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A Check In On The Use Of Model Portfolios

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Analyzing every investment position can be labor-intensive, so advisors aiming to balance their time between portfolio management and business development often turn to tools, such as model portfolios. Models can help advisors combine multiple asset classes more efficiently to meet a range of investment needs, such as targeting a specific level of risk or providing income. While many firms prefer to devise an in-house model, the $3 trillion marketplace for third-party model portfolios continues to grow, catching the attention of analysts and Morningstar.

Advisors can choose, however, to outsource some, or all, of their investment management responsibilities using third-party model portfolios. These external solutions, unlike some traditional investment vehicles, such as funds, can allow financial advisors discretion over many aspects of portfolio management, including underlying holdings, asset allocation, rebalancing frequency, and trading.

In line with our quest to find out what firms expect and receive from using external investment expertise—and for the first time since we launched our Race to Scalability survey series—we asked advisors about their use of third-party model portfolios.

The Race To Scalability 2020 offers researched insights on how advisors decide whether and how to engage external support to grow their firms. As part of our 10-year commitment to this knowledge area, in 2020, FlexShares recently talked to more than 500 respondents in the advising profession, including RIAs (33%), independent broker/dealers (35%), hybrid/dually registered RIAs (13%), regional broker/dealers (8%), Insurance broker/dealers (6%). The size of assets under management across the respondent pool ranged from under $50 million (27%) to over $3B (13%).

Key Takeaways

  • The majority of advisory firms rely on in-house investment competencies
  • Nearly three quarters of advisors using third-party models take the turn key approach
  • Access to model portfolios is a top driver in using external investment support

Our newest line of inquiry gave us some insights as to why and how advisors adopt model portfolios in their advising practice. While 41% of survey respondents reported the use of a third-party model portfolio for their clients, the majority (59%) said do not employ this tool in their practice.

However, for advisors looking for investment vehicles via an external manager, model portfolios appear to be a popular incentive. About 29% of the advisors working with external investment managers engage this outside expertise to help in some form with asset allocation models. Of the 13% of overall survey respondents who said access to investment vehicles was a key driver in their decision to use external investment managers, 65% were specifically seeking to access model portfolios.

Model portfolios, unlike many other turnkey asset-management solutions, layout a plan for essential portfolio management objectives rather than provide a direct investment opportunity. Turnkey asset management platforms (TAMPs), provide advisors with increased capacity to build portfolios for their clients. Some TAMP solutions offer a mix of portfolio management, reporting, billing, and other services, too.

“Advisors are typically seeking a holistic, cost-efficient, outcome-oriented solution from a trusted brand. Our models seek to provide a robust framework to navigate global markets and offer a straightforward means to help advisors build scale, enhance client service and satisfy regulatory expectations,” according to Melinda Mecca, Head of Investment Solutions, Northern Trust Asset Management.

 


Advisors are typically seeking a holistic, cost-efficient, outcome-oriented solution from a trusted brand.
–Melinda Mecca, Head of Investment Solutions, Northern Trust Asset Management.

Among advisors who use third-party model portfolios, 72% say they use a turn-key approach in which the third-party provider has full discretion for rebalancing and making changes to the model. In contrast, 28% of third-party model portfolio users take measures to maintain a level of internal discretion over allocation decisions and rebalancing activities with their managed portfolios. Often referred to as a “paper” solution, this more hands-on approach can involve options such as selecting from a preapproved menu of strategies, funds, or securities.

Client Experience: Can Using Model Portfolios Add Value?

We wanted to hear from advisors about their motivations for using model portfolios and we allowed respondents to provide multiple reasons as applicable. We discovered that the top five incentives were:

  1.  Improve efficiencies (64%)
  2.  To free up time to focus on other aspects of the client relationship (61%)
  3.  Incorporate expertise into the asset allocation process (55%)
  4.  Fiduciary responsibilities (54%)
  5.  Performance (34%) and Cost (33%)

By using model portfolios—in-house or third- party—to uncover efficiencies in portfolio management, advisors can potentially boost their capacity to serve clients at a lower cost and gain an increased ability to focus on strengthening client relationships.

In turn, clients can reap benefits across portfolio management objectives, such as asset allocation, diversification, and even research or analysis. However, advisors using model portfolios may need to navigate client expectations regarding fees, performance, etc. If clients later decide to take a more hands-on approach to manage their portfolios, advisors using external solutions may need to prepare for navigating the challenges of this switch.

To learn more about streamlining your business with multi-asset class portfolio’s check out resources from The Investment Institute at Northern Trust Asset Management.

Looking outside or even using model portfolios may not be the best solution for every firm. FlexShares remains committed to understanding how advisors choose to grow their business and sharing what we discover. To learn more, check out our white paper, The Race to Scalability 2020. You can find in-depth coverage of our survey results to keep you updated on how peer firms are strategizing to stay on the competitive side of a rapidly transforming industry. Also, follow our blog series to get more snapshots and insights.


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Created in conjunction with Tasha Williams of TTW Consulting

Smart beta investing combines the benefits of passive investing and the advantages of active investing strategies. The goal of smart beta is to obtain alpha, lower risk or increase diversification at a cost lower than traditional active management and marginally higher than straight index investing.

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