Comeback of volatility: robo-advisors stumble

Comeback of volatility: robo-advisors stumble

First of all, let’s be clear: yesterday’s drop in the Dow Jones index of 1175 points is not at all historic: a fall of 4.6% does not even rank it in the top-20 of daily percentages losses.  The fixation on the “record” point loss is fun for headlines or to create clickbait, but meaningless for the rest.

In addition, this is a long overdue correction after a prolonged period of subdued volatility and ever rising stock prices.  As such, it was anticipated by the broader market community and especially by most wealth managers with some historic perspective.   It also serves as a first test for some crowded trades, such as long equity, short volatility and favouring passive (ETFs) over active investment vehicles.  With VIX jumping from its subdued level at around 10 at the start of the year to almost 40 currently (yes, moves of 300% in a month), the people that “discovered” easy money selling volatility are now nursing their losses, with the first casualties already among the inverse VIX ETFs.

However, it also gives us some data regarding other market infrastructure changes.  We will only be able to determine the impact of algorithmic trading on the speed and the size of the correction after careful analysis, but one smaller issue has already come to the fore.  Robo-advisors have stumbled at this first test: leading firms Wealthfront and Betterment both had outages “because of the unexpected volume”.   While the outages were relatively short and nothing is as yet known regarding the performance of the underlying portfolios, it shows that there is still some work to do to deliver on the early promises for cheaper and better wealth management for the masses.

Unfortunately Jon Stein, CEO of Betterment, did not apologise and promise to do better.  He stated instead that there is no problem for robos because clients do not say to him “We really want someone who is going to be there for me during a downturn“.  This seems more akin to a reaction from a tone-deaf banking incumbent than from a client-centric fintech disruptor.  Part and parcel of wealth management and providing “peace of mind” to clients is precisely to be there in panic and stress situations.  Today, this is still best done via human interaction (through “phygital models“), but nothing prevents robo-advisors from working on advanced AI solutions that might serve this task equally well in the future.  However, that requires them to acknowledge that they have a problem first.

If the correction continues, we will be able to stress-test other financial innovations that have done well in the recent years of “complacency” in order to build more robust solutions for the future.  As such, painful as it might be, the correction could well have salutary effects.


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