The low-cost, passive investing style of many exchange-traded funds (ETFs) has long been the major draw for the robo-advisory firms that rely on these products for the ready-made investment portfolios robo-advisors offer to clients. And, as the ETF industry grows, more sophisticated ETF products could find space on the shelves of digital advice platforms.
Simple, index-tracking ETFs make up the bulk of products now offered by robo-advisors. But, in light of recent stock market volatility, smart beta (a.k.a. factor-based) ETFs could gain in popularity. These ETFs are designed to improve upon market returns, increase income or reduce volatility through different exposures than basic benchmark stock and bond indices offer.
“[Volatility has] been a very important theme in 2016,” says Pat Chiefalo, managing director and head of iShares Canadian product with Toronto-based BlackRock Asset Management Canada Ltd. “You can start to see where minimum-volatility ETFs begin to take a greater share – and a more prominent share – in those types of portfolios.”
In general, robo-advice platforms in Canada offer portfolios targeted to a wide range of investors whose objectives range from conservative to aggressive. Each portfolio is made up several ETFs- up to 15 at some companies – that suit an individual client’s investment strategy.
For example, a Risk Level 1 portfolio from Toronto-based Wealthsimple Financial Inc. is described on the firm’s website as being “designed for the risk-averse individual in mind.” This portfolio consists of eight ETFs and is skewed toward conservative ETFs, including Purpose Core Dividend (with a 7.5% allocation), iShares Core MSCI EAFE (5% allocation) and BMO Short Corporate Bond Index (30%).
At the other end of the spectrum, Wealthsimple’s Risk Level 10 portfolio, which is “designed for an individual with high risk tolerance,” also consists of eight ETFs. That portfolio includes the three ETFs mentioned above, albeit with different weightings. For example, only 5% of the Level 10 portfolio is invested in BMO Short Corporate Bond Index. And the Level 10 portfolio also includes the more aggressive iShares Core MSCI Emerging Markets (with a 12.5% allocation).
Although basic, index-tracking ETFs are core products for robo-advisors, some robos have decided to offer smart beta ETFs. For example, Vancouver-based WealthBar Financial Services Inc. includes smart beta ETFs in its portfolios, thus providing clients with exposure to preferred shares and real estate investment trusts, as well as a covered call options strategy designed to increase income.
This product shelf brings more depth to digital wealth management’s offerings, according to Tea Nicola, WealthBar’s CEO and co-founder: “Our investment philosophy is of broad diversification [and the] mitigation of volatility.”
Moving past index-tracking funds to smart beta means potentially higher management costs in the form of higher management expense ratios (MERs), but, Nicola argues, this will be less of a concern in future. Says Nicola: “The trend of the cost of the MERs of these [smart beta] ETFs is definitely downward.” That’s because technology is making trading within an ETF’s portfolio more efficient, which, in turn, drives down the cost of managing an ETF.
Other digital-advice platforms emphasize that they bring a degree of management to their portfolios in different ways. Portfolio IQ (a robo-advisory platform owned by Toronto-based Questrade Financial Group Inc.) and SmartFolio (owned by Toronto-based Bank of Montreal [BMO]) both emphasize that client accounts are managed to determine the appropriate strategy and asset allocation.
In fact, regulations stipulate that digital platforms must employ licensed advising representatives who must review and, if necessary, discuss a client’s portfolio with the client.
“It’s not as if the clients are just buying into a broad index and sitting in it when they choose SmartFolio,” says Bruce Ferman, senior vice president and managing director, products and services, with BMO Nesbitt Burns Inc. “They are getting [portfolio] management.”
A factor that could spur the growth of robo-advice – and the use of ETFs – in portfolios is the integration of the ETF provider and the distribution channel. For example, SmartFolio uses BMO ETFs exclusively in client accounts – although BMO emphasizes that it is open to incorporating other providers’ products in its robo portfolios in future if there is client demand.
As well, BlackRock Canada, whose U.S.-based parent company owns a robo-advisor called FutureAdvisor, is interested in this growing area of financial services. “In the end, it’s just about delivering the best investment solutions for clients,” says Chiefalo. “And if that means getting closer to robos to be able to do that, then we’re more than happy to.”
In the U.S., Vanguard Group Inc. of Valley Forge, Pa., and San Francisco-based Charles Schwab Corp. have their own robo-advice platforms, both of which include proprietary ETFs in client portfolios.
Such a service model allows these companies to keep a little more in fees, says Mark Yamada, president and CEO of Toronto-based PUR Investing Inc., and also gives companies the chance to sell more products and financial services to clients down the road as more of a client’s financial history is gathered.
Robo-advisors select ETFs for client portfolios based on a number of factors. For example, Oakville, Ont.-based robo-advisor Invisor Investment Management Inc. (which does not have any form of partnership with an ETF provider), chooses specific ETFs for its set model portfolios based on factors such as ETF track record, tax implications for a Canadian- vs U.S.-listed ETF, MER, trading costs, bid/ask spread and liquidity.
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