How do Robos React During Market “Corrections?”

Posted on March 5, 2020

  • The recent shock from the coronavirus has pushed the down S&P 500 down as much as 15%
  • The drop provided robo advisors with an opportunity to place tax-loss harvesting trades
  • Most robos exhibited similar upside and downside capture ratios, with a few exceptions

As the world fretted over the spreading Coronavirus, markets dropped precipitously last week. The S&P 500 index dropped as much as 15% from its peak, as investors flocked to safer securities, primarily U.S. Treasury bonds. The yield on the 10-year U.S. note dropped below 1% for the first time ever. 

At Backend Benchmarking, this provided a chance for us to examine how robo advisors perform during sharp market downturns. This is the first such downturn that many of our accounts have experienced. The only comparable event was the large drop at the end of 2018. Since then, we have opened new accounts at providers that offer tax-loss harvesting to specifically track the effectiveness of robo tax-loss harvesting technology. 

How Did Robos Fare?

We ran upside and downside market capture ratios for a majority of the robos that we track from January 1 through February 28. While most of the portfolios exhibited similar up- and down-market capture ratios, there were a few examples of portfolios that captured significantly more of one than the other. One of the most noticeable examples was Schwab, whose greater downside can be traced to some of its portfolio strategies. Relative to the average robo portfolio, Schwab has a higher exposure to international equities. International equities have performed worse than domestic equities. Additionally, Schwab has a value tilt. Value has continued to underperform growth in 2020. Its fixed-income portfolio has small exposures to high-yield and international fixed income which have not rallied like domestic investment-grade fixed income during this downturn.  The third reason is the high cash allocation at Schwab. Cash holdings will miss out on fixed income rallies during periods of market volatility. While performance has not been stellar year-to-date, Schwab is one of the few robo portfolios that we have witnessed significant tax-loss harvesting activity over the past week.

On the other side, TD Ameritrade’s standard and SRI portfolios stood out for capturing far more upside than downside. These portfolios have high domestic allocations. Their fixed-income holdings are more concentrated in investment-grade securities whose pieces tend to rise when equity values fall. 

Tax Loss Harvesting Activity

Tax-loss harvesting is the selling of a security at a loss to write off that loss against one’s income. The wash-sale rule prevents investors from recognizing that loss if the security is bought within 30 days of the sale. However, robos invest in indexed ETFs created by various companies. For example, both Vanguard (ticker: VOO) and iShares (ticker: SPY) have their own ETFs that track the S&P 500. Thus, if a robo portfolio holds VOO and the S&P 500 (and therefore VOO) declines in price, the robo can sell its shares of VOO and buy shares of SPY. The allocation of its portfolio has not changed but it has avoided the wash sale rule by buying back a different security. The investor can then record the loss from the sale of VOO against their income when filing taxes. 

Four of our accounts at digital advice providers executed tax-loss harvesting trades last week:  Schwab Intelligent Portfolios, Wealthfront, Axos Invest, and US Bank. We have opened accounts at a handful of providers that are specifically designed to allow us to track tax-loss harvesting.  We make monthly deposits into these accounts to create more tax lots to increase the opportunities for tax-loss harvesting. We have these accounts at Betterment, TD Ameritrade, Wells Fargo, Schwab, Axos Invest, Wealthfront, UBS, US Bank, Morgan Stanley, SigFig, and Citizens Bank.  As of the end of the day Tuesday, March 3, Schwab, Wealthfront, Axos Invest, and US Bank were the only four that executed notable TLH trades. Given the events last week, we expected to see more activity in harvesting losses. 

As markets fall we would also expect that rebalancing trades will start to appear, selling fixed income and buying equities to maintain target allocations.  So far, there has been minimal rebalancing as a result of last week’s market volatility. However, the events are very fresh and managers may be waiting for volatility to die down before executing rebalancing trades. 

Passive Mentality

Robo advisors were founded on the principle of passive, indexed, and long-term investing. In this regard, the lack of activity is not surprising. Outside of tax-loss harvesting and rebalancing trades, we would not expect to see a flurry of activity around a market event like this. Most robo portfolios are going to stay the course and appropriately avoid attempting to time markets. 

There has been a lot of communication coming from providers about the events last week.  In general, the message has been to inform clients about what is driving the volatility and to downplay the concerns of long-term economic impacts of the virus.  The aim of these messages is to encourage investors to keep a level head and stay the course. Traditionally, this is good advice and at the heart of what robo advisors do; individual investors are notorious for selling at low points and buying back in after the market has rebounded. 

Upside Downside Capture Ratios 12/31/2019 to 2/28/2020

Upside Capture %*Downside Capture %*
Axos Invest103.6499.66
Citizens Bank122.24108.61
Fidelity Go95.1595.39
Future Advisor83.2890.19
Interactive Brokers76.0987.25
JP Morgan Chase
You Invest
Merrill Edge97.56100.24
Morgan Stanley102.3103.89
Personal Capital101.57109.65
TD Ameritrade126.09112.38
TIAA CREF101.1297.67
United Income82.42100.68
Wells Fargo111.21109.72

*Upside and downside capture are compared to a benchmark that is a composite of all of our taxable robo portfolios’ returns.

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