Robo-advisory in India

Yesterday’s edition of Mint featured a wonderful article on Robo Advisories in India (Link). Its a very nice review of the ones that are available in India though the article doesn’t go deep into their philosophies and methodologies. For me though, the last para (part of which is reproduced below) held the key.

Ultimately, its portfolio performance that will matter. So, the algorithm has to be accurate and better than others in selecting and reviewing recommendations. It’s too early to judge or analyse the existing platforms, but as these firms go through more market cycles and recommendations change, the winners will come through.

I am a systematic trader and in the arena of the stock market, I see people constantly peddling black box strategies that are supposed to have delivered wonderfully over the back-test period. The problem though is since you do not know anything about the strategy, you are just blindly hoping that the said performance will continue in future as well.

Also given that market cycles are long (a business cycle for instance lasts around 5 years) and given that there is no public info on how good their algorithm is proving to be (other than for those invested), how good it will be to know 15 / 20 years down the lane that the algorithm was not as good as promised?

The current crop of Robo Advisory as far as I can see is a set of black boxes with each firm claiming to have done extensive research and validated the results to come up with the said model. But for you the end user, you are pretty clueless as to why a certain fund was selected as the choice of investment while another fund was redeemed out.

In United States where the concept of Robo Advisory originated, the logic is to use low cost ETF’s and a re-balancing strategy to ensure maximization of gains for the client. Since ETF’s are very low key in India, most Robo Advisories are going through the Mutual Fund route given that they have shown ability to out-perform (on long term) Mutual Funds. While I doubt how long this can last, for now, Mutual Funds are the way (if you select the right ones, that is).

While researching for this write up, I came across list of funds recommended by one such Robo Advisor. The year and funds they were in is listed below

{Click on the image above for viewing it in full}

They compare their performance to Nifty (not TRI as far as I can see) and claim to have succeeded. But the kind of churn witnessed really boggles my mind. Its as if they are trying to jump from one fund manager to another in the hope of better performance. Also as is the case, Nifty is not the right benchmark if funds are being invested in both Large cap and Mid / Multi cap oriented funds.

They also claim not to invest in sectoral / thematic funds since they believe its best left to the fund managers discretion on which sector he wants to invest more. But if one is indeed punting on momentum (which is what all the fund picking is all about), would it not make sense to have at least a small portion allocated to the sector that is showing the best momentum across board? Would it not add the Alpha one is searching for?

While I see various experts preaching on how you should not go by historical performances when selecting funds but also weigh in other aspects, as far as I have seen, fund performance is what dictates everything. When a fund manager is on a hot streak, his AUM literally explodes (unless he is Direct only like Quantum) and when the said streak ends, slowly but surely AUM keep dropping until the only guys left are those who have forgotten they have invested in such a fund.

As a trader and a technical analyst, I see nothing wrong there. After all, you end result is based on the returns you are able to generate, doesn’t matter what philosophy you may choose to use. But being open about it enables one to understand both in good times and bad. The reason investors jump out of ship when the performance goes down is because they have no clue about the philosophy of the fund manager and the risks such a philosophy would entail.

Robo is the future, but unless I can understand their process (and hence understand the risks), I would stay away from Black Boxes which seem to have figured it all.