Automated stock portfolios gain space in investor portfolios – 07/22/2023 – From Grain to Grain

Anyone who has followed me for a longer time knows that I have always argued in favor of investing in stocks through investment funds. Part of this bias is explained by the fact that I worked for almost fifteen years as an analyst and manager of equity funds. So, I believe in the specialization of these teams. However, the way some automated wallets have been set up more recently made me change this bias.

Independent brokers and analysis houses have always produced recommended portfolios. However, there were four problems with these wallets:
I – There was no commitment to performance;
II – There was no way to monitor and understand past performance;
III – The people who produced used to be more junior;
IV – Systematically operationalizing the portfolio was difficult.

Competition and market evolution have changed these characteristics and overthrown my arguments and my bias.

Currently, just as you invest in a fund by analyzing the team, performance and risk, you can also do the same with an automated portfolio and still have some advantages that I will describe.

First I will explain what these automated wallets are. They are a recommended portfolio from an independent brokerage or analysis house and are operationalized in your portfolio automatically.

Thus, periodically, it is rebalanced and reassessed, according to the analysts’ recommendation. This is a positive point, as in the past this movement demanded a more active attitude from investors. By not having time to be continuously monitoring, in the past, this investor ended up missing opportunities. That changed with automation.

The performance of many automated portfolios has surpassed the return of many popular funds in the market, in addition to the Ibovespa, and they also combine four other advantages.

The first advantage is liquidity. Funds typically have redemption terms of 31 days or more. With an automated wallet, you have 2-day liquidity.

The second advantage is the exemption from IR on dividends. I understand that this portfolio advantage over funds may be reduced or ended soon with the tax reform. But for now it remains valid.

Let’s calculate how much this advantage is worth. Assume that the long-term return on the stock market is 12% per year and that 30% of this return comes from dividends. Thus, the dividend return would be 4% per year. As a fund is taxed at 15% income tax, this means that a direct portfolio of shares would have an advantage of 0.6% per annum because of this exemption benefit.

The third advantage occurs if you invest less than R$80,000 directly in stocks. Monthly, one or two assets in the portfolios are exchanged either because they have already reached their potential or because there are other better opportunities. There is also the rebalancing in which the excess of rise that some assets have had is sold and those that have fallen are bought. As the sale value is less than R$ 20,000, the gains are exempt from income tax.

I will estimate this advantage. As the portfolio is continually rebalanced, the total capital gain becomes tax-free. Therefore, considering that estimate of the average long-term return on the stock market and the 15% income tax rate, this advantage adds 1.2% (=8% * 15%) more relative gain.

Finally, the fourth advantage would be cost. As I mentioned, one to two assets are exchanged monthly. Let’s consider an average of two assets to simplify and level up. Assume a maximum brokerage cost of 0.5% of the amount. This means that this portfolio would pay a total of 2.4% per year in brokerage.

Funds usually charge a 2% management fee plus a 20% performance fee. In addition, in-fund stock exchanges and rebalancing also pay brokerage, although they are lower than retail brokerage.

Given the fund’s performance rate, the better the portfolio and the fund, the greater the portfolio’s advantage. For example, if a fund earns its benchmark by 5% percentage per year, the cost of the fund would be more than 3%. Therefore, already superior to that of an automated wallet.

Let’s take an example to add all the advantages.

Consider a fund and an automated portfolio that have a 20% return in one year when the Ibovespa rises 12%. In the automated wallet you will have a net return on income tax and fees of 17.6%. However, in the end, the net return on income tax and fees would be 13.94%.

It should be remembered that the return shown on a fund’s advertising materials is already net of fees. Therefore, the return you would see from this example fund would be 16.94%. The return would drop to 13.94% when the fund is redeemed and income tax paid.

In this example, it can be seen that the automated portfolio would have a return net of fees and income tax 26% higher than that of an investment fund with the same gross return.

Thus, for values ​​up to BRL 80,000, automated portfolios are an excellent alternative for those who wish to be exposed to the stock market and do not want to waste time analyzing stocks and dedicating themselves to monitoring the market.

Michael Viriato is an investment advisor and founding partner of Investor House.

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