Recently a robo advisor has been hugely flamed with their decision to liquidate KWEB, a China Tech ETF earlier this week at about over 70% from its highs. This is in response to the huge rebound on 16 March 2022 of more than over 30% since the last bottom. We see some comments that go along the lines of “KWEB should never have been bought.” or “KWEB should not have been sold.”
Last week, I sat together with one of my friends who was involved in this saga in a community sharing by this robo advisor over a zoom session to explain why they decided to sell away KWEB completely. (before the rebound took place)
I have no vested interest to speak for the customers or the robo advisor. The aim of this post is to be objective and to allow investors to see and understand things as they are.
The revelation unfolds
By running through some of the comments posted, we felt that the primary issue is that there is a mismatch in expectations between what the investors expect and what the robos can realistically deliver.
A robo-advisor to some has been deemed as a know-it-all, hassle-free, zero-worries, almost sure-to-win proposition in the long term. If there are going to be any crashes, robo-advisors are assumed to be smart enough to anticipate early and do what they are supposed to do. The robo-advisor claims to have a robust system that is able to react promptly to protect much of their client’s capital before a crash happens. Because it is assumed that retail investors do not know any better and tend to react adversely especially during extreme market conditions, hence we have the robo-advisors to rely on to make rational decisions. Robos take emotions out of the picture and help investors in buying into ETFs diligently with a DCA approach. It is touted as the no-brainer way to do well over the long term.
And to be fair, this misconception is reasonable because if you look at it, most robo-advisors have been branding themselves as such in their marketing communications. It is not uncommon to see them using wordings such as “invest safely with xxx” or “invest smarter with xxx”. And it does not help that there is no lack of content creators who may know little about investing, flooding the marketplace with awesome reviews about these robos in exchange for some benefits. With such messaging and perceived expectations, it is only going to be a matter of time before things will turn nasty if not for the general bull markets we have been having in recent years since their launch.
It is not unreasonable for most laymen to understand by investing “safely” and “smartly” to mean to be free from huge drawdowns and to be able to rebalance their portfolio in an efficient manner to maximize returns.
The bigger problem is that this will not be the only isolated episode and if such expectations remain, more investors will be in for a rude awakening.
Would have, should have, could have?
But before we go on to bash the robo-advisor further, let’s be objective and imagine this:
What if the rebound might only have happened when KWEB went further down to say 5-10 dollars? (which means a 90% decline from its highs) The markets can be impossibly irrational and remain so, longer than what we can stomach or prepare for.
If you are the one managing the investment, what would you have done? The sight of seeing your hard earned money “evaporating” day by day. Would it have come across to you to perhaps accept the losses and rather search for an alternative place to invest to recover from?
It is not unreasonable to believe that there would have been huge pressure piling on these robo-advisors by the investors to continue to be invested in something that is facing such huge drawdowns. Either the robo-advisors stop the bleeding, or the next likely scenario is that they are going to see a massive exodus of their Assets Under Management (AUM) which in that case they have nothing much to manage to help the investors to recover from. My point is that, in any case, would you have allowed the robo-advisor to continue to hold even if they held onto their conviction? The same scenario applies if today you have a human financial planner to do the investments for you. Would you demand to get out of this ETF or listen to your financial planner to stick to the original investment thesis?
The truth is everyone who got invested in KWEB or other China Tech stocks are caught in a situation where there is no best answer to it. If China aids Russia in their war efforts and faces secondary sanctions (which we highly doubt so) or if the rebound happened only at a much lower price or never did, the robo-advisor would have been the hero that saved your last bit of money by biting the bullet there and then. It is always easy in hindsight to blame whoever is managing your investments because you are judging the soundness of their decision purely from the eventual outcomes.
My point so far is that in investing, there is no such thing as “should have”, “would have” or “could have”. (Just like Laszo could have paid his 2 pizzas with cash instead of 10,000 BTC) IMHO, the investment thesis to invest in KWEB is a fair and legit one at the start. For the majority of these Chinese Tech companies, they are profit making and are fundamentally sound. It was the right and sound decision to include KWEB as one of the ETFs that is investable. No doubt it eventually led to an unfortunate bad outcome for the past several quarters.
But on the other hand, to capitulate only when KWEB retraced more than 70% from its high is something that investors would definitely not be able to grapple with understandably. Investors have been told to remain convicted and stay invested for the longest time, to dollar cost average (DCA) regularly and yet now the robo-advisor tries to intervene manually, contradicting what the investors have been sold to all along and are thus seeming to be “timing the market.”
Perhaps some investors might prefer that the robo-advisor stick to their guns and explain the rationale for holding on should it fall further. Some investors proposed that the robos should have an exit strategy which may liquidate some partial holdings earlier should an underlying ETF have fallen by more than 30-40%. It is still the same problem however. What if the ETF recovers immediately at the 40% mark? The robo-advisor will be pounded for liquidating partially as well. Hence there is no best approach until investors can fully understand returns in the context of risks as well. If you are agreeable to liquidating partially should the ETF decline by 40%, you must be equally agreeable to forgo the gains that might materialize should the ETF rebounds back up after that. There will also be the question of what percentage is reasonable. To some investors 25% drop is huge enough, let alone 40%. There is no way the robo-advisor can come up with a specific percentage to cut some losses that everyone can agree upon.
But what we do know is that when a fundamentally sound stock or ETF ever retraces more than 60%-80%, the chance of a rebound gets even much higher and when it happens, it is usually going to be a very violent one. Exiting at such a juncture and fully is a very risky maneuver that requires some serious explanation and accountability should the rebound happen. An investor who can still remain convicted at 70% drop is still likely to do so at 80% drop. (Partly also because there is nothing much left to lose) The only way to rebound is to remain invested and the long term odds are good because we are talking about some of the most profitable companies around in China!
And in the worst case scenario should there be secondary sanctions on China that causes KWEB to plunge further, the robo-advisor could have justified it as a known risk which has a low probability of happening. That is a lot more palatable than letting it all go by claiming that there are just too many “unknown unknowns” for the China markets as they did in the community sharing. They can pull out charts like the risk/impact matrix and will also not look as bad alongside the other robo-advisors who are in the same plight by holding onto the China stocks. When you are a robo or human advisor managing people’s money, it is alright to fail together but not when you are the only one.
So what can we expect from Robo-Advisor (realistically)
The possibility to invest safely and smartly in an easy manner without much effort is too good to be true. As humans we love to hear that there is a quick fix to the things we struggle with and to have someone to do the heavy lifting for us at a low-cost can be so attractive. But as in all things in life, you get as much as what you pay for. (or sometimes less) It is important to be aware of what we sign up for and to acknowledge the pros and cons so that your investing journey with the robos can be a joyful one.
First off, robo-advisors certainly have their merits. Robos can be hassle-free by helping you to rebalance your portfolio allocation in line with your risk profile from time to time. The weightage of higher-risk equities are kept in check automatically so that you face lesser drawdowns when the markets become bad.
Next, for passive investors who neither have the disposition nor time to be involved in the markets, robo advisory is a great option for them to still earn a better return in the long run than just having the money idling in their bank savings account. While it may not be that difficult to try to construct a simple portfolio on your own with discount brokers, the truth is it still takes a little bit of time and effort. It is still better to get started somewhat in their investing journey than to have nothing going on at all. Frankly if not for the seamless process offered by the robos, many retail investors would probably never have dipped their toes into investing because it seems too difficult.
That said, it is equally important for investors to understand what to expect out of the robos. There are quite a number of points we can cover, but perhaps let us touch on three key ones that will address most of the common feedback on the ground.
Comments