Robots Leave Money On The Table

September 04, 2014

 

Developed Ex-US Funds Expense Ratio Median Daily Dollar Volume ($,M) Tracking Error Median Tracking Difference AUM ($,B) Securities Lending Rebate Spreads Underlying Volume/Unit (Market Impact Proxy)
GWL 0.34% 1.7 0.04% -1.17% 0.9 100% 0.11% 0.06%
IEFA 0.14% 13.3 0.01% 0.18% 2.5 75% 0.05% 0.02%
SCHF 0.08% 8.3 0.02% -0.12% 2.6 100% 0.06% 0.01%
EFA 0.34% 782.4 0.01% -0.16% 55.1 75% 0.01% 0.14%
VEA 0.09% 97.9 0.01% 0.19% 23.4 100% 0.02% 0.08%
                 
Emerging Markets Funds                
GMM 0.59% 0.4 0.10% -0.09% 0.2 100% 0.30% 0.38%
IEMG 0.18% 31.0 0.03% 0.00% 5.2 75% 0.03% 0.19%
SCHE 0.14% 5.9 0.08% -0.04% 1.2 100% 0.06% 0.04%
EEM 0.67% 1,577.0 0.02% -0.56% 42.5 75% 0.02% 0.39%
VWO 0.15% 397.3 0.07% -0.18% 48.4 100% 0.02% 0.55%

Data: ETF.com as of July 30, 2014

VEA’s and VWO’s low expense carried the day, at all five shops. The secondary criteria—mostly regarding liquidity—must have knocked out the actual low-headline-cost leader Schwab funds.

A second possibility is that the robo CIOs wrote off funds with comparatively low daily volumes.

That’s a pity, because ETF daily volumes don’t matter that much to market makers, who earn their keep by assisting investors—even robo advisors—to make large ETF trades. If robo advisors are to grow, they’ll have to get comfortable working with these liquidity providers, who often assess portfolio liquidity rather than share volume.

When I pointed this out to Burt Malkiel, Wealthfront’s CIO, he quickly conceded the point. Indeed, all the robo masters I talked to were eager to work with ETF.com to refine their fund selection process, to measure holding costs more effectively and to understand the opportunity costs of their exposures more thoroughly.

Practical Advice

It’s early innings for the robo-advisor field. Even Wealthfront, the current asset leader, crossed the $1 billion in assets under management line only a few months ago, in June. There’s a competitive advantage to whoever can demonstrate the smartest fund selection process.

Those who offer tax-loss harvesting, or who operate on multiple platforms, have a path for transitioning existing clients, and can use data about exposures and opportunity cost to rerank their primary, secondary and even tertiary fund choices.

But even the firms that don’t offer tax-loss harvesting can revisit their fund selection process. Smart fund selection is a win for clients; explaining this well is a marketing advantage.

May the best robot win.


At the time of this writing, the author was stuck in a low-basis position in EEM. Contact Elisabeth Kashner, CFA, at [email protected].

 

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