As robo-advisors go through growing pains, should investors worry?

As the passive-investing pitch for digital advice gets old, one firm is changing tack in a questionable way

As robo-advisors go through growing pains, should investors worry?

When robo-advisors entered the picture a few years ago, they were seen as upstart start-ups that would eventually overthrow human advisors by offering people access to low-cost, passive investments. And while they have changed the game, they haven’t exploded as many expected — which, in the case of two US-based robo-advisors, could spell trouble for clients.

”Neither Wealthfront nor Betterment, it turns out, has seen the kind of exponential growth that [venture capitalists] tend to look for; both of them have seen their growth rates level off or even fall since mid-2015,” said a recent report by Wired.

Like many in the industry, the two companies have built a solid base among millennials, but such clients are reportedly not expected to become major owners of investable assets until 2030. As robo firms struggle to attract sophisticated investors who don’t want middlemen and less-informed investors who don’t understand what they offer, they are starting to inch away from their early no-frills passive-investing ideals.

“At Betterment, there’s a little bit of mission creep, but it’s being done in a manner that stays broadly true to the founders’ principles,” the report said. That includes giving clients who pay an extra 0.15% per year access to human advisors who can speak about estate planning or equity-based compensation. Clients can also pay extra for investments that are more socially responsible, or have a smart-beta spin that aims to outperform — but could end up underperforming — the broader market.

“At Wealthfront, on the other hand, a recent US$75 million investment round led by Tiger Global Management … seems to have precipitated a much more drastic change,” the report said. While the firm still declares a belief in passive investing on its website, it has reportedly decided to put 20% of its investors’ funds into an internal “risk parity” fund that is mostly invested in total return swaps. The switch in strategy would see investor fees go from an average of 0.09% to 0.17%.

According to the article, the firm “is moving from passive to active and from cheap to expensive, but only when Wealthfront itself owns the fund in question.” In addition, the new fund’s active trading strategy racks up a lot of taxable gains, it’s only being used in taxable accounts. The change is apparently being rolled out on an opt-out basis, which means investors who signed up for passive management will have to actively overrule their fund manager’s recommendations.

Wealthfront’s reported actions look bad, but since it was founded by active investor Andy Rachleff formerly of US-based Benchmark Capital, it might not reflect how the broader industry will move. Still, the case raises concerning questions for clients who have a “set it and forget it” investing style.