Don’t like mutual funds? Try robo-advisers
Their fees are much lower, which could mean more money in your pocket
I get a lot of email from people complaining about mutual funds.
Some dislike the high fees (by some measures, among the highest in the world). Others are put off by sub-par results — most actively managed mutu- al funds fail to beat the indexes. Still others are concerned that financial advisers push high commission products to the exclusion of less expensive, better-performing funds.
With all these criticisms, it may come as a surprise that the mutual fund industry is doing very well, thank you. As of the end of September, Canadians had invested more than $1.5 trillion in mutual funds, according to the Investment Funds Institute of Canada (IFIC). That was up by almost $95 million from the same time last year.
By comparison, exchange-traded funds (ETFs), which have been touted as a cheaper, more transparent way to invest, have only $163 billion under management.
And what about the new kid on the block, the robo-advisers? 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 per cent a year between now and 2022, to a total of more than $18 billion.
That’s still small potatoes compared to 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 online questionnaire, which directs them to the type of portfolio that best suits their profile. Typically, these are 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 to 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 per cent on assets up to $100,000 and 0.4 per cent beyond that. Add to that the fees charged by the ETFs in the portfolios, which are about 0.2 per cent annually, and the total cost is in the range of 0.6 to 0.7 per cent. By comparison, the average management expense ratio for a comparable balanced mutual fund portfolio is 2.17 per cent.
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.
Last week, Canada’s leading non-bank online brokerage firm announced it is moving aggressively to grab a share of what it sees as a potentially large and growing market.
Questrade announced that it has launched 10 Questwealth Portfolios that will offer investors lower fees, more diversification, and active management.
The new lineup, which will replace the Questrade Port- folio IQ funds, will charge basic management fees of between 0.2 and 0.25 per cent. Total cost, including ETF management charges, will be in the 0.4 to 0.5 per cent range — about 20 basis points less than Wealthsimple.
There are 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 five-year-average annual compound rate of return of 6.75 per cent to Sept. 30. It is 60 per cent invested in equities and 40 per cent 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 Questwealth portfolio handily beat the category average of 5.94 per cent (adviser class).
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.