Ghosts In The Robo Advisor Machine

August 19, 2014

Wealthfront modifies historic asset-class returns with current market implied expected returns (Black-Litterman) as well as with the in-house views of Chief Investment Officer Burton Malkiel’s team. In addition, Wealthfront sets minimum and maximum weights for each asset type. The resulting portfolio has an unmistakable Malkiel flavor to it, with an emerging market allocation that reflects his interest in China.

Betterment uses Black-Litterman currently implied market expected returns, but deliberately includes small-cap and value as separate asset classes, adding a classic Fama-French factor tilt. It doesn’t constrain the portfolio weights, but they do account for downside risk. Betterment’s portfolios wind up quite similar to the global market, at least on the equities side.

Covestor deliberately veers away from its optimizer to hedge its portfolios against inflation and to adjust for downside risk. Its wide constraints allow heavy weights to emerging markets.

Wise Banyan constrains its portfolio weights “tighter than most,” back toward market-cap weights, according to Herbert Moore, co-founder and chief investment officer. This might explain why its portfolios allocate generously to U.S. equities, and away from the rest of the global equity market.

Invessence includes the largest number of asset types, adding granularity to the fixed-income side. It bases asset-class returns expectations on up to 80 years of historical ETF or index returns, but uses only nine years of volatility history. Invessence employs gold as an inflation hedge. It also constrains all asset weights except for U.S. equity. Sure enough, the U.S. dominates its equity allocation.

FutureAdvisor doesn’t optimize. Instead, its builds its portfolio in sleeves, creating a glide path much as the target-date mutual funds do. It builds in a “strategic” allocation to REITs as an inflation hedge, adding Fama-French type tilts. They’re not kidding. The firm’s portfolios emphasize small- and midcap stocks, and financials (REITS), with highest-in-class dividend yields and lowest price/book ratios.

  Wealthfront Betterment Future Advisor Covestor WiseBanyan Invessence
Portfolio construction Mean-variance optimization Mean-variance optimization Sleeves & glide path Mean-variance optimization Mean-variance optimization Quadratic optimizer
Number of funds 8 (7 in taxable accounts) 12 12 7 10 21
Constraints Yes No N/A Yes Yes Yes
Tilts No Small cap/value & downside protection Small cap/value & inflation hedge Growth, inflation hedge & downside protection No No
Capital markets assumptions Historical returns, market cap weights, investment committee view Historical returns, market-cap weights N/A Historical returns Historical returns, market-cap weights, investment committee view Historical returns
Intent to mimic the markets No Yes No Yes No No

Let’s look at how these philosophies and use of constraints determine each firm’s weighting to Vanguard FTSE Emerging Markets (VWO | C-90) within their 90 percent equity portfolios.


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