Controversial cash allocations in Schwab's robo protected clients in 2022

Charles Schwab Corp. has defended its use of cash in portfolios managed by its robo-advisor, even in the face of legal and regulatory challenges. The market turbulence of 2022 may have vindicated its position.

As the S&P 500 fell 18.2% and the bond market (as measured by the iShares Core US Aggregate Bond ETF) fell 13% in 2022, cash became one of the only safe places for investors to hide during one of the worst years for traditional 60/40 portfolios in history.

Schwab’s Intelligent Portfolios helped protect investors better than most other robos on the market, according to the latest edition of The Robo Report, a research report published by Condor Capital that tracks the performance of 57 accounts opened at 32 different robo-advisors. Thanks to cash allocations and its use of ETFs weighted by fundamentals rather than market capitalization, Schwab posted the second-best one-year trailing performance, behind only Wealthfront.

“The high cash allocation benefited clients in 2022 as both equity and fixed-income returns were largely negative,” said David Goldstone, manager of investment research at Condor Capital. “A cash allocation as high as Schwab's is not something we see at the other robo portfolios we track. Most robos generally stay fully invested or very close to it in their portfolios from our experience.”

The researchers also named Schwab’s robo as having the third-best three-year trailing performance, behind Wealthfront and Zacks Advantage.

Condor Capital’s research aligns with data published by Schwab on the historical performance of Intelligent Portfolios. A moderate portfolio, which holds about 10% in cash, declined 12% in 2022. In addition to cash and fundamental ETFs, allocations toward gold also helped moderate declines, Alison Wertheim, Charles Schwab’s managing director of investment communications, said in an email.

“Underscoring why it’s an important part of a well-diversified portfolio, cash helped moderate declines in all Schwab Intelligent Portfolios as it was the only asset class with a positive return in 2022,” Wertheim said. “Cash helped provide its intended ballast throughout last year’s turbulent market environment.”

In June, Schwab agreed to pay $187 million to settle charges with the SEC that the brokerage profited by sweeping cash held in portfolios to its affiliate bank, loaning it out and keeping the difference between the interest earned and what it paid out, while not properly disclosing this conflict and advertising Intelligent Portfolios as free from advisory and hidden fees. While Intelligent Portfolio’s disclosures stated that allocations to cash were determined by a disciplined methodology that sought optimal returns, Schwab’s own internal analysis showed that it would cause clients to make less money under most conditions, according to the SEC.

Of that fine, $52 million was set aside for disgorgement plus interest. Schwab began mailing checks to impacted clients in January.

The firm also faced a class-action lawsuit from clients claiming Intelligent Portfolios violated its fiduciary duty by overinvesting in cash. That lawsuit was dismissed by a Northern California District Court judge in June.

Despite the challenges, Schwab has stood by its cash allocations. “We believe that cash is a key component of any sound investment strategy through different market cycles,” the company said in a company statement in June.

While the cash position may help protect investors' portfolios in the short term, over the long run it will underperform other asset classes, Goldstone said. Other robos have stayed fully invested or very close to it throughout the 2022 volatility, according to Condor Capital’s analysis.

“While Schwab is just now sending out checks, the lawsuit was over a period dating back some years,” Goldstone said. “Schwab is also not tactically moving in and out of cash as their outlook on markets changes. The high cash allocation has been in the portfolios since we opened accounts more than six years ago.”