Three reasons all RIAs should include algorithmic strategies in their menu of client offerings.
DEAN SMITH
CHIEF STRATEGIST | FOLIOBEYOND
5 min read
If you are like most successful Investment Advisors, you are always on the lookout for new products and tools that can improve returns for your clients and make it easier for you to identify and serve their needs. Well-designed algorithmic investment strategies (“algos”) can help you achieve both of those objectives. Here are three important reasons why:
1) Algorithmic investment strategies respond predictably to market events.
While it may be impossible to predict market events before they happen, a well-designed algo should have a predictable response to events that do occur. For instance, a strategy designed to manage volatility and drawdown risk will reduce exposure to sectors experiencing a period of higher than typical market volatility. And, when that sector reverts to a more normal pattern, it will add exposure. Sound algos don’t “roll the dice” and they don’t ever say “this time is different!”
Another important property a good algorithmic strategy will exhibit is to regularly rebalance exposures to stay within preset tolerances for diversification and risk management. It won’t forget to rebalance, and it won’t be tempted to overplay recent market moves – either up or down. When sector, industry, or other exposures get out of line due to market movements, the algo will rebalance automatically.
You might be thinking this goes against the oft-stated adage to “cut your losses and let your winners run.” But the reality is that this quip is only applicable, if at all, to active traders, not ordinary investors looking to manage their wealth over the long-term. Regular rebalancing to manage risk and stay with a discipline is far wiser for the vast majority of your clients, who, after all, will happily get rich slowly and not risk financial ruin. Smart, algorithmic strategies ensure this discipline.
2) Algorithmic investment strategies don’t exhibit style drift.
This is related to but distinct from the first point. It’s very easy for even good investment advisors to get caught up in recent market trends and react to the news cycle. When this happens it can be almost imperceptible in the short-run. A trade or two here or there can seem smart or opportunistic at the time but might be based on fleeting market trends or some news that could well be ephemeral. It’s only with the benefit of hindsight one can see how far from an initial plan any investor’s portfolio has drifted. With a well-designed algorithmic strategy, this doesn’t happen.
This does not mean that a solid algo can’t have a lot of inter-sector rotation. They can and do, so the actual portfolio allocations can vary widely over time. But the underlying logic of the strategy is always maintained. The permitted investments, minimum and maximum sector of securities positions, maturities, credit quality, and other metrics will have to be met or the algo simply won’t make the trade. This ensures that the parameters, constraints and goals of the strategy won’t vary unpredictably over time. The investor is assured of getting what they bargained for.
3) Using algorithmic investment strategies helps you serve your clients better by saving you time and energy.
You may very well be an excellent investment analyst. You may have a knack for finding undervalued or overlooked companies. But you would still likely be better off using that time to understand and serve your clients with long-term financial goals.
If we are being honest with ourselves as advisors, we know that the most important thing we do for our clients is engaging in personal service. We need to take time to understand each client’s goals and plans for the near, medium, and long-term. In terms of value-add, having a better and more complete picture of those goals far exceeds any incremental return you might gain through superior investment selection. The most important thing you can do for your clients is to help them articulate and understand their goals, and then design a plan to help them achieve them. And then, most importantly, you have to take the time to make sure that plan stays relevant over the years.
Each minute you spend selecting individual stocks, bonds, or funds detracts from that much larger goal and makes you less effective as an advisor.
There may be some advisors who resist this job description. That is their prerogative, even though the evidence is quite clear. Clients stay with advisors who take the time and effort to understand their needs and to stay on top of life changes that call for adjustments to the game plan. They also recommend them to their friends and colleagues.
Finding a way to eke out another percentage point or so per year — itself an extraordinary and rare achievement — pales in comparison as a way to maintain customer loyalty, and to attract assets. The use of well-designed algorithmic strategies frees up time for those higher touch, higher value-added duties. And, ultimately, it can add to overall investment performance if the provider of the strategies is competent and disciplined.
