Is there a robo-advisor in your future?

Investors attracted by lower fees

I get a lot of e-mail from people complaining about mutual funds. Some dislike the high fees (by some measures, average Canadian fund fees are among the highest in the world). Others are put off by sub-par results – most actively-managed mutual funds fail to beat the indexes. Still others are concerned that financial advisors push high commission products to the exclusion of less expensive, better-performing funds. And I’m getting more questions about the possibility of switching to lower-cost robo-advisors. But is that really a good option?

With all the criticisms about mutual funds, it may come as a surprise that the mutual fund industry is doing very well, thank you. As of the end of November, Canadians had invested $1.47 trillion in mutual funds, according to the Investment Funds Institute of Canada (IFIC). That was up 1.1%, or $15.5 billion, from October.

By comparison, exchange-traded funds (ETFs), which have been touted as a cheaper, more transparent way to invest, have $160 billion under management as of Nov. 30.

And what about the new kid on the block, the robo-advisors? According to Statista.com, their share of the Canadian wealth management market is a paltry $4.2 billion. That’s like a pimple on the back of an elephant. Except for one key forecast: Statista projects that the assets of Canadian robo-advisors will grow by an average of 44% a year between now and 2022, to a total of more than $18 billion.

That’s still small potatoes compared with mutual funds and ETFs, but it represents a unique opportunity to companies looking to establish a foothold in the wealth management business.

Robo-advisors are a new and relatively unknown concept. Investors answer an on-line questionnaire, which directs them to the type of portfolio that best suits their profile. Typically, these are broadly categorized as conservative, balanced, and aggressive. Each portfolio invests in a selection of ETFs, chosen by computer analysis (hence “robo-advisor”). Fees are very low, especially in comparison with mutual funds, and small investors are welcome.

The leading Canadian company in this business is Wealthsimple, which claims to have $2.5 billion in assets under management. It offers three basic portfolios, as described above, plus a socially responsible (SRI) version of each. The management fee is 0.5% on assets up to $100,000 and 0.4% beyond that. Add to that the fees charged by the ETFs in the portfolios, which are about 0.2% annually, and the total cost is in the range of 0.6% to 0.7%. By comparison, the average management expense ratio for a comparable balanced mutual fund portfolio is 2.17%.

So far, Wealthsimple, which is heavily financed by Power Financial, has dominated Canada’s fledgling robo-advisor sector. But BMO is making a push with its SmartFolios, and smaller companies like Nest Wealth, WealthBar, Modern Advisor, and Justwealth are vying for customer attention.

Recently, Canada’s leading non-bank online brokerage firm, Questrade, announced it is moving aggressively to grab a share of what it sees as a potentially large and growing market. It launched 10 Questwealth Portfolios that will offer investors lower fees, more diversification, and active management.

The new lineup, which will replace the Questrade Portfolio IQ funds, will charge basic management fees of between 0.2% and 0.25%. Total cost, including ETF management charges, will be in the 0.4% to 0.5% range – about 20 basis points less than Wealthsimple.

Questrade offers five core portfolios from which to choose – Aggressive, Growth, Balanced, Income, and Conservative – plus SRI versions of each. The active management feature, unusual in robo-advisors, involves rebalancing the portfolios periodically to reflect changing market conditions.

One of the concerns I have with robo-advisors is the difficulty of comparing the performance of their portfolios with alternative choices, including higher-priced mutual funds. Questrade offers performance numbers back to 2012 for the Questwealth funds, but no comparisons with any other option.

So, I did a little research. The Questwealth Balanced Portfolio showed a 5-year-average annual compound rate of return of 6.75% to Sept. 30. It is 60% invested in equities and 40% in fixed income. I did a search and found 133 entries (mutual funds and ETFs) in the Canadian Neutral Balanced category that had done better, even with higher management fees. However, the average annual return for the Questwealth portfolio handily beat the category average of 5.94% (advisor class) in the period.

This suggests that the Questwealth Portfolios won’t be the top performers in their categories. But thanks to the low fees, they and other robo-advisors should turn in respectable results at minimal cost. And, all else being equal, the lower the costs, the more money you’ll have in your pocket.

For more information on robo-advisors, visit Questwealth Portfolios, Wealthsimple, BMO Smartfolio, Justwealth, Wealthbar, Nest Wealth, and ModernAdvisor.

This is an edited version of an article that originally appeared in The Toronto Star.

Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, which are available through the Building Wealth website.

For more information on subscriptions to Gordon Pape’s newsletters, check the Building Wealth website.

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Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions.