Inside Robo Advisor Asset Allocation

August 22, 2014

The humans behind the robo advisors seem to be tilting away from the market.

This is the third blog in a multiple-blog series by ETF.com’s Director of Research Elisabeth Kashner on the new “robo advisory” industry. The first was titled ”Which Robo Advisor For My Teen?” and the second was titled ”Ghosts In The Robo Advisor Machine”.

 

“`I wonder what makes us build inefficiently shaped human robots instead of nice streamlined machines.’

`Pride, sir,’ said the robot.”

—Terry Pratchett (“The Dark Side of the Sun”)

The humans behind the robo advisors have reason to be proud of their work. They build broad-based portfolios for a range of risk levels and offer them at low-cost, often with rebalancing and tax-loss harvesting.

But are these portfolios truly streamlined, or are they a touch humanoid?

As I mentioned in my previous blog, robo portfolios reflect the philosophies of their human creators. As part of my due diligence for investing my son’s bar mitzvah money, I did a deep dive into each one, to see how these philosophies came to life.

Good news: These guys pretty much practice what they preach, though a few who promised downside protection are are a bit light on its delivery. Some are evangelical, following strong convictions, while others use a lighter touch.

The resulting portfolios offer plenty of choice. All take bets, but in very different ways. Let’s dig in, and see what our choices are.

Robo-Portfolio Tilts

In the tables below, the black type shows the weights from a 60 percent equity-40 percent fixed-income/commodities allocation, while the blue type shows the weights from a 90 percent equity version. The first table assesses risk; the second shows notable portfolio exposures.

Robo-Portfolios Risk Vs. Benchmarks
  Equity Weight Equity Risk Vs. VT Fixed Income Risk Vs. AGG
Wealthfront 60% Low High
90% Moderate High
Betterment 60% Moderate High
90% Moderate High
Future Advisor 60% High Low
90% High Low
Covestor 60% Moderate Moderate
90% Moderate Moderate
WiseBanyan 60% Moderate High
90% Low High
Invessence 60% Low Very high
90% Low Very high
 
 
 
Robo-Portfolio Exposure Highlights
  Equity Emphasis Equity Sector Over/Underweights Fixed-Income Emphasis Other
Wealthfront US Equities Underweight financials Long-dated Munis Broad-based commodities
Emerging Markets   Long-dated Munis Gold
Betterment Value   Long-dated Munis, International bonds  
Value Underweight technology Long-dated Munis, International bonds  
Future Advisor Emerging Markets
Small Cap & Value
Overweight REITs Short-dated TIPS, International bonds  
Emerging markets
Small Cap & Value
Overweight REITs Short-dated TIPS, International bonds  
Covestor US Equities, Emerging Markets,
Small Cap & Value
Overweight REITs Long-dated TIPS Broad-based commodities
Emerging Markets
Small Cap & Value
Overweight REITs Long-dated TIPS Gold
WiseBanyan US Large Caps, Growth Overweight REITs Long-dated Corporates, International Bonds  
US Large caps   Long-dated Corporates, International Bonds  
Invessence US Equities Overweight Technology Long-dated Munis, High Yield Gold, Cash
US Equities Overweight Technology Long-dated Munis, High Yield Cash

Robo Advisor Equity Portfolios

 

I scaled the robo advisors’ equity and fixed-income portfolios to 100 percent, as if each were an independent portfolio. Then I compared them with a single benchmark ETF: the Vanguard Total World Stock (VT│ B-100) for equities and the iShares Core US Aggregate Bond (AGG | A-97) for bonds.

With the help of ETF.com’s Analytics tool, I was able to roll up statistics from each of the component ETFs to find the portfolio characteristics for each of the six robo-advisor portfolio pairs. I’ve included the full results in an appendix, for those who are up for a deep dive.

For the rest of us, here’s a top-line rundown of the robo-portfolio bets and balancing acts, compared with each firm’s stated goals. We’ll go robo-firm by robo-firm, looking at overweights; size and style tilts; sector bets; and interest-rate and credit risks. Maybe one or two of them will suit you—or my 13-year-old son, who has a small pile of bar mitzvah money, a job as a Little League umpire and a lifetime of earnings potential.

Wealthfront

Weallthfront’s current portfolios overweight emerging markets at the expense of developed-ex-U.S. equities, expressing their investment committee’s current views. Their taxable accounts take on significant interest rate and credit risk in munis, while retirement accounts go heavily into REITs. And there are major differences between their moderate portfolios and their risky ones.

Wealthfront’s 60 percent equities allocation emphasizes the U.S. and, by extension, large-caps; while the 90 percent version tilts small, because of its 31-plus percent emerging market allocation (scaled, as above). In both cases, the allocation to the Vanguard Dividend Appreciation (VIG │A-56) pushes weighted average market-cap weights up, and increases the U.S. representation. Note that Wealthfront’s Chief Investment Officer Burt Malkiel employs VIG as a fixed-income substitute.

Wealthfront (and Betterment) trade control over portfolio duration, yields or credit risk for the tax-free status and tradability of broad-based U.S. municipal bond ETFs. Malkiel believes today’s muni yields are generous, because municipal defaults in Detroit and Puerto Rico have spooked the market.

 

Betterment

Betterment has come through on its pledge to deliver marketlike exposure with a value orientation. But its promised small-cap tilt and downside protection are not in evidence. Like Wealthfront, Betterment takes on moderately high duration and credit risk from its muni bonds.

Betterment pulls off the trick of being both marketlike and value-oriented while not tilting small by making value allocations with U.S. equities only. U.S. large-cap value funds emphasize mega-caps, so Betterment’s value tilt increases its portfolio-weighted average market cap.

If, in the future, Betterment ventures into international value funds, as Chief Executive Officer Jon Stein suggested they might if expense ratios fall, its portfolio-weighted average market cap would likely rise further, approaching the global-weighted average, since mega-cap firms dominate value funds globally.

FutureAdvisor And Covestor: Balancing High-Risk Equity Positions Against Lower-Risk Fixed Income

FutureAdvisor delivers on its promise of a clear small-cap and value tilt, with potential inflation hedging in both REITs and TIPS. In fact, FutureAdvisor leads the pack in small-cap slants, because of its allocations to non-U.S. small-caps and REITs, shaving 23 percent off its weighted average market cap compared with VT. It leads in value, too; at least by the price/book ratio.

FutureAdvisor’s REITs allocation pushes around 35 percent of its equity weight to financials. Simon Moore, the firm’s CIO, explained that this isn’t a specific sector bet, but the effect of results of the value and small-cap tilts in combination with REIT exposure. Whatever the origin, FutureAdvisor’s small-cap and sector bets add risk to its equity portfolio.

In fixed income, FutureAdvisor shortens its overall portfolio duration and raises its credit quality in relation to its core aggregate U.S. investment-grade fund. It keeps its TIPS duration short, counterbalancing the long duration in its international bonds. FutureAdvisor’s clients will be well positioned for increases in the Consumer Price Index, but will give up yield while they wait.

Covestor

Covestor promises inflation protection, which it delivers—potentially—via REITs and TIPS. It also promises downside hedging, but instead takes on a good bit of risk in its equity portfolios by overweighting emerging markets. Its 60 percent equity portfolio has both a strong U.S. overweight and the highest emerging market exposure of the robo bunch. Meanwhile, its 90 percent equity portfolio ranks second highest in emerging market allocations. Those who believe in the long-term stability of the U.S. could interpret the U.S. equity overweight as downside protection.

In fixed income, Covestor extends the duration of our benchmark AGG by using long-dated TIPS, taking on interest-rate risk while reducing portfolio credit risk.

 

WiseBanyan And Invessence

WiseBanyan and Invessence take the opposite approach to FutureAdvisor and Covestor, balancing higher risk in each of their bond allocations against lower equity risk.

WiseBanyan’s U.S.-centric, large-cap equity tilt might compensate for its elevated interest-rate risk. By dropping the influence of the REITs at the higher risk level, WiseBanyan raises its allocation to large-caps as it moves from 60 percent to 90 percent equity. Ex-REITs, WiseBanyan’s U.S.-heavy portfolio pushes up its market caps, compared with the global market.

WiseBanyan takes on duration risk, but keeps credit risk on par with AGG. Both types of risk come primarily from iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD | A-68), though long-dated TIPS and U.S. government paper contribute to the interest-rate sensitivity.

Lastly, Invessence’s strong home-country equity bias shows the pitfalls of partial constraints. Its no-constraints-on-the-U.S.-equity-market philosophy pushes the U.S. to 80 percent of its equity portfolio, with 60 percent parked in the SPDR S&P 500 ETF (SPY | A-98) alone.

There’s a 500-stock hole between SPY and the other part of Invessence’s U.S. equity suite, the iShares Russell 2000 ETF (IWM │ A-79). The missing midcap stocks, along with a huge emphasis on the U.S. market, make Invessence’s portfolio rather top-heavy, with the highest-weighted average market caps of all the robo advisors.

Invessence has made good on its intention to cover the full yield curve and credit spectrum, delivering the most complexity, longest duration and greatest credit risk of the bunch. A primary allocation to long-term munis (duration 11.75) brings plenty of interest-rate risk, and a slug of high-yield bonds pumps up credit risk, bringing 4.44 percent yields.

Streamlined Or Humanoid?

And that’s it. Each of the six robo allocations makes some bets away from the broad market: Wealthfront’s 31 percent emerging market bet (in the 90 percent equity version); FutureAdvisor’s small-cap tilt; and Invessence’s extreme SPY allocation might deliver handsomely, but come with plenty of downside. Forewarned is forearmed.

Even though most of the robo advisors promote features such as rebalancing, tax-loss harvesting or zero cost, the risk levels and specific portfolio exposures will largely determine their returns. Investors are the real winners here, with a range of interesting choices. Streamliners might prefer sticking to VT and AGG, but those looking for human input will find it aplenty.

 

 

APPENDIX

Data sources: Wealthfront, Betterment, FutureAdvisor, Covestor, WiseBanyan, Invessence (various dates) and ETF.com, July 1, 2014

Robo Advisor Equity Portfolios
Ticker Equity Fund Name Wealthfront Betterment Future Advisor Covestor WiseBanyan Invessence
    60% 90% 60% 90% 60% 90% 60% 90% 60% 90% 60% 90%
VTI Vanguard Total Stock Market 30.0% 35.0% 11.6% 16.2% 9.6% 14.1% 33.2% 34.9% 36.0% 54.0%    
VEA Vanguard FTSE Developed Markets 13.0% 22.0% 24.7% 37.5% 5.6% 8.3% 12.7% 19.5% 19.5% 29.3%    
VWO Vanguard FTSE Emerging Markets 9.0% 28.0% 5.2% 10.5% 11.6% 17.0% 14.9% 21.0% 4.5% 6.8% 8.7% 15.7%
VEU Vanguard FTSE All-World ex-US                     2.9% 4.6%
SPY SPDR S&P 500                     37.2% 54.4%
VB Vanguard Small-Cap         4.8% 7.0%            
IWM iShares Russell 2000                     10.1% 17.5%
VTV Vanguard Value     11.6% 16.2% 9.6% 14.1%            
VOE Vanguard Mid-Cap Value     3.7% 5.2%                
VBR Vanguard Small-Cap Value     3.2% 4.5%                
EFV iShares MSCI EAFE Value         6.0% 8.8%            
VSS Vanguard FTSE All-World ex-US Small Cap         3.8% 5.5%            
VNQ Vanguard REIT         4.5% 6.6% 5.1% 5.0% 8.0% 2.0%    
VNQI Vanguard Global ex-U.S. Real Estate         4.5% 6.6%            
VIG Vanguard Dividend Appreciation 7.0% 5.0%                    
                           
Total Equity weight 59.0% 90.0% 60.0% 90.1% 60.0% 88.0% 65.8% 80.5% 68.0% 92.1% 58.9% 92.2%

 

Not all the equity weights add up to exactly 60 percent or 90 percent—intentionally. FutureAdvisor’s 88 percent portfolio is the riskiest it offers. Covestor offers only three portfolios; we’re looking at its “balanced” and “growth” portfolios. WiseBanyan’s weights do indeed sum to 60 and 90 without the REITs, which they consider a nonequity asset class.

 

 

Size & Style Analysis

  Wealthfront Betterment Future Advisor Covestor WiseBanyan Invessence VT
  60% 90% 60% 90% 60% 90% 60% 90% 60% 90% 60% 90%  
Avg. Market Cap ($B) 85.6 74.5 76.0 74.3 61.0 61.1 75.4 72.4 78.3 85.2 87.9 83.6 79.0
Large Cap 75.1% 71.9% 70.8% 70.6% 59.1% 59.3% 69.9% 69.9% 71.3% 74.4% 70.4% 67.9% 71.3%
Midcap 20.3% 23.5% 25.1% 25.4% 27.6% 27.5% 24.2% 24.7% 23.0% 20.8% 14.8% 15.6% 21.1%
Small Cap 4.0% 4.1% 3.8% 3.8% 11.9% 11.8% 5.3% 4.9% 5.1% 4.1% 12.5% 13.9% 6.9%
Micro Cap 0.6% 0.5% 0.3% 0.3% 1.4% 1.4% 0.6% 0.5% 0.7% 0.7% 2.2% 2.5% 0.7%
                           
Dividend Yield 2.0% 2.1% 2.1% 2.1% 2.3% 2.3% 2.2% 2.2% 2.1% 2.0% 1.8% 1.8% 2.0%
P/E Ratio 19.2 17.8 18.6 18.4 19.1 19.1 19.8 19.1 22.0 20.4 20.8 20.9 20.2
P/B Ratio 2.3 2.1 1.9 1.9 1.8 1.8 2.2 2.1 2.2 2.2 2.4 2.3 2.1

Geographic Breakdown

  Wealthfront Betterment Future Advisor Covestor WiseBanyan Invessence VT
  60% 90% 60% 90% 60% 90% 60% 90% 60% 90% 60% 90%  
US 63% 44% 50% 47% 47% 47% 58% 50% 65% 61% 80% 78% 49%
Developed Ex-US 25% 31% 43% 44% 35% 35% 24% 30% 30% 33% 7% 8% 44%
Emerging 12% 25% 7% 9% 17% 17% 18% 21% 5% 6% 13% 14% 7%

 

Note: ETF.com considers South Korea to be a developed market.

 

 

Sector Breakdown

  Wealthfront Betterment Future Advisor Covestor WiseBanyan Invessence VT
  60% 90% 60% 90% 60% 90% 60% 90% 60% 90% 60% 90%  
Basic Materials 5.2% 6.7% 6.0% 6.5% 5.7% 5.8% 5.2% 6.0% 4.4% 6.0% 4.4% 4.6% 6.0%
Consumer Cyclicals 12.3% 11.2% 11.6% 11.3% 8.9% 8.9% 11.1% 10.8% 11.6% 10.8% 12.0% 11.8% 12.6%
Consumer Non-Cyclicals 10.7% 9.6% 9.4% 9.4% 7.0% 6.9% 8.3% 8.4% 8.2% 8.4% 8.5% 8.4% 9.1%
Energy 9.8% 9.8% 9.2% 8.9% 9.1% 8.8% 9.3% 9.1% 8.3% 9.1% 10.1% 10.0% 9.5%
Financials 18.4% 22.7% 22.3% 23.8% 34.8% 36.1% 26.7% 27.7% 28.9% 22.6% 19.6% 20.0% 21.5%
Healthcare 9.8% 8.2% 10.2% 9.5% 7.3% 7.1% 8.5% 8.0% 9.4% 10.2% 10.4% 10.2% 9.7%
Industrials 13.8% 12.1% 13.1% 13.0% 10.1% 10.3% 10.9% 11.1% 11.5% 13.1% 12.4% 12.3% 13.3%
Technology 13.1% 11.5% 9.4% 8.8% 9.3% 8.5% 12.6% 11.0% 11.3% 11.8% 15.6% 15.5% 11.3%
Telecommunications 3.6% 4.7% 4.1% 4.2% 4.1% 4.1% 4.0% 4.3% 3.2% 3.5% 3.3% 3.4% 3.7%
Utilities 3.1% 3.4% 4.5% 4.4% 3.5% 3.5% 3.1% 3.3% 3.0% 3.3% 3.3% 3.3% 3.3%

 

Robo-Advisor Fixed-Income And Commodity Portfolios

Ticker Bond & Commodity Fund Name Wealthfront Betterment Future Advisor Covestor WiseBanyan Invessence
    60% 90% 60% 90% 60% 90% 60% 90% 60% 90% 60% 90%
AGG iShares Core U.S. Aggregate Bond             24.2% 9.4%        
SCHZ Schwab U.S. Aggregate Bond         11.0% 3.3%            
MUB iShares National AMT-Free Muni Bond 35.0% 5.0% 23.5% 5.5%                
MLN Market Vectors Long Municipal                     18.1%  
ITM Market Vectors Intermediate Municipal                     1.8%  
SHM SPDR Nuveen Barclays Short Term Municipal Bond                     1.8%  
LQD iShares iBoxx $ Investment Grade Corporate Bond     2.3% 0.6%         14.0% 3.5%    
VCLT Vanguard Long-Term Corporate Bond                     1.8% 1.5%
JNK SPDR Barclays High Yield Bond                     7.6% 1.6%
PFF iShares U.S. Preferred Stock                     1.8% 1.9%
VGIT Vanguard Intermediate-Term Government Bond                 10.0% 2.5%    
SHY iShares 1-3 Year Treasury Bond                       0.3%
IEF iShares 7-10 Year Treasury Bond                       0.3%
TLT iShares 20+ Year Treasury Bond                       0.4%
TIP iShares TIPS Bond             4.4% 4.4% 8.0% 2.0%    
VTIP Vanguard Short-Term Inflation-Protected Securities         18.0% 5.4%            
BNDX Vanguard Total International Bond     9.0% 2.4% 11.0% 3.3%            
VWOB Vanguard Emerging Markets Government Bond     5.2% 1.6%                
EMLC Market Vectors Emerging Markets Local Currency Bond                   1.8% 0.8%
DJP iPath Dow Jones-UBS Commodity Total Return ETN 6.0%           5.0%          
IAU iShares Gold Trust   5.0%           5.0%     4.6%  
Cash               0.5% 0.7%     2.1% 1.0%
                           

Total Weight

41.0% 10.0% 40.0% 10.1% 40.0% 12.0% 34.2% 19.6% 32.0% 8.0% 41.1% 7.8%

Duration, Yields And Credit-Spread Durations

  Wealthfront Betterment Future Advisor Covestor WiseBanyan Invessence AGG
  60% 90% 60% 90% 60% 90% 60% 90% 60% 90% 60% 90%  
Effective Duration 6.7 6.7 6.8 6.8 4.2 4.2 5.5 5.8 6.9 6.9 8.4 8.6 5.2
YTM 3.05% 3.05% 2.87% 2.89% 1.30% 1.30% 2.03% 1.97% 2.33% 2.33% 4.44% 4.75% 2.09%
Credit-Spread Duration 6.4 6.4 5.9 5.9 2.1 2.1 3.1 2.5 3.5 3.5 7.6 1.2 3.6

 

At the time this article was written, the author held no positions in the securities mentioned. Contact Elisabeth Kashner, CFA, at [email protected].

 

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