Q3 2017 Robo Report: Increase in Tax Planning Tools

Posted on December 2, 2017

Digital advice is gaining traction both among individual investors and advisory firms. Although the concept of a robo-adviser was pioneered by start-ups like Betterment and Wealthfront, the technology is being adopted across the advice marketplace. Increasingly, individual investors will come into contact with digital advice solutions as they search for advice providers. For those interested in a low-cost advice and investment selection solution, there are no longer just a few firms from which to choose. Over the last year alone T. Rowe Price, Zacks Advantage, TIAA, TD Ameritrade, Merrill Lynch and Wells Fargo have all released digital advice products. Additionally, LPL and Cetera Financial Group both recently made a robo-advice product available to their advisers to market to end clients. As choices in providers expand, the selection process for investors increases in complexity.

Performance, services, costs and special features should all play into an investor’s decision about robo-advisers. Levels of service range from automated advice only, to a dedicated adviser and everything in between. Some services, like Betterment and Schwab, have different levels of service at different costs. Betterment and Schwab clients can add access to live advisers without having to change providers or portfolios. This can help investors who are not sure what level of service they need, or are concerned that they will outgrow the digital-only service and want to upgrade to having access to a live adviser.

Emerging Trends in the Robo-Adviser Industry

As competition increases, robo-advisers are trying to differentiate their products with new features and offerings. The most common feature is tax-loss harvesting. Tax-loss harvesting is when an asset that has declined in value is sold for a loss and another similar asset is purchased, minimizing the change in overall portfolio exposure. The loss can be offset against income or other capital gains at tax time, deferring the tax burden of gains into the future. This technique can add to performance but its impact can vary. Portfolios that are contributed to in regular intervals increase their chances of being able to benefit from tax-loss harvesting. Volatile markets, unlike the markets of recent years, also increase the likelihood that this technique will add value. Some robo-advice providers offer this service for free, others only offer the service on accounts above a certain dollar level, while others do not offer this feature at all.

Wealthfront and Personal Capital are focused on maximizing the opportunities of tax-loss harvesting. Both offer this feature on accounts above a certain asset level where individual stocks are held instead of broader-market funds. By owning individual stocks, the likelihood of a single security being sold at a loss increases, in turn increasing opportunities for loss harvesting.

Another emerging trend in feature sets is socially responsible investing, or impact investing, as it is often called. These strategies take into account non-financial aspects of companies, like the impact on the environment, a company’s track record with human rights or corporate responsibility. This year, many robo-advisers have either launched with this option or added it. Socially responsible investing is available at Motif Investing, Hedgeable, TIAA, Betterment, Wealthsimple, Earthfolio, OpenInvest and it is anticipated as part of the upcoming Morgan Stanley offering. Robo-advisers are expanding the options for investors who want to use their investment decisions to encourage certain behaviors in companies.

Some advisers, like Acorns, have other unique features to help investors save and manage budgets. Acorns automatically saves and invests money for you by rounding up your credit or debit card purchases and investing the difference. Betterment, on the other hand, just announced a charitable giving feature that encourages using appreciated stock instead of cash for donations. This can reduce the giver’s long-term tax bill by using assets with taxable gains as donations. It can also decrease costs for the receiving charity by eliminating fees associated with taking donations via credit and debit cards. Wealthsimple, in addition to socially responsible investing options, has a portfolio that complies with Islamic investing principles. As competition in the space increases, we only expect to see more companies increasing their offerings in this regard to stand out to investors.

Third-Quarter 2017 Robo Report

This quarter we began tracking robo-offerings from TIAA, SoFi and Wealthsimple. Next quarter, we look forward to adding robo-products from T. Rowe Price and Zacks Advantage.

While new robo-advisers are launching, other robos are gaining more assets. Vanguard recently reported $100 billion in assets under management (for their robo-product), while Schwab’s robo-program is approaching $25 billion and Betterment reports over $11 billion in assets under management.

A new report from Aite Group predicted that assets managed by digital advisers will reach $166 billion by year-end and $1 trillion by 2020.

In the third-quarter 2017 Robo Report, you will find summaries of interviews with Betterment, Personal Capital and WiseBanyan.

Domestic equity markets continued their strong year-to-date run in the third quarter of 2017, with international and fixed-income markets generally following suit. The S&P 500 index posted a 4.48% gain, finishing the quarter at yet another all-time high. Steady macroeconomic data and another round of strong corporate earnings growth were two key catalysts here, helping domestic markets shrug off some lingering concerns over higher-than-average valuations.

Small caps led their mid- and large-cap peers in the quarter, as they are expected to gain the most from a potential tax reform. That said, large caps have outperformed year-to-date on strong earnings and an improving global economy.

Asset Allocation

While feature sets can be important, performance of assets ranks high among most investors’ priorities. Although most portfolios are based in modern portfolio theory and follow a passive, or mostly passive, strategy there are still significant differences in how these portfolios are constructed. Portfolio allocation and trading decisions have created a wide dispersion of returns this year. This year, equity performance in some of our simplest portfolios have done the best. The four top year-to-date equity performers all rely on a total stock market ETF for their entire domestic equity exposure. SigFig, Vanguard and WiseBanyan hold the Vanguard Total Stock Market ETF (VTI), while TD Ameritrade holds the iShares Core S&P Total U.S. Stock Market ETF (ITOT). These ETFs have helped outperform by having large allocations to large-cap companies and not taking on a style bias between value and growth.

Of the robo-advisers we track, Betterment led the group of moderate taxable portfolios in year-over-year returns ending September 30, 2017, with a 11.97% net-of-fees return. Acorns trailed the group over the same period, returning just 7.85%. This represents a more than 4% gap from the first- to last-place performer over the course of year, a significant difference.

This quarter we needed a more in-depth asset allocation analysis of the equity portion of the taxable portfolios. The style map in Figure 1 is not created using underlying holdings, but rather regression analysis on returns. Only portfolios open for one year were included in the analysis in order to improve the accuracy of the output.

Figure 1. Robo-Adviser Style Map

Figure 1. Robo-Adviser Style Map

One of the most interesting findings was the clear bias toward value stocks, which is even more interesting because growth has outperformed value this year. We have noted in previous reports that all of our portfolios show either a neutral weighting between value and growth or a tilt toward value with one notable exception: our Hedgeable IRA. Schwab, Merrill Edge, Betterment and Ellevest all have value-oriented weightings, which have continued to detract from performance this year.

Although we typically see very little trading activity in our portfolios, there are a few portfolios that have made some sector bets and allocation changes. Acorns has made the most significant changes to our taxable portfolio over the last year. It reduced the significant allocation to small caps, reduced the large allocation to emerging markets, introduced international developed markets exposure and significantly cut the REIT holding. The timing of its adjustments within market-cap and international weightings was poor, resulting in lower performance. Wealthfront holds a dedicated position in the energy sector in our taxable portfolio. Energy has performed poorly this year and although this position has not done well, it did provide Wealthfront with an opportunity for tax-loss harvesting, which was executed.

Hedgeable is one of the few robos that follows an active trading strategy, and the IRA portfolio we track exhibits the most trading in our universe. The equity portion of this portfolio is heavily invested in the tech sector and outperformed the other equity portions of our other IRA portfolios in the third quarter. Hedgeable IRA holds all individual securities, ending the quarter with just eight equity holdings, six of which are technology stocks representing nearly 60% of its total allocation. This heavy weighting toward technology stocks led its IRA equity portion to significantly outperform its peers, returning 7.21%. The next-best IRA equity performance was by the SigFig IRA at 5.56% for the quarter.

Despite having very strong equity performance, Hedgeable maintained a large fixed-income allocation compared to our other aggressive IRA portfolios in the second and third quarters this year. Strong equity returns in the markets means the fixed-income allocation held back the overall returns, resulting in the Hedgeable IRA finishing last for the quarter. So far this year, it appears that the portfolios making active allocation decisions are trailing their more passive peers.

We see a couple of trends in the portfolios that have shown the strongest performance this year. High allocations to international equities have helped these portfolios. Betterment and Schwab both hold nearly half of their equities in international and were the top two year-over-year performers among our taxable portfolios. Schwab is an interesting case, as it mandates a large cash allocation in its portfolio; in times of strong equity market performance, cash allocations can hold back returns. Despite this cash allocation, Schwab has continued to perform well. This is in part due to its aggressive fixed-income securities selection. Schwab has large fixed-income allocations to high-yield and international debt, two historically riskier asset classes. This has served it well this year but may ultimately lead to a more volatile portfolio in a bear market.

Both robo-advising products and features offered by existing players are increasing at a rapid rate. With so many options available, investors may find it difficult to narrow the field of options. Features, risk, performance and level of service all play an important role when selecting a digital advice solution. We look forward to continuing to provide actionable information to investors assessing robo-advice providers in 2018.


Total portfolio performance for the quarter ranged from 3.01% to 3.97% in our moderate taxable portfolios. In our aggressive IRA portfolios, total performance ranged from 3.24% to 5.21% in the quarter. Year to-date, performance ranges from 9.07% to 11.81% in the taxable accounts and 12.80% to 16.89% in our IRAs. This quarter, two of our portfolios—Betterment and Schwab—have full two-year numbers. The two-year return on the taxable Schwab portfolio was 25.94% and the Betterment portfolio was 21.89%.

In the next report we will add Acorns, Personal Capital, SigFig, WiseBanyan and Vanguard to the portfolios with two-year numbers and look forward to diving into the long-term results of these seven portfolios.

Figure 2. BackEnd Benchmarking Results Tracking Robo-Advisors

Figure 2. BackEnd Benchmarking Results Tracking Robo-Advisors

Figure 3. BackEnd Benchmarking Returns for Taxable Accounts Tracked

Figure 3. BackEnd Benchmarking Returns for Taxable Accounts Tracked

Figure 4. BackEnd Benchmarking Returns for IRA Accounts Tracked

Figure 4. BackEnd Benchmarking Returns for IRA Accounts Tracked

Risk and Return

Last quarter we introduced our risk/return analysis section. This quarter we are expanding our analysis to include upside and downside capture ratios in addition to the Sharpe Ratio and standard deviation metrics. Analysis is based on 12-month trailing returns ending September 30, 2017. An equal-weighted blended benchmark of the robos with a full year’s return is used as the benchmark for the upside/downside capture ratios. For those not familiar with upside/downside capture ratios, a basic explanation is a portfolio is desirable if it has a high upside and low downside capture ratio, and will plot to the lower right side of the chart displayed in Figure 6.

Two portfolios immediately stand out in our risk/return analysis. The first is Schwab, which tied for the lowest standard deviation (risk), but also achieved a close second in the one-year return. This has given Schwab’s portfolio the highest Sharpe ratio in the group. We still reserve judgment on Schwab’s portfolio until we see it perform in a down market. Schwab’s fixed-income allocation in particular is invested heavily in historically riskier assets. Acorns’ portfolio also stands out with a high downside capture ratio of 153% and a low upside capture ratio of 84%. We believe this is due, in part, to its high allocation to small caps, which have whipsawed on political news throughout the year, and its shifting international allocation. Acorns has also adjusted its allocation in international and small-cap equities at inopportune times over the past year. This data also implies that Personal Capital and FutureAdvisor may not offer the best risk-adjusted returns.

We want to remind readers that, although risk is important, it can be difficult to measure, especially over a time frame as short as one year, and the utility of our data will grow with time.

Figure 5. Risk Measures for Robo-Advisers

Figure 5.

Figure 6. Upside/Downside Capture Ratios for Robo-Advisers

Figure 6. Upside/Downside Capture Ratios for Robo-Advisers


There has been a rapid increase in competition in the digital advice industry, and it shows no signs of stopping. Independent robo-advisers need to quickly acquire market shares and innovate or they risk being overshadowed by larger, more established financial institutions. Going forward, we expect to see the market share for robo-advice products continue to expand as the trend toward digitization continues to impact all aspects of people’s lives.

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