The debate between proprietary and open architectures 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 so-called robo-advisors — or automated financial advisor software platforms — have faced a similar debate. Charles Schwab’s Corp. (SCHW) Intelligent Portfolios platform enables investors to access a wide array of funds, including those of its competitors, while The Vanguard Group’s Personal Advisor platform uses only 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 about $3 trillion in assets under management. 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 roughly half of Vanguard’s assets under management and made its name in the discount brokerage business. The company’s ETFs may be very competitively priced — alongside Vanguard’s ETF portfolio — but it doesn’t have nearly the depth that's available via Vanguard. As a result, the company may have more of a reason to include third-party funds.
In general, investors should look for robo-advisors that support a greater diversity of funds, although it’s important to consider the fees, liquidity and index-tracking efficiency associated with the funds that ultimately end up being used.
Transparency, Above All
Vanguard’s Personal Advisor 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, where 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. For investors, 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. To compare their traditional broker branches, check out Investopedia's article Charles Schwab vs Vanguard.