The battle of the robo-advisers heats up

[April 02, 2015]  By Mark Miller

CHICAGO (Reuters) - Here's something you don't see every day: two investment companies in a very public fight about values, greed and putting the interests of customers first.

This is what has happened since Charles Schwab launched Schwab Intelligent Portfolios last month, becoming the first major investment company to leap into the so-called "robo-advisory" market.

These automated portfolio management services use algorithms to select a mix of mostly low-cost ETFs for clients who answer online inputs, and then manage the accounts. The field’s early leaders are Wealthfront (https://www.wealthfront.com/)and Betterment (https://www.betterment.com/).

Schwab Intelligent Portfolios' debut prompted an attack by the chief executive officer of Wealthfront, Adam Nash. He charged in a widely circulated blog post that the service marked a departure from Schwab's core values of transparency, low cost and putting customers first.

"Much to my dismay, I now find myself hoping we never lose our identity the way Charles Schwab has. It's my hope that we always place our clients first and show them the transparency they deserve."

That prompted an angry response from Schwab: "Adam wishes he could build a moat around Wealthfront and protect it against competition. But misrepresenting facts isn't the way to do that."

The Wealthfront-Schwab food fight focuses on some specific criticisms of the new Schwab service's fees and portfolio structure. But it also illustrates a much broader phenomenon that retirement investors should understand: the growing links between allegedly independent, unconflicted advisory services and owners of those services who push proprietary investment products.

CHANGE IN THE AIR

The Schwab launch is just one recent sign of change. Last week, the Northwestern Mutual [NMLIC.UL] Life Insurance company bought LearnVest, a tech-enabled registered investment advisory firm that had tried to stake out turf as an independent player providing holistic planning advice. Learnvest is not a robo-adviser; it does not manage assets. But the acquisition will turn LearnVest into a giant lead generator for Northwestern Mutual products.

Vanguard Group is beta-testing Personal Advisor Services, a home-grown planning service that will offer only Vanguard funds.

The threat to upstarts like Wealthfront is real. Schwab is off to a fast start, attracting more than a half billion dollars in assets in just three weeks; Vanguard’s service already is managing $10 billion.

With big players moving in, the potential pitfall is home cooking. This problem is at the crux of the criticism traditional brokerage firms face.

"On the one hand, you have unconflicted fiduciaries, from the independent RIAs to the "pure" robo-advisers, and on the other hand, you have brokerage firms in the business of manufacturing and distributing financial products and using 'advice' as a vehicle for selling product," says Michael Kitces, partner and director of research for Maryland-based Pinnacle Advisory Group.

That's not new, he notes. "It's just 'new' when the companies using advice to sell their proprietary products happen to be Vanguard and Schwab, companies we've traditionally put on the 'other side' of the self-interested-products line."

For investors, the biggest challenge is fee transparency. Wealthfront charges an advisory fee of 0.25 percent on accounts with more than $10,000 in assets, plus fees on Exchange-Traded Funds (ETFs) averaging 0.15 percent.

Schwab advertises Intelligent Portfolios as charging "no advisory fees." Yet a portion of investor's funds are invested in the company's proprietary "smart beta" ETFs, which carry higher fees than market-weighted funds. A Schwab spokesman says those fees actually are lower than Wealthfront’s total costs, ranging from 0.18 percent for a conservative portfolio to 0.26 percent for an aggressive portfolio.

One big caveat: Cash is the other way Schwab will make money. Customers will be required to hold 6 to 30 percent of their accounts in cash. It's not possible yet to gauge how much extra cost that will add.

And that's the key problem with home-cooked advisory services. Technology has opened the door to bring low-cost planning and investment advice to middle-market retirement savers. But if the entry of big-foot players moves the field away from transparent, independent advice and into selling, we will lose a great opportunity to offer a square deal to small retirement savers.

(Editing by Lauren Young, Beth Pinsker and David Gregorio)

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