The debate between proprietary and open architecture has been ongoing for decades. In the smartphone industry, Google’s Android platform was built from the ground up to work with nearly any hardware platform while Apple’s iOS platform was designed to operate exclusively on its proprietary iPhone hardware. Google may have greater market share, but Apple has generated far more profit.
Many robo-advisors — or automated financial advisor software platforms — have faced a similar debate. Charles Schwab’s Intelligent Portfolios platform enables investors to access a wide array of funds — including those of its competitors — while Vanguard Personal Advisor platform only uses its own funds. With the rise of robo-advisors, experts are closely watching where investors put their money.
In this article, we’ll take a look at some open architecture issues associated with robo-advisors and how to evaluate them based on these dynamics.
A Matter of Diversity
Vanguard is the largest provider of mutual funds and second-largest provider of exchange-traded funds (ETFs) in the world, with more than $5 trillion in assets under management as of the end of January 2019. With its wide range of low-cost index ETFs, the company’s Personal Advisor business has little reason to look toward other providers in order to provide additional benefits to its clients.
By contrast, Charles Schwab has about $3.36 trillion in assets under management and made its name in the discount brokerage business. The company’s ETFs may be very competitively priced compared to Vanguard’s ETF portfolio, but it doesn’t have nearly the depth that's available through Vanguard. As a result, the company may have more reason to include third-party funds.
Although investors should look for robo-advisors that support a greater diversity of funds, it is important to consider the fees, liquidity and index-tracking efficiency associated with the funds that ultimately end up being used.
Before we go into the nuances of each platform it's a good idea to look at what each offers its clients.
Vanguard's Personal Advisor Services is the largest robo-advisor around. It has a minimum balance requirement of $50,000, so it cuts out a big group of investors — those who are looking to start small. It offers a management fee of 0.30%, which is low for a hybrid service that provides both an automated and human touch, with unlimited access to financial advisors. It gives investors access to the brokerage's wide range of proprietary investment vehicles.
By contrast, Charles Schwab's Intelligent Portfolios has a $5,000 account minimum and it doesn't charge an advisory fee or commission. The company makes its money by investing client money in its own ETFs creating revenue for itself. It also invests in third-party vehicles for which it receives compensation. Schwab also provides a hybrid service with unlimited calls to advisors as well as automatic rebalancing. The one drawback is that it doesn't offer all its clients' tax harvesting services. To qualify, you have to have at least $50,000 in your account for that perk.
Above All, Transparency
Vanguard’s platform has very little potential for conflicts of interest since it only uses its own low-cost ETFs. In addition, the company provides a fixed-fee structure, charging management fees on top of its funds. Many investors appreciate this level of transparency, as they know exactly where they are being charged and how much they are being charged for the service.
Charles Schwab’s Intelligent Portfolios platform differs in that there’s a potential conflict of interest between using its own funds and third-party funds. Moreover, the company’s compensation comes from reinvesting cash allocations and receiving payments from third parties that it uses to execute trades or invest. In many ways, these fees are a bit more unpredictable and opaque for investors.
In general, investors should try and avoid conflicts of interest in favor of transparent fee structures in order to avoid any problems. The easiest types of fees to analyze are those charged on top of the funds since they can be quickly calculated.
Potential Conflicts of Interest
Many other robo-advisors, such as Wealthfront, face a different set of concerns since they are free to utilize any third-party providers. While conflicts of interest may no longer be an issue, some of these robo-advisors stick to a single fund provider, while others look to include as many options as possible. These dynamics mean that the open architecture debate still applies just as much to them.
Often times, robo-advisors simply select the lowest cost providers. Wealthfront, for example, notes on its FAQ: “We regularly survey the ETF landscape and rank ETFs in each asset class using the objective criteria described in the FAQ below titled ‘How do you pick ETFs?’ Vanguard ETFs often come out on top. We receive no compensation for recommending Vanguard products or any other ETFs.”
In general, investors should look for robo-advisors that have open policies aimed at securing the best deal for their investors.
The Bottom Line
Robo-advisors have become a popular way for individual investors to access institutional-quality asset managed based on Modern Portfolio Theory principles. These programs can lower costs and potentially increase long-term returns. For advisors, partnering with the right robo-advisor can create a pipeline of potential clients who need more comprehensive advice. Either party should be careful when considering potential conflicts of interest, though.
In general, it’s a good idea to research a robo-advisor’s policies before committing any capital to ensure that your best interests are at heart. Of course, not everyone wants their portfolio managed by a robot — regardless of their successful history. Fortunately, both Charles Schwab and Vanguard are very established traditional brokers.