concentration risk. To give an example, the Schwab Intelligent Portfolio has nearly 7,000 stocks and the top 10 stocks represent only 5.75% of the portfolio (see Fig. 3). Fig. 3 — Stock Concentration Risk in Schwab Intelligent Portfolio Compared to LW Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth MSCI World M (MSCIAC Wor Current Portfolio Re Po Charles Schwab Portfolio Loring Ward Portfolio Gap Total Stocks 7,097 9,514 2,417 Top 10 Stocks 5.75% 7.59% 1.84% Cash Efficiency 0.08 0.99 0.91 Global Market Wealthfront Portfolio Loring Ward Portfolio Gap % Weight % Weight % Weight % Weight U.S. Core Equity 44 53 56 3 International Core Equity 43 33 38 5 Emerging Core Equity 13 14 6 8 Not Classified 0 0 0 0 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% E R C U U C 10% 90% 8.5% 21.5% 5% 65% 2% 65% 33% Cash Bond Stock Other Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortes Highest CreditQuality Lowest Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Growth MS (MS Curren Portfo Charles Schwab Portfolio Loring Ward Portfolio Gap Total Stocks 7,097 9,514 2,417 Top 10 Stocks 5.75% 7.59% 1.84% Cash Efficiency 0.08 0.99 0.91 Global Market Wealthfront Portfolio Loring Ward Portfolio Gap % Weight % Weight % Weight % Weight U.S. Core Equity 44 53 56 3 International Core Equity 43 33 38 5 Emerging Core Equity 13 14 6 8 Not Classified 0 0 0 0 18% 16% 14% 12% 10% 8% 6% 4% AnnualizedReturns 18% 16% 14% 12% 10% 8% 6% 4% AnnualizedReturns 18% 16% 14% 12% 10% 8% 6% 4% AnnualizedReturns ROBO-ADVISORS: Looking Beyond the Low-Cost Service 7
  8. 8. 2% 65% 33% Cash Bond Stock Other Less Risk Shortest Longest Highest Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Ward olio Gap 4 2,417 % 1.84% 9 0.91 nt Loring Ward Gap Stock Risk Analysis: The benchmark portfolio emphasizes small-cap and value stocks in an effort to increase the return potential of the stock allocation. Research by Professors Eugene Fama and Ken French established size and value as two key factors that contribute to expected return.5 The robo-advisor portfolios had lower small-cap and value stock weightings than the benchmark portfolio. The stock style matrix for all the robo-advisor portfolios compared to the benchmark portfolio is shown in Fig. 4. Fig. 4 — Stock Style Risk Across Robo-Advisor Portfolios Compared to LW Portfolio 10% 90% 8.5% 21.5% 5% 65% 2% 65% 33% Cash Bon Stoc Othe Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Highest CreditQuality D Lowest Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio S L Growth MSCI W (MSCIAC Current Portfolio Charles Schwab Portfolio Loring Ward Portfolio Gap Total Stocks 7,097 9,514 2,417 Top 10 Stocks 5.75% 7.59% 1.84% Cash Efficiency 0.08 0.99 0.91 Global Market Wealthfront Portfolio Loring Ward Portfolio Gap % Weight % Weight % Weight % Weight U.S. Core Equity 44 53 56 3 International Core Equity 43 33 38 5 Emerging Core Equity 13 14 6 8 Not Classified 0 0 0 0 18%18% 18% 5 Eugene F. Fama and Kenneth R. French “The cross-section of expected stock returns”, The Journal of Finance, Vol. XLVII, No. 2, 1992 Vanguard Schwab Wealthfront Betterment Personal Capital ROBO-ADVISORS: Looking Beyond the Low-Cost Service 8
  9. 9. Bond Risk: There are two primary risk factors that contribute to the level of volatility in bonds: credit quality and maturity. Historical evidence shows us that investors have not been adequately compensated for extending the credit quality of their bond portfolio below investment-grade (i.e. a credit rating below BBB). While low-quality bonds have a higher average yield, during periods of deep recession their risk of default and loss of principal is higher than invest- ment-grade companies. The benchmark portfolio we used for comparison is comprised 100% of investment-grade bonds. We observed that the bond quality of the robo-advisor portfolios is lower on average, with some including junk grade bonds, as observed in Fig. 5. Robo-advisors don’t have any gap with regards to maturity or global diversification in their bond portfolio. Fig. 5 — Bond Risk Across Robo-Advisor Portfolios Compared to LW Portfolio 10% 90% 8.5% 21.5% 5% 65% 2% 65% 33% Cash Bond Stock Other Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Highest CreditQuality Dura Lowest Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Sma Larg Growth MSCI World (MSCIAC Wo Current Portfolio R P Charles Schwab Portfolio Loring Ward Portfolio Gap Total Stocks 7,097 9,514 2,417 2% 33% Cash Bond Stock Other Longest uration More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk mall Small Small Vanguard Schwab Wealthfront Betterment Personal Capital ROBO-ADVISORS: Looking Beyond the Low-Cost Service 9 Current Portfolio Recommended Portfolio
  10. 10. Portfolio costs: Management expenses and transaction costs are less than 40 bps for the robo-advisors, except Personal Capital that charges 89 bps for wealth management. Portfolio efficiency: A portfolio is efficient if the investor gets the maximum return for risk that they are willing to take. The risk and return estimates for different asset classes used to construct the portfolio are best estimates; therefore a range of returns is possible for a specific risk, even for an efficient portfolio. This range of returns for different risks results in an efficient range of diversified portfolios. Wealthfront and Betterment portfolios are not within the efficient range, as seen in Figure 6. Fig. 6 — Betterment and Wealthfront Portfolios are Below the Efficient Range Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Charles Schwab Portfolio Loring Ward Portfolio Gap Total Stocks 7,097 9,514 2,417 Top 10 Stocks 5.75% 7.59% 1.84% Cash Efficiency 0.08 0.99 0.91 Global Market Wealthfront Portfolio Loring Ward Portfolio Gap % Weight % Weight % Weight % Weight U.S. Core Equity 44 53 56 3 International Core Equity 43 33 38 5 Emerging Core Equity 13 14 6 8 Not Classified 0 0 0 0 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 3 Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Charles Schwab Portfolio Loring Ward Portfolio Gap Total Stocks 7,097 9,514 2,417 Top 10 Stocks 5.75% 7.59% 1.84% Cash Efficiency 0.08 0.99 0.91 Global Market Wealthfront Portfolio Loring Ward Portfolio Gap % Weight % Weight % Weight % Weight U.S. Core Equity 44 53 56 3 International Core Equity 43 33 38 5 Emerging Core Equity 13 14 6 8 Not Classified 0 0 0 0 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 3 8.5% 21.5% 5% 65% 2% 65% 33% Cash Bond Stock Other Less Risk Shortest Longest Highest Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Small Large owth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Charles Schwab Portfolio Loring Ward Portfolio Gap 7,097 9,514 2,417 5.75% 7.59% 1.84% y 0.08 0.99 0.91 Global Market Wealthfront Portfolio Loring Ward Portfolio Gap % Weight % Weight % Weight % Weight 44 53 56 3 43 33 38 5 13 14 6 8 0 0 0 0 Deviation 0% 25% 30% 35% 40% Deviation 0% 25% 30% 35% 40% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% Efficient Range Recommended Current U.S. Market U.S. Fixed Income Cash 65% 65% Other Less Risk Shortest Longest Highest Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Less Risk Shortest Longest Highest CreditQuality Duration Lowest More Risk Small Large rowth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Small Large Growth Value MSCI World Market (MSCIAC World Index) Current Portfolio Recommended Portfolio Charles Schwab Portfolio Loring Ward Portfolio Gap 7,097 9,514 2,417 5.75% 7.59% 1.84% y 0.08 0.99 0.91 Global Market Wealthfront Portfolio Loring Ward Portfolio Gap % Weight % Weight % Weight % Weight 44 53 56 3 y 43 33 38 5 13 14 6 8 0 0 0 0 Deviation 20% 25% 30% 35% 40% Deviation 20% 25% 30% 35% 40% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% AnnualizedReturns Standard Deviation 0% 5% 10% 15% 20% 25% 30% 35% 40% Efficient Range Recommended Current U.S. Market U.S. Fixed Income Cash Wealthfront Betterment ROBO-ADVISORS: Looking Beyond the Low-Cost Service 10
  11. 11. Portfolio Risk: Financial independence at retirement requires taking into consider- ation factors with fiduciary implications, such as the future earning potential of the client and current and future liabilities — such as student loans, home mortgage, children’s education plans, moving to a different state for retirement and several other unique situations. Holistic financial planning needed to ensure financial in- dependence at retirement is essential to understand the risk profile of an investor and eventually the portfolio risk. Thus, holistic financial planning becomes the most critical first step of the wealth management experience. Moreover, the financial regulatory landscape is constantly changing and the new fiduciary requirements that are about to be mandated by the Department of Labor (DOL) are significant. In a recent white paper, Melanie Fein, an attorney who served as senior counsel to the Board of Governors of the Federal Reserve System, suggests that robo-advisors may not be able to meet the fiduciary stan- dards largely because they don’t always provide portfolio analysis that examines the risk and reward features of an investment in the context of the portfolio as a whole, and as part of an overall investment strategy that considers other invest- ments, assets, liabilities, sources of incomes and other resources.6 Robo-advisors provide a free automated advisory service that attempts to under- stand the basic financial needs of the clients. However, experienced registered investment advisors typically have a deep conversation with their clients regarding future financial needs and can build a comprehensive financial plan for a nominal fee. An in-depth conversation with an experienced advisor is important for millen- nials to help them picture multiple, complex future financial scenarios, and we believe it more than justifies the nominal fees charged for future potential financial independence. 6 “Robos and the challenges of fiduciary advice” white paper by Investment News ROBO-ADVISORS: Looking Beyond the Low-Cost Service 11
  12. 12. Robo-advising is an innovative service that will most likely have an impact on future money management. The low asset minimums and low fees gear the service towards millennials who cannot yet afford to invest with a traditional financial advisor. While inexpensive, the portfolios of these robo-advisors appear to be constructed inefficiently and may expose young investors to risks they may not fully understand. Robo-advised portfolios provide global diversification, and have a large portion of assets allocated to emerging markets, significantly increasing portfolio risk. Their lack of small and value tilts also lowers the potential of their returns. These port- folios also have bond risk due to exposure to low quality junk bonds and longer duration bonds. The deficiencies in the robo-advisor portfolios show that these investors might have risk in achieving their future financial goals. Finally, the robo-advisors lack the benefits of holistic wealth management with a real-life advisor who takes into account specific situations with fiduciary implications, such as moving to another state in retirement or personal situations such as plan- ning for a special needs child or for specific charitable bequests. We believe that holistic wealth management is the key to achieving future financial independence for many investors. CONCLUSION ROBO-ADVISORS: Looking Beyond the Low-Cost Service 12
  13. 13. Table 1 — Robo-Advisor Universe with Total AUM of $50 Million or More7 Robo-Advisor Services AUM ($million)7 Vanguard Personal Advisors 37,000 Schwab Intelligent Portfolio 7,400 Betterment 4,000 Wealthfront 3,000 Personal Capital 2,500 Asset Builder 671 Future Advisor (owned by Blackrock) 250 Rebalance IRA 225 Liftoff 150 SigFig 70 WiseBanyan 50 Etrade Adaptive Portfolio NA (started in 2016) Fidelity Go NA (started in 2016) APPENDIX ROBO-ADVISORS: Looking Beyond the Low-Cost Service 13 7 AUM as of Q1 2016
  14. 14. Table 2 — Asset Allocation for a Moderate Portfolio Developed by Wealthfront Asset Allocation Wealthfront Name of Investment Ticker % of Portfolio U.S. Stocks Vanguard Total Stock Market ETF VTI 20.0% Vanguard Dividend Appreciation ETF VIG 15.0% Foreign Stocks Vanguard FTSE Developed Markets ETF VEA 17.0% Vanguard FTSE Emerging Markets ETF VWO 13.0% Bonds iShares iBoxx USD Investment Grade Bond ETF LQD 15.0% iSharesJ.P.MorganUSDEmergingMarketsBondETF EMB 8.0% Other Vanguard REIT ETF VNQ 12.0% Table 3 — Asset Allocation for a Moderate Portfolio Developed by Betterment Asset Allocation Betterment Name of Investment Ticker % of Portfolio U.S. Stocks Vanguard Total Stock Market ETF VTI 16.2% Vanguard Value ETF VTV 16.2% Vanguard Mid-Cap Value ETF VOE 5.2% Vanguard Small-Cap Value ETF VBR 4.5% Foreign Stocks Vanguard FTSE Developed Markets ETF VEA 37.5% Vanguard FTSE Emerging Markets ETF VWO 10.5% Bonds Vanguard Total International Bond ETF BNDX 3.6% VanguardTotalBondMarketETF BND 3.2% iSharesiBoxxUSDInvestmentGradeBondETF LQD 1.7% VanguardEmergingMarketsGovernmentBondETF VWOB 1.6% Fees: Investors pay a management fee of 0.35% for their first $10,000 with New York City–based Betterment, or $3 a month if they’re not auto-depositing at least $100 a month. The next $90,000 costs you 0.25%, and beyond that the fee is 0.15%. Fees: Investors don’t pay a management fee for their first $10,000 at Palo Alto, Calif.–based Wealthfront, and above that amount the fee on assets is 0.25%. ROBO-ADVISORS: Looking Beyond the Low-Cost Service 14 Basis Point: Basis point (BPS) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument. Sharpe Ratio: The Sharpe ratio is a risk-adjusted measure of return. It is calculated using the standard deviation and excess return to determine the return per unit of risk. Standard Deviation: Standard Deviation is a statistical measurement of dispersion about an average, it depicts how widely the returns have varied over a certain period of time.
  15. 15. Table 4 — Asset Allocation for a Moderate Portfolio Developed by Personal Capital Asset Allocation Personal Capital Name of Investment Ticker % of Portfolio U.S. Stocks Domestic Equities NA 44.0% Foreign Stocks International Equities NA 19.0% Bonds Domestic Fixed Income NA 20.0% ForeignFixedIncome NA 5.0% Other Cash NA 1.0% Alternative Investments NA 11.0% Table 5 — Asset Allocation for a Moderate Portfolio Developed by Schwab Intelligent Portfolio Asset Allocation Schwab Intelligent Portfolio Name of Investment Ticker % of Portfolio U.S. Stocks Schwab Fundamental U.S. Large Company ETF FNDX 11.0% Schwab U.S. Large-Cap ETF SCHX 8.0% Schwab Fundamental U.S. Small Company ETF FNDA 7.0% Schwab U.S. Small Cap ETF SCHA 4.0% Foreign Stocks SchwabFundamentalInternationalLargeCompanyETF FNDF 8.0% Schwab International Equity ETF SCHF 5.0% Schwab Fundamental International Small Company ETF FNDC 5.0% Schwab Fundamental Emerging Markets Large Company ETF FNDE 5.0% Schwab Emerging Markets Equity ETF SCHE 4.0% Schwab International Small-Cap Equity ETF SCHC 3.0% Bonds U.S. Corporate High Yield Bonds SHYG 8.0% VanEck Vectors Emerging Markets Local Currency Bond EMLC 7.0% VanguardMortgage-BackedSecuritiesETF VMBS 3.0% VanguardTotalInternationalBondETF BNDX 2.5% SPDRBarclaysIntermediateTermCorporateBondETF ITR 1.0% Other Cash N/A 8.5% iShares Gold ETF IAU 5.0% Schwab U.S. REIT ETF SCHH 3.0% Vanguard Global ex-U.S. Real Estate ETF VNQI 2.0% Fees: Does not charge a management fee. Fees: Investors pay a management fee of 0.89% to Personal Capital for the first $1 Million, and it progressively decreases to 0.49% for clients that invest more than $10 Million. ROBO-ADVISORS: Looking Beyond the Low-Cost Service 15
  16. 16. Table 6 — Asset Allocation for a Moderate Portfolio Developed by Vanguard Asset Allocation Vanguard Name of Investment Ticker % of Portfolio U.S. Stocks Vanguard 500 Index Admiral VFIAX 22.0% Vanguard Extended Market Index Admiral VEXAX 8.5% Vanguard Small Cap Value Index Admiral VSIAX 9.5% Vanguard Total Stock Market Index Admiral VTSAX 5.0% Foreign Stocks Vanguard Total International Stock Index Admiral VTIAX 20.0% Bonds Vanguard Intermediate-Term Bond Index Admiral VBILX 2.0% VanguardLong-TermInvestmentGradeAdmiral VWETX 3.0% VanguardTotalInternationalBondIndexAdmiral VTABX 8.0% VanguardTotalBondMarketIndexAdmiral VBTLX 20.0% VanguardShort-TermBondIndexAdmiral VBIRX 2.0% Table 7 — Asset Allocation for a Moderate Portfolio Developed by Loring Ward Asset Allocation Loring Ward Name of Investment Ticker % of Portfolio U.S. Stocks DFA US Core Equity 1 I DFEOX 15.0% DFA US Large Cap Value I DFLVX 12.0% DFA US Small Cap I DFSTX 8.0% Foreign Stocks DFA International Value I DFIVX 14.0% DFA International Small Company I DFISX 7.0% DFA Emerging Markets Value I DFEVX 5.0% Bonds DFA Five-Year Global Fixed Income I DFGBX 17.0% DFAOne-YearFixedIncomeI DFIHX 16.0% Other Cash N/A 2.0% DFA Real Estate Securities I DFREX 4.0% Fees: Investors pay a management fee that is dependent on the client’s assets as well as the client advisor’s assets with Loring Ward. Clients with assets less than $500,000 pay a management fee between 0.5% and 0.65% based on the client advisor’s assets with Loring Ward. Management fees progressively decrease as the client’s assets increase. Clients with assets greater than $5 Million pay a management fee between 0.1% and 0.2% based on the client advisor’s assets with Loring Ward. Fees: Investors pay a management fee of 0.3% to Vanguard for the benefits of a Vanguard advisor, a customized financial plan and ongoing portfolio management. ROBO-ADVISORS: Looking Beyond the Low-Cost Service The risks associated with investing in stocks and overweighting small company and value stocks potentially include increased volatility (up and down movement in the value of your assets) and loss of principal. Diversification neither assures a profit nor guarantees against loss in a declining market. LWI Financial Inc. (“Loring Ward”) is an investment adviser registered with the Securities and Exchange Commission. Securities transactions are offered through its affiliate, Loring Ward Securities Inc.,member FINRA/SIPC. Dimensional Fund Advisors is an investment advisor registered with the Securities and Exchange Commission and is unaffiliated with LWI Financial Inc. B 16-060 (9/18) 10 Almaden Blvd., 15th Floor, San Jose, CA 95113 800.366.7266 | loringward.com

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