A financial revolution: algorithms, automation, and advisors

The investment management industry continues to experience exponential change due to the impact of Moore’s Law, as the application of technology is growing more profound.  But despite the pie in the sky predictions that Robo-Advisors would dismember the brokerage firms by replacing human advisors, this hasn’t been the case. Still, the changing relationship between algorithms, automation, and advisors cannot be dismissed. The common denominator in this paradigm shift is the use of exchange-traded funds to build and manage portfolios. In fact, one could argue that algorithm-driven ETF platforms have been as impactful as the ATM machine. 

Today, there are a number of automated investment management platforms available to investors.  While they are offered by different companies with different product mixes, they are still very similar in their use of exchange-traded funds to build and manage portfolios. The result being the ongoing dismantling of the large mutual fund complexes and the resulting race to the bottom in ETF fees. 

Algorithms, automation, and advisors

The reduction in fees and an increase in transparency brought about by the use of ETFs and algorithms count the individual investor as the biggest beneficiary.  Still, these benefits have not come without introducing other problems, including the impact on overall market volatility. In fact, our CIO, Mike Parker, points to the impact of algorithms in deepening the losses incurred by the market at the end of 2018.  While the sell-off was nowhere near as sudden as say previous “flash crashes”, trading algorithms and large index positions exacerbated the downturn by selling both good and poor positions.  The result is that many investors experienced sharper drawdowns in their portfolios at the end of 2018.

The continuing push into the use of index products like ETFs, coupled with the ever-increasing use of algorithms by investment banks and hedge funds, will continue to increase overall market volatility.  To make matters worse, there are now more indices that stocks

We think that the increased propensity for volatility that is brought about by the broad adoption of algorithms and the underlying use of ETFs reinforces the notion that robo-advisors alone cannot properly function to serve the needs of the affluent and ultra-affluent without being coupled with human oversight. These are not mutually exclusive in our view. Look no further than the ATM; it did not make the local bank a relic of the past, but instead of being staffed with tellers, banks have reallocated their resources by hiring more specialists.

At SWS Partners, we see the ATM as the historical precedent that financial planners must re-allocate their resources too. Our use of portfolio automation and algorithms would not suffice without pairing them with our ability to actively manage our clients’ portfolios in-house. We think this appropriately balances the need for technology with human involvement thereby providing our clients the greatest chance of success.