Robo Advisory and India

Financial Advisory business is a big business outside India and when one says outside India, its specifically meant in US / Europe. They provide detailed personalized advise to their clients on the kind of investments that need to be done. But personalized advisory is expensive and hence most advisers take on client accounts only above a certain net-worth. The Private Wealth Management (PWM) division of UBS caters to clients with minimum net worth of $25 million.

But there are only so many rich guys / kids around. Before the advent of technology, you could do little for the small guy on the street who would have loved to have some professional advise on how to deal with his money so that he can achieve his goals other than by way of DIY.

Technology has been a great leveler though. Today, a man on the street can be serviced by these very firms but all without having to allocate a army of advisers. Instead, most of them build a model questionnaire and based on the results gathered, select previously developed models that are suitable.

While Robo Advisory is active in US since 2005, its only recently that we are seeing firms launch their own solutions in India. In fact, one of the goals of Portfolio Yoga is to become a Robo-Adviser.

Before I attempt to take on the India model, let me provide a brief about how the US model operates. Like India, in US, you have 3 avenues for investing in markets

• Hedge Funds (for the Ultra Rich)
• Mutual Funds (for those looking at Active Management)
• ETF’s (for those Passive Investors).

The total AUM more or less is in the same order as well though owing to the fact that many Hedge Funds are not domiciled in US, data seems to suggest that Mutual Funds are a major asset class with total AUM being > 15 Trillion USD.

Passive Investing which while has been available for a very long time has only post 2008 picked up in terms of a better way to invest money in markets since research after research has showcased the fact that very few funds can consistently beat the markets.

But while ETF’s maybe a poor cousin, the total AUM is nothing to sniff about. As of December 2014, the total number of index-based and actively managed exchange-traded funds (ETFs), including commodity ETFs, domiciled in the United States stood at 1,411. Total net assets of these ETFs were $1.974 trillion.

Compare for a moment to the current situation in India where only a dozen or more ETF’s are available and even the best of them have huge liquidity issues. We have a long way to go before we catch up to the size (in percentage terms if not AUM) of the US Market.

But, lets not digress. Back to the Robo Adviser, how does it operate in United States?

When you sign-up for a Robo Adviser, you generally fist go through a series of questions to determine your savings, spending and goals after which the model provides you with a asset allocation strategy that suits you.

You sign-up for their services and ideally handover your money to the custodian (TD Ameritrade for example) which is then invested based on the allocation model that was selected as being best for you. Most Robo Advisers use the low cost ETF’s as the ideal vehicle to invest via and since ETF’s don’t pay a fee for getting investors abroad, the adviser shall charge somewhere between 0.02% to 0.75% on the total assets.

In India though, there is a issue. As we saw earlier, our ETF is a really small part of the financial exosphere and guess what, Indians want everything to be Free.

The model that is right now available in India is hence FREE (and as with other good things in life, nothing comes for Free, Right?) and rather than build on the ETF gets build on the Mutual Fund.

But there is a issue out here. Most Mutual Funds have a very high expense ratio (2.25% to 3% )if you were to go through a distributor. And since fund managers do not want clients to withdraw within short duration, you also have a exit load (which at the initial stages can be fairly high).

Over long periods of time, Mutual Funds seem to have produced tremendous amount of Alpha. But as you start shortening the time scale, you can see that most (average of Top 10 funds for example) cannot beat the returns given by a simple combination of a Large Cap ETF (Nifty Bees) and a Mid Cap / CNX 100 tracking ETF.

I believe that as markets get more mature and our Index is able to capture much of the total market in a small list of stocks, the probability that any fund manager will be able to beat it year after year will reach Zero, but thats my view and only time can answer whether I am right or wrong.

I have not used any Robo Advisor solutions available in India and hence cannot claim to know first hand the weakness of strategies used by them. But by using Mutual funds, they are

1. Cannot call themselves conflict free since the fee could influence where money should be invested (not that it shall, but money does speak)
2. Solutions offered by them aren’t cheap. If a In and Out costs you 3 – 5% of your investment, its shall have a pretty adverse affect in the long term regardless of what the adviser shall claim.

Re-balancing is Tax advantageous in US due to the fact that US has both Short and Long Term taxes. But in India where long term is free (and lets be honest, 1 year is not actually something that could be called Long Term anyways), does it really make sense to claim harvesting of losses as some claim (copy / paste from US I wonder)

Once upon a time, Stock Brokers used to charge brokerage of 2.5% and some more (difference between actual traded price and the one you were given). But competition ensured that today you can trade literally for Free (subject to conditions of course).

While Robo Advisory is claimed to be Free, the charge you pay is actually around 0.75% of your total investment and since we are dealing with percentages, as your AUM grows (Organically or Inorganic), so does the amount you pay to the adviser.

While for small accounts, this may not make a lot of difference in monetary terms (it does in percentage), as you grow your AUM, this amount could equal or more what even fixed fee advisers charge (not that finding them is easy, fixed fee is not something that is widely accepted as a model).

Since no one knows the future, no Adviser will even assure you of whether your long term goals can be achieved even if you stick to the model they prescribe (think about a Doctor saying, well, take this medicine for X years at the end of which I am sure you will be perfectly fine, but if not, maybe we can think about what to change then) unless they invest totally in Fixed Deposits which assure you of a certain maturity value.

For now, Robo Advisory appears a sexy way to invest, but if you were to dig deeper, all you will find is that is actually the most expensive way with the only hope being that funds  continue to deliver Alpha and in that way falsifying all the years of research that US has seen.

Human behavior is tough to change and as much as I rant, I do know that not many will even think about this, let alone act. But if this post makes you think, I think this mornings work is well worth the time spent.

Resources: Betterment