When will the days of passive wealth management be over

Passive Asset Management with Robo Advisors 1.0 is on the rise

Robo Advisors 1.0 are on the rise since 2010. They have a very simple concept: "Buy the broad market as cheap as possible" and this concept has worked well since the end of the financial crisis in 2009.

The benefits of low fee passive investment are repeated like a mantra:

  • Invest in the market with a "forever" investment horizon because the market will go up forever
  • Look for the cheapest offer. Any company can make a passive investment and the cheapest is the best.
  • Active investment is a loser. As the market goes up forever it makes no sense to be anything but long the broad market.

No matter where you look, every broker or bank has its free Robo Advisor 1.0 now (mostly selling their own products) and even neutral Robo Advisor 1.0 like www.ways2wealth.com offer their advice for free. Passive funds now account for some 36 percent of all U.S. retail fund assets (Source: Morningstar) and there seems to be no end to this trend.

Robo Advisor 1.0 was not a product innovation, passive investment ideas were around since 1950. It was a distribution and price innovation as Robo Advisors 1.0 were not using the expensive classic investment sales channels but selling direct through the internet with a much lower price.

"Blind investing" or passive investing has become the norm. Is it possible that something can be added on something that is so good and running so well?

 

Governments have pushed huge amounts into the markets

With governments issuing more and more money and an increasing number of passive investors investing blindly and full of confidence it distort the reasons for markets to exist as mechanism to provide money to the efficient companies.

The idea of the market is that investors invest in good companies and let them prosper and take away money from firms with lower productivity.

With one central bank easing program after the other and waves of money rolling over the company in the passive indexes there is no separation between the good and bad or even thinking about on where to invest into. In a kind of finance socialism all companies get the same share in which they are indexed in one of the big indexes like SMI, DAX, Euro Stoxx, Dow Jones or S&P.

Government easing has given money to everyone; made the stock market more equal and there is no sector rotation and no surviving of the fittest anymore. This builds a kind of cycle from central bank easing - which brings in easy money everywhere - and instead of investors analyzing and investing in the best companies the money is invested in the same ratio into all sectors.

Stopping the surviving of the fittest, giving money to everybody and have financial socialism is not a bad thing (and even I am a big fan of passive investment) but it contains the risk that money is given to the wrong companies; that bubbles are build, the market mechanisms do not work anymore and some bad companies are overvalued in addition to the overvaluation of the market.

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If you invest for example in the NASDAQ index then you own a part of Snapchat's non-voting right shares with the ticker symbol SNAP. Snapchat was listed in March 2017 in the NASDAQ and it is a smartphone based social network app on which the messages disappear after some time. Snapchat's value is 40 000 Million US $ and it has never made any profit and will probably not make any profit in the near future. It is run by some 20 something year old CEOs who pay them self 1 Mio. US $ salary a day and it has fierce competition from Facebook, Twitter and Google. A conservative investor would probably not have invested in Snapchat as it is a risky investment but in the index it is sold as good long time investment to ETF investors.

The same has happened with Collateralized Debt Obligation (CDO) which has led to the financial crisis in 2007. Different real estate mortgages of lower quality (called subprime debt) were bundled together and sold with the argument that "it is a diversified investment in the broad marked, backed by a broad bundle of real estate". The idea of diversification was good but just the fact that too much subprime was in the package made it a loser. Snapchat can be seen as a subprime debt packed in the NASDAQ and your investment portfolio.

The Robo Advisor 1.0 investor is comparable with the CDO investor of 2007. Or with O'Neill words a investor in a “bubble machine” or a winner-take-all system that inflates already large companies, blind to whether they’re actually selling more widgets or generating bigger profits will be build (The New Yorker - Is passive investment actively hurting the economy?).

Outcome: Passive Investment ETFs and Robo Advisors 1.0 further fill the bubble and can miss allocate money.

How high are assets valued today

Total market cap (measured by the Wilshire 5000 Total Market Index or Global market cap) in relation to GDP is a broadly accepted measure of under or overvaluation of the stock market as both measures are somehow in a fundamental relation to each other. In our propriety SAMT AG system the Wilshire to GDP ratio shows a stock market over validation of 25%, the highest over validation reading ever. At the bottom of the real estate bubble crash in March 2009 the ratio showed an under validation of 30%. Note that this indicator is not a good source to trade as an over validation or under validation does not mean that the market has to correct in the near future. The under or over validation can go on for many years.

But the ratio can tell if you buy for a high or a low price compared to history. Keeping cash to only invest in a market under validation will not work as a concept, as it is impossible to say when the next under validation will appear and it offers - based on scientific analysis - a poor performance. In fact we know that if we invest now we get a bad price but we have to invest anyhow because we are not able to say when markets will correct again.

Outcome: Market price can be measured and it can be understood if price is high or low but it does not help for trading as it does not indicate when the price will change or correct again.

How can I personally make a better investment with Robo Advisor 2.0?

Robo Advisor 2.0 is a concept which goes beyond the simple ETF investment concept. Robo Advisor 2.0 is based on the direct to customer online sales distribution innovation from the 1.0 concept but in addition it offers product innovation in alternative investment concepts which are not correlated with the stock market.

The Robo Advisor 2.0 is a core satellite concept where a stock or ETF investment is the core and different non-stock market correlated investments are the satellite investments. The core is still based on a long term buy and hold approach but has additional approaches on how to handle and act in expensive or cheap markets, measured by market capitalization in relation to GDP.

SAMT AG has developed a standardized approach in which they offer an ETF or stock core investment and different alternative modules as satellite investments. The SAMT AG enduring core module is constructed in a way that it does not need to be changed for many years while a 2nd module offers an alternative investment in spreads between commodities and a 3rd module offers different investment advisors, for example with a fundamental value approach or futures swing trading. This all is controlled by a risk management module and the money is split between different modules. In addition ETFs or stocks can be hedged with options all the time or in phases of higher volatility. This all allows to be fully invested but not only in stocks. The shift between the modules is changed and more of the money is invested in stocks while they are cheap.

Final investment conclusion:

Bubbles and miss-investing in stocks, bonds and real estates is everywhere but this does not mean that something burst. A correction still can take years but if markets correct it will take years or decades to reach the old level again. Investors are forced to invest somewhere as idle cash is not an option as it will deliver lower performance.

Robo Advisor 2.0 offers investment which diversifies in additional dimensions such like alternative Investments like managed Futures, Commodity spreads and offers fundamental investment or other diversified investments for a fair price over the internet.

Robo Advisor 2.0 offers investment which diversifies in additional dimensions such like alternative Investments like managed Futures, Commodity spreads and offers fundamental investment or other diversified investments for a fair price over the internet.

Author: Dr. Mirko C. Ulbrich (Samt.AG, a Swiss registered and regulated Wealth Manager)

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