Rebooting Robo Advisors’ ETF Selection

August 25, 2014

A robotic focus on expense ratios costs more than you think.

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

Thirteen years ago, my husband and I half expected to find a tiny maple leaf on our newborn’s bottom, because our California baby had been—ahem—made in Canada. Our family has a soft spot for our neighbors to the north.

How sad that only one of the six all-ETF robo advisors—the firms we’re considering as managers of his bar mitzvah money—offers even a sliver of exposure to Canadian equities.

Canada boasts the fifth-largest stock market in the world, larger than France’s or Germany’s. The iShares MSCI Canada ETF (EWC | A-92) returned 10.9 percent per year in the decade ending July 30, 2014, versus 8.7 percent for the U.S.’ Russell 1000 Index.

Have the robots gone rogue? Why did they boot out Canada?

Not deliberately. Canada, it turns out, is a casualty of the robo advisors’ ETF selection process, which prioritizes low expense ratios over all other criteria.

Beyond The Price Tag

The chief investment officers (CIOs) of these robo advisors aren’t measuring the true costs of ownership, or the opportunity cost of portfolio gaps. As a result, they’re missing real opportunities.

Wealthfront and Betterment could offer state-specific muni funds. The iShares California AMT-Free Muni ETF (CMF | B-85) and the iShares New York AMT-Free Muni ETF (NYF | B-88) are efficient and accessible, trading a median $1,300,000 and $700,000 per day, respectively. The long-term tax savings are probably worth the extra 0.11 percent trading spread cost between these two funds and the iShares National AMT-Free Muni Bond ETF (MUB | B-74).

Betterment and Future Advisor could get a stronger small-cap/value tilt with Guggenheim’s S&P 500 Pure Value ETF (RPV | A-64). With the fund’s 1.39 price-to-book ratio (P/B) and its $37.3 billion weighted average market cap, the value tilt both firms get by allocating to the Vanguard Value ETF’s (VTV | A-96) is lower. VTV clocks in with a 2.04 P/B and $127 billion weighted average market cap.

FutureAdvisor and Covestor could tailor their U.S. aggregate bond exposure. FutureAdvisor needs liquidity to support its tax-loss harvesting program, and so should hold the iShares Core U.S. Aggregate Bond ETF (AGG | A-97) that Covestor favors (AGG has 0.02 percent spreads, versus 0.07 percent for the Schwab U.S. Aggregate Bond ETF (SCHZ | A-99). At the same time, Covestor should focus on SCHZ’s long-term holding costs (-0.10 percent median annual tracking difference, versus -0.13 percent for AGG). Instead, both firms have done the exact opposite.

Invessence could avoid a 500-stock hole in its U.S. market coverage by switching from the SPDR S&P 500 ETF (SPY | A-98) to the iShares Russell 1000 ETF (IWB |A-92).


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