EXPLORE
There is no question about it – the model portfolio market is heating up. From asset managers offering strategies chock-full of their own funds to wirehouses further centralizing (or should that be controlling?) advisors’ investment picks, not a week goes by without one institution or another launching a new set of models. Each has their own agenda, but the end result is the same: the market share of models just keeps growing. According to BlackRock, the model market currently sits at around $2.8 trillion in assets under management, a figure it has tipped to grow by another $5.9 trillion. In May 2018, Greg Weiss, head of BlackRock’s managed accounts, told Citywire: ‘We believe we are still in the early innings and expect models to continue to grow exponentially, like they did in our early-days iShares ETF business.’ High ambitions indeed. And it is not just asset managers that are driving this trend as a means to grow flows. As mentioned, wirehouse home offices are a major player here, as is the fast-growing RIA industry, both the advisor firms themselves and the turnkey asset management programs that serve them. In this Citywire special report, we dedicate a chapter to each of these four key drivers of the model portfolio market, exploring their unique challenges and opportunities.
ALEX STEGER
EDITOR, CITYWIRE USA asteger@citywireusa.com
The use of model portfolios has grown exponentially in the advisory community and much of this is being driven by wirehouses and brokers. These firms, which are often viewed as slower movers in an industry that has steadily moved away from its reliance on dealers, have quietly taken steps to build out significant model portfolio offerings and are regaining control of the asset management process. For wirehouses and broker-dealers, offering model portfolios does two things: creates consistency across the entire advisory platform and ensures that the control of all asset management decisions remains with the in-house research team. For most of the firms that Citywire spoke to for this story, model portfolios offer a way for the chief investment officer (CIO) to set strategic and tactical allocations that are put in place firm-wide and make it down to even the smallest client accounts. In this way, wirehouses and broker-dealers can express their views internally and to the market. And, because wirehouses and broker-dealers are doing the trading for their model portfolios, if market conditions change, they can reposition within models and update advisors and clients accordingly, rather than issuing recommendations and hoping advisors follow along. Regaining control of the asset management process also gives wirehouses and broker-dealers a new source of fees as asset strategists for the model.
Bailey McCann
Wirehouses and broker-dealers have adapted to the rise in popularity of model portfolios by building out their CIO teams and adding third-party options, moves that have given them greater control over how their advisors are investing
Rethinking asset management
Model portfolios are proving to be a source of innovation for wirehouses and broker-dealers. With their newfound control over the asset management process for advisors and clients, CIOs at these firms have taken the opportunity to rethink their investment strategies and express their new vision in models. ‘Our CIO has been very novel in terms of rethinking asset allocation frameworks,’ said Chris Andersen, head of Americas portfolio construction at UBS Global Wealth Management. ‘An example is some of the work we’ve done on sustainable investing. When our sustainable investing portfolios were first launched, they were built on traditional asset allocation and now that we have more information about the relationship between ESG and performance, we have revamped that asset allocation approach.’ UBS has also made updates to some of its yield-seeking strategies on the credit side to reflect changes in the bond market and updated views on securities selection. Through conversations with advisors and investors, wirehouses and broker-dealers are also coming to market with modern versions of traditional portfolios. So, while advisors and investors still have ready access to a basic 60/40 portfolio at every major firm, wirehouses and broker-dealers are working to differentiate themselves by adding models that can better align with investors’ various financial goals.
Wells Fargo integrated its current model portfolio team in 2015, bringing together groups from advisory and asset management. From there, it built out nine core investment objectives. The investment objectives are designed to represent typical milestones and/or broad financial goals that investors have over their lives. Mark Litzerman, head of global portfolio management at the Wells Fargo Investment Institute, then creates models that map to those nine objectives. Currently, there are approximately 130 models available that advisors can use to meet the unique needs of each client. These portfolios represent nearly every strategic approach to asset management there is, such as passive, active, ESG, income-generating and global exposure. The process effectively updated and expanded Wells Fargo’s approach to model portfolios. ‘We had already been doing model portfolios on the advisory side for 20 years, so we have always had the view that models are important.
ETFs IN MODEL PORTFOLIOS SET TO SURPASS MUTUAL FUNDS IN 2020
SOURCE: BROADRIDGE DATA AND ANALYTICS
1. Demand for ETFs inside model portfolios has been strong relative to mutual funds. ETF asset share has increased by 10% to 42% compared with mutual funds.
2. ETFs are poised to surpass mutual funds inside model portfolios in 2020 based on historical growth metrics. This is based on a 37% compound annual growth for ETFs versus 11% for mutual funds inside models over a two-year period ending December 31, 2019.
What we’re able to do now is bring new products and technology to bear on the model portfolio space, such that we feel like we’re running one of the more cutting edge programs available today,’ Litzerman said. Efforts such as those currently underway at UBS and Wells Fargo highlight how wirehouses and broker-dealers are using innovations in asset management to provide value. This approach to model portfolios is also a bit more nuanced than the paper portfolios that have long been offered by big firms. Paper portfolios effectively served as the first version of model portfolios, but the advent of financial technology and more sophisticated lower-cost products has made it almost as easy to put real support, real investment teams and assets behind model portfolios in order to stand out. With new models come new insights about what investors want. All of the wirehouses and broker-dealers that we spoke to said they speak to advisors and investors regularly to understand what they’d like to see in terms of product development, but nothing tells the story quite like asset flows. If you look there, it’s clear that investors are breaking away from traditional portfolios. ‘Everyone is buying the hybrid,’ said Tom Thornton, research director at Raymond James’s asset management services. Thornton is referencing a type of model portfolio that blends active and passive investment strategies. The resulting portfolio looks like something that was once only available to institutional investors. Each version of this model is a little different, but set-up basically works like this: the core holdings of a portfolio are expressed through passive products (think large-cap equity index funds – basically any area where it’s very difficult to consistently beat the market). Around that core are satellite products that are actively managed and proven to generate alpha. The hybrid model can help manage downside risk and provide diversity to the total portfolio. It’s an approach that has long been popular with institutional investors, but until recently, was harder to replicate for mainstream investors.
According to Thornton, investors like the idea of having a mix of investment strategies in their model. He notes that ESG-focused portfolios are also gaining in popularity as investors seek to align their investments with greater sustainability.
A renewed relationship
Through the growth of model portfolios, wirehouses and broker-dealers have not only been able to regain control of asset management, but they are also building renewed relationships with advisors. Rather than spending time pitching trades or funds, wirehouses and broker-dealers have been able to reposition as platforms upon which advisors can scale their businesses. Building and managing portfolios takes time. Model portfolios are designed to save the advisor time by removing the need to individually allocate, trade and manage 500 customer accounts. Instead, those accounts can be segmented into a handful of portfolio types overseen by the wirehouse or broker-dealer.
‘We’re trying to bring to bear the full weight of our firm in terms of asset allocation, manager selection, risk management and other areas where we have the scale and efficiency we can provide to the advisor,’ said Paul Ricciardelli, head of investment advisor research at Morgan Stanley. Wells Fargo’s Litzerman added that because the portfolios are being managed by the investment team, they’re able to make tactical decisions about allocations and then provide those rationales back to the advisor and the client, thereby removing some of the friction and investor emotion that has historically been part of the trading process. Ricciardelli agreed: ‘There’s a huge benefit to the client and advisor on a playback basis, where we are able to provide not only trade decisions but manager research as well, so everyone understands what’s going on in the portfolio at a very granular level.’ In an era in which investment research is becoming increasingly commoditized, the interaction between wirehouses, broker-dealers and model portfolio end-users renews the value proposition for research. This is especially true for wirehouses and broker-dealers that have what are known as open-architecture models. These models are offered by firms that may not have their own investment products and instead use their research platforms to do due diligence of managers and strategies so as to build portfolios made up entirely of third-party funds. Other open-architecture model providers use a mix of in-house funds and third-party funds. With open-architecture, providers use their research process to stand out and become de facto gatekeepers for what funds are included. LPL Financial, for example, focuses on external manager research, which has become a differentiator for the firm. ‘Our goal is to be a resource, so we’re indifferent to how they use that, whether it’s just research or whether they want to work with a portfolio strategist. Both options help us build relationships,’ said Steve Snyder, who oversees investment product management at LPL Financial. Open architecture also means that wirehouses and broker-dealers can insert themselves into a consultancy role of sorts. Andrew Kitchings, portfolio manager at financial network Commonwealth Financial, said that he spends time talking to advisors about a range of issues.
‘We will talk to advisors about their models, our models, our research. We aren’t just hawking our wares in every conversation,’ he explained. ‘We also have the benefit of being able to show the depth of our platform in this way. We have performance records on some of our models that go back 10 years, so we can bring a practical perspective to answering advisory questions – in the sense that our portfolios have real assets in them and they are live today.’
Despite the current popularity of model portfolios, there is still a long runway for growth. Data from Cerulli Associates shows that there is still $6 trillion of investor assets that would benefit from a transition to a model portfolio. Cerulli believes that 45% of advisors are model targets or advisors who should be implementing models in their practices. This compares with only 12% of advisors who currently outsource these investment decisions.
Looking ahead
So what’s holding them back? A mix of platform fatigue and a lack of education, mostly. The firms Citywire spoke to emphasized that many advisors are still in the education phase in terms of understanding what models are available and how they can transition existing client portfolios to a model with minimal interference. Morgan Stanley has built an internal system that is designed to help advisors compare model portfolios and experiment with mapping them to client needs. Ricciardelli noted that there is also a dedicated sales team that can help advisors navigate the transition by providing education, portfolio information and materials that they can share with clients. Brian Partridge, head of the investment solution specialists team at Merrill Lynch Wealth Management, added that his firm has created a significant amount of educational collateral that is available to advisors, so that they can have intelligent conversations with investors about how to make the right moves and so that they too understand how best to approach using model portfolios. Internally, wirehouses and broker-dealers are also looking ahead to their next innovations. Very few would consider their model lineups complete. UBS’s Andersen said that his team is in constant conversation with the firm’s advisors to understand what investors are asking about and what advisors would like to be able to offer. ‘There is constant fluid communication going on so we can understand what the next trend is,’ he said. One trend that has already started to emerge is building model portfolios that are designed to help investors who are in retirement. The bulk of model portfolios are focused on the accumulation phase of investing, but few models are designed to help as investors start spending what they’ve saved up. The financial advisor plays a key role here, especially as advisory has shifted to whole life financial planning. Advisors can provide recommendations for how to rebalance portfolios as investors age, but that may also require new model portfolios. Wells Fargo’s Litzerman said that he expects it’s only a matter of time before model portfolio providers get there. ‘The way to succeed in this business is to build out a sophisticated team that builds quality solutions. Advisors and clients want your best ideas. Advisors want to be able to offer sophisticated products that meet their clients’ financial goals. To do that we have to keep our eye on what’s next.’
Factor Investing in Model Portfolios
ALESSIO DE LONGIS SENIOR PORTFOLIO MANAGER, INVESCO INVESTMENT SOLUTIONS
In our conversations with clients about model portfolio construction, it’s clear that factor investing is increasingly informing the discussion. To a growing extent, the question isn’t whether factors should be a part of the models — the question is how they should be implemented. Unsurprisingly, clients readily recognize that a diversified multifactor allocation (much like a diversified asset allocation) has the potential to enhance returns and reduce risk. But we don’t view this as a “set it and forget it” allocation decision. While a static multifactor portfolio has the potential to improve a portfolio’s performance, we believe there is an even stronger case for a dynamic multifactor portfolio allocation. MOVING FROM STATIC TO DYNAMIC Academic research has shown that factors have the potential to outperform the broad market over the long term. But they have also exhibited strong cyclicality, and individual factors can underperform or outperform for prolonged periods of time. A static multifactor approach can help mitigate the negative effects of cyclicality by diversifying among differently performing factors. However, the Invesco Investment Solutions team believes investors may be able to benefit from cyclicality by dynamically adjusting their factor allocation. IDENTIFYING MACRO REGIMES IN REAL TIME Traditionally, economists perform historical analyses of economic cycles using indicators like GDP, industrial production or the unemployment rate — but these measures are less practical for real-time investment decisions, since they tell us about the past rather than predicting future asset price returns. To overcome these limitations, the team constructs a leading indicator of the US business cycle using current market sentiment combined with economic and financial data released in a timely manner, available at a higher frequency (at least monthly) and not subject to revisions.
Important Information: This does not constitute a recommendation of any investment strategy or product for a particular investor. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is being provided for informational purposes only, is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in any investment making decision. This should not be considered a recommendation to purchase any investment product. As with all investments, here are associate inherent risks. Diversification does not guarantee a profit or eliminate the risk of loss. The opinions expressed in this article are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Factor investing is an investment strategy in which securities are chosen based on certain characteristics and attributes. Low volatility cannot be guaranteed. Momentum style of investing is subject to the risk that the securities may be more volatile than the market as a whole, or that returns on securities that have previously exhibited price momentum are less than returns on other styles of investing. Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale. A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets. The Russell 1000 Single Factor Indexes are comprised of securities within the Russell 1000 Index and track the performance of recognized factors. The Russell 1000 Single Factor Indexes each apply a consistent and transparent methodology to achieve controlled exposure to its target factor while considering levels of diversification and capacity. Exhibit 3 looks at the Russell 1000 Quality Factor Index, the Russell 1000 Size Factor Index, the Russell 1000 Volatility Factor Index, and the Russell 1000 Value Factor Index. The Russell 1000® Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of large-cap stocks. An investment cannot be made directly in an index. Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.
MO HAGHBIN CHIEF OPERATING OFFICER, INVESCO INVESTMENT SOLUTIONS
WHEN DO WE EXPECT DIFFERENT FACTORS TO OUTPERFORM? Before implementing a dynamic factor approach, it’s important to understand how different factors may be expected to perform in different macro environments. Exhibit 2 illustrates the framework we use when thinking about factor performance in different environments. The Invesco Investment Solution team that: • Size and value tend to be pro-cyclical factors. • Low volatility and quality tend to be counter-cyclical factors. Momentum, which identifies stocks with recent strong returns or recent weak returns, is a bit unique, as it is based on a behavioral bias in the market, where investors chase recent outperformers. Therefore, it has tended to outperform in the late stages of cyclical upswings and the late stages of cyclical downturns. It has tended to underperform in periods subsequent to turning points in economic activity. Therefore, we would generally look to combine momentum with size and value during expansionary periods, and with low volatility and quality during contractions.
WHAT DRIVES THIS CYCLICALITY? When you examine the fundamentals of factors, you can see why they have behaved this way in differing economic environments. Exhibit 3 shows us that: • Size and value tend to be pro-cyclical because these companies have had lower profit margins and lower return on assets. As a result, their ability to cover capex expenditures and interest expenses with internal resources (i.e., earnings power) has been reduced during economic downturns when earnings come under pressure. • Low volatility and quality tend to be counter-cyclical because these companies have had higher profit margins and higher return on assets. As a result, they have a greater ability to navigate through an economic downturn, covering capex expenditures and interest expenses with internal resources. INVESTMENT IMPLICATIONS When creating model portfolios, investors have historically thought about their allocation across regions, asset classes, and sectors. But our team believes that examining a portfolio’s factor allocation is just as important. When creating factor allocations for client portfolios, the Invesco Investment Solutions team generally emphasizes a diversified multifactor exposure with a dynamic strategy that actively rotates exposure to the factors that we expect to deliver superior risk/return characteristics in a particular macroeconomic environment. LEARN MORE ABOUT OUR DYNAMIC APPROACH To discuss your particular portfolio needs, and the extensive research that underpins the approach discussed here, contact your Invesco representative. You can also learn more about our team at invesco.com/solutions.
ABOUT THE AUTHORS Alessio de Longis, CFA®, is a Senior Portfolio Manager for the Invesco Investment Solutions team. He leads the group’s global tactical asset allocation effort, focusing on the development, implementation and management of macro regime-based investment strategies across asset classes, risk premia and factors. Additionally, he develops and manages active currency overlay strategies and solutions for multi-asset portfolios. Mo Haghbin, CFA®, CAIA®, serves as the Chief Operating Officer for the Invesco Investment Solutions team, which develops and manages customized multi-asset investment strategies for institutional and retail clients. He is responsible for product management, strategy development and overall business management. This involves strengthening the investment platform with new capabilities, developing a roadmap for greater use of data/technology, and working with investment teams to bundle Invesco’’s portfolio management expertise.
Manage Investments Efficiently, Deliver Higher Value
Outsourcing investment management may allow advisors to focus on their core business while evolving their clients’ experience.
MATTHEW GOULET SVP, MODEL PORTFOLIOS FIDELITY
According to a Fidelity outsourcing trends study¹, 43% of advisors surveyed said their firms currently hire external consultants, third-party providers, or individual specialists for some business functions—a practice often referred to as outsourcing. “Outsourcing is a strategic way to free up time, enabling advisors to give more attention to client relationships and provide deeper value,” says Matthew Goulet, a senior vice president at Fidelity Institutional Asset Management®. Fidelity’s study also found that among firms that hired outside specialists, 84% indicated that they had a successful experience. THE RATIONALE FOR SEEKING OUTSIDE HELP FOR INVESTMENT MANAGEMENT
With greater regulatory pressure, increased price compression, and a growing number of investment options, the considerations that must be factored into investment decision-making can be daunting. According to Fidelity’s study, one of the top areas currently being outsourced is investment management and portfolio construction, with 40% of advisors saying that their firms outsource at least a portion of these activities. Investment management is also perceived as the highest risk area for outsourcing, but with the highest potential impact on quality of client service. Outsourcing investment management can be engaged at both the firm and advisor level, and it’s not an all-or-nothing proposition. There are many ways firms and advisors can selectively outsource investment management, from full-on managed accounts to turnkey asset management platforms (TAMPs) to utilizing external tools and expertise for help with investment management decisions. By working with specialists and exploring technology-based solutions, firms and advisors can focus on what matters most: servicing their clients while helping them achieve fulfillment and peace of mind.
FINDING SUCCESS WITH MODEL PORTFOLIOS Choosing a full-service approach when it comes to investment management may make sense for some advisors. According to a 2018 Cerulli report on U.S. Asset Allocation Model Portfolios, 41% of advisors’ assets, which is more than $8 trillion in assets under management, can be addressed by a model portfolio provider. However, adoption is only approximately 12% ($2.5 trillion), as advisors appear reluctant to hand over the responsibility of building and maintaining client portfolios, even when the next generation of investors wants services beyond investment management.² “By seeking help from outside specialists, advisors can enhance the value they deliver to clients. They can focus on evolving the client experience from solely investment management to holistic financial planning,” says Goulet. In addition, as seen in the table above, advisory firms that outsource have shown stronger business results than others. CONSIDER FIDELITY MODEL PORTFOLIOS Model portfolios continue to rise in popularity, as advisors shift their business models from investment management to planning. Leveraging insights from more than 70 years of investment management experience, Fidelity understands the impact a disciplined approach to portfolio construction can have on your bottom line. With Fidelity’s Model Portfolios, you can offer your clients consistent, institutional-quality investment management—enabling you to spend less time managing money and more time building the valuable relationships that grow your practice.
Authors: Matthew Goulet, CFA l Senior Vice President Matthew Goulet is senior vice president of Model Portfolios at Fidelity Institutional Asset Management® (FIAM®), Fidelity Investments’ distribution and client service organization dedicated to meeting the needs of consultants and institutional investors, such as defined benefit and defined contribution plans, endowments, and financial advisors. In this role, he is responsible for leading a team of specialists who work closely with TAMPs, fintech firms, and model hub providers, and coordinates specialist support for Fidelity relationship managers. He has been at Fidelity since 2012. Mr. Goulet is also a CFA charterholder. ¹ The 2018 Fidelity Financial Advisor Community: Outsourcing Trends study was fielded May 18–31, 2018. Participants included 383 advisors who manage client assets either individually or as a team, and work primarily with individual investors. These advisors are from a mix of banks, independent broker-dealers, insurance companies, regional broker-dealers, RIAs, and national brokerage firms (commonly referred to as wirehouses), with findings weighted to reflect industry composition. Fidelity is not identified as the sponsor of the study and all research is conducted by an independent firm not affiliated with Fidelity Investments. ² The Cerulli Report—U.S. Asset Allocation Model Portfolios 2018. The report is the result of ongoing research and analysis of the wealth management marketplace by Cerulli Associates (CA). The data for this report comes primarily from CA’s proprietary survey database. In addition to survey data, CA analysts compiled information available through third parties, such as eVestment Alliance and Morningstar Direct, as well as publicly traded firms’ financial filings, to enhance the analysis contained in this publication. As with all Cerulli Reports, Cerulli Associates believes the information from these third-party sources to be reliable, and CA has made every reasonable attempt to verify it. However, CA cannot guarantee its accuracy or completeness. Information provided in this document is for informational and educational purposes only. To the extent any investment information in this material is deemed to be a recommendation, it is not meant to be impartial investment advice or advice in a fiduciary capacity and is not intended to be used as a primary basis for you or your client’s investment decisions. Fidelity and its representatives may have a conflict of interest in the products or services mentioned in this material because they have a financial interest in them, and receive compensation, directly or indirectly, in connection with the management, distribution, and/or servicing of these products or services, including Fidelity funds, certain third-party funds and products, and certain investment services. Fidelity Model Portfolios are made available to financial intermediaries on a nondiscretionary basis by FIAM LLC, a registered investment advisor, or by Fidelity Investments Institutional Services Company, Inc. (“FIISC”), a registered broker-dealer. An investment may be risky and may not be suitable for an investor’s goals, objectives and risk tolerance. Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC. “Fidelity Investments” and/or “Fidelity” refers collectively to FMR LLC, a U.S. company, and its subsidiaries, including but not limited to Fidelity Management & Research Company (FMR Co.) and FIAM LLC. Fidelity Institutional Asset Management® (FIAM®) provides registered investment products via Fidelity Investments Institutional Services Company, Inc., and institutional asset management services through FIAM LLC or Fidelity Institutional Asset Management Trust Company. 901068.1.0
As model portfolios have taken off, asset managers are seizing the opportunity to create portfolios made up entirely of their funds or by being on portfolio menus alongside other third-party funds. Model portfolios give asset managers an opportunity to express the capabilities of their existing fund lineups by showing how products can help advisors create client solutions. In this way, asset managers have been able to reassert their roles as providers of intellectual capital alongside fund management. This provides a valuable entry point for asset managers as they try to fight for the attention of financial advisors and stand out in an increasingly crowded field.
Asset managers are finding a new avenue of revenue through model portfolios but competition is growing as investors demand more than just innovative investment solutions
Building the relationship
BlackRock has also created an education program around its models and overall approach to asset management. ‘Advisors are thinking about how they want to partner, whether they want to outsource, customize or build portfolios in-house,’ Cout said. ‘We want to be part of all of those paths and have created tools that advisors can use regardless of what decision they make.’ While it may seem obvious that BlackRock, the world’s largest asset manager, would have a suite of model portfolios and accompanying literature at the ready, it’s still a differentiator. Not every asset manager has been able to greet the rise of model portfolios with the same speed and breadth. To that end, asset managers that were already using models internally have been able to stand out. Legg Mason is another such firm. Its quantitative investment arm, QS Investors, has been offering model portfolios through its advisory practice for several years. Roger Paradiso, who heads Legg Mason’s alternative distribution strategy, said this has allowed the firm to be well-positioned for the rise of asset managers within the model portfolio world. QS Investors offers models that include a combination of Legg Mason and third-party funds. Advisors appreciate the diversification within model fund menus, Paradiso said, and that diversification also allows Legg Mason to stand out because it’s doing investment manager research in addition to investment strategy, creating two layers of value for advisors. By providing value to advisors, asset managers are leveraging model portfolios to build relationships that tend to be stickier than they have been in the past. Once an advisor selects a model or a fund menu for a model, that decision tends to remain in place. Assets in model portfolios are much stickier than those that end up in funds through less programmatic decisions. Asset managers can also get a strategist fee for creating and running the portfolio, alleviating some of the fee pressure that is endemic throughout other parts of the asset management business.
Legg Mason’s Paradiso noted that making investments in technology can help when it comes to model distribution. It also supports client service by giving advisors the capability to customize models. ‘It’s one thing to say that you have savings for college as a goal,’ Paradiso said. ‘In the past, that would mean any investor with that goal ends up in a basic 529 target date plan that only uses the date of use to determine the allocation. When we combine multi-asset class expertise with technology we can build in a custom target date. ‘So, using several factors such as time, initial funding, ongoing contributions and market performance, we can construct a personal target that creates the most likely scenario to reach the goal. Technology allows personal multi factors to be used, which leads to better outcomes for the investor.’
‘Models are quickly becoming the vehicle of choice,’ said Eve Cout, who leads the model portfolio pillar team within BlackRock’s US wealth advisory unit. ‘We want advisors to know what we offer and that models are the simplest way to grow their practice.’ BlackRock’s approach to models is defined by two flagship strategies – target allocation and multi-asset income. Those two core strategies act as anchors from which models are created with various levels of customization based on investor needs or based on the flavor of the model – for example, types of equities and credits or factor tilts. ‘What this allows the advisor to do is understand a basic investment philosophy and then orient the solution from there. It allows advisors to learn one story, but tailor for client preferences,’ Cout said. She notes that according to BlackRock’s own internal estimates, model portfolios save advisors approximately 400 hours per year. That’s the equivalent of 120 client meetings – and clients frequently rate the amount of facetime they get with advisors as a key indicator of their satisfaction.
At your service
Beyond simply creating and running investment portfolio asset managers have also stepped in to help advisors with client service. ‘In our view, the investment part is sort of useless unless you’re also providing scale for client service,’ BlackRock’s Cout said. BlackRock’s model portfolio platform includes client-approved podcasts and talking points for client conversations alongside trade rationales and investment research. According to Cout, these resources can be especially helpful for advisors because they’re coming directly from the team tasked with investment management, so advisors aren’t just reading recent trading reports and trying to reverse engineer what they should highlight for clients. BlackRock, Invesco and Legg Mason also have turnkey portfolio modeling through their robo-advisory platforms, which are available to advisors and can provide an additional set of client solutions for small dollar accounts.
Asset managers that can position themselves as comprehensive resources to advisors and the market provide an additional layer of value that can aid with distribution to platforms as well. Franklin Templeton advocates its dynamic asset allocation approach through its model portfolios. ‘We think markets change over time, and market fundamentals can change over time, so we have intentionally designed our asset allocation strategy to be adaptive and we have also intentionally built in a lot of education around that philosophy,’ explained Pierre Caramazza, head of the financial institutions group and head of ETF distribution at Franklin Templeton. Franklin’s models use a combination of in-house funds and third-party managers. According to Caramazza, its third-party manager due diligence capability has helped when it comes to model distribution. ‘We have been working on open-architecture asset allocation since 2006,’ he said. ‘We have an in-house manager research team and we have been able to pick best fit strategies for specific outcomes from both our lineup and others. Having that capability is a differentiator for the platforms we are putting our products on and for the model space overall.’ These differentiators are increasingly important as platforms become overcrowded. Many platforms are shifting toward models of platform curation either by creating lists of recommended models or by assigning ratings to asset managers. Other asset managers have been able to capture prime mover advantages either by offering unique strategies or by competing on structure and sheer size. Vanguard was first to market with a full range of models using its ETFs. As Vanguard offers its models across platforms and through its massive distribution network, they are readily available to most advisors.
‘We find our lineup being used by three different client types,’ said Rich Powers, head of ETF product management at Vanguard. ‘ETF strategists use us as a component of the portfolios they build, home offices who offer models to their advisors do the same, or we can be a straight to the advisor strategic one-stop solution for those that use Vanguard-created models.’ Vanguard was the first and largest ETF model portfolio provider and it is still adding to its lineup. The firm’s decision to offer funds at low costs has also pushed other providers of similar size to offer many of their core ETFs at similar prices. In this way, Vanguard has had an outsize influence, not just on the ETF model portfolio market, but across the broader wealth management universe. Powers said that Vanguard has created a very clear message around what models are available and how they can be used. The tone and tenor of that message is reflected in other collateral for ETF portfolios from other providers, suggesting that Vanguard’s first-mover advantage has defined its corner of the model portfolio market.
The tone and tenor of that message is reflected in other collateral for ETF portfolios from other providers, suggesting that Vanguard’s first-mover advantage has defined its corner of the model portfolio market.
Curves ahead
In some ways, asset managers have found new life through model portfolios. The low barriers to entry have opened up new sales and distribution channels that have resulted in stickier relationships with advisors and investors. Model portfolios have also supported asset managers’ efforts to reassert their reputations for being masters of the universe that are able to understand markets and create high-performance portfolios. Yet, as more of the industry focuses on model portfolios, asset managers are increasingly under pressure to show that they can consistently outperform and that their portfolios are well constructed. Platform providers are buckling under the weight of new products, while advisors Citywire spoke to cited the opaqueness of the model portfolio market overall. It can be difficult to compare and contrast models, identify peers or identify actual live performance over time. Earlier this year, Morningstar said that it would be assigning ratings to model portfolio ranges from five asset managers – BlackRock, American Funds, Fidelity, Invesco and OppenheimerFunds. Morningstar expects to add more asset managers to its coverage over time.
The criteria for model portfolio ranges that are included in Morningstar’s coverage are that they must offer a separately managed account version, seeded with actual capital and that has live performance. Jason Kephart, Morningstar’s associate director of alternative strategies, said he views these models as the ‘golden copy’ – essentially the version that is closest to the asset manager’s original intent and therefore a sufficient proxy for expected performance. ‘The challenge with models is that the performance can be hypothetical or it can change based on how the advisor uses a model and how often they rebalance. So we had to find a baseline,’ Kephart said. ‘For models that don’t have that kind of support or for paper portfolios, we aren’t comfortable assigning a rating.’ Other platform providers are looking at ways to curate products by ranking models, creating peer groups or building style boxes. Asset managers are already familiar with these forms of oversight, but it’s too early to tell whether it will be easy for them to find the right bucket for each model or provide more clarity around expected performance.
As a larger number of investors enter retirement than ever before, asset managers will also be under pressure to create models that are designed for investors that are spending what they’ve saved. That could mean asset managers start putting a greater emphasis on income-generating strategies or other approaches that are beneficial to investors who are in retirement. It may also push more asset managers into open architecture models to bring on new capabilities faster. Cout is philosophical about these changes. For her, it’s an indicator that models are coming full circle. ‘We’ve kind of been on this continuum where it was multi-manager, and then we went all prop and, now we’re swinging back toward multi-manager portfolios. ‘We want to offer advisors choice. Our research has indicated over half of advisors are looking for a multi-manager approach.’
Model Portfolios May Help Advisors Avoid Costly Fixed Income Timing Traps
“Buy the dips” is a refrain often heard after equity market sell-offs. The logic is sound: If your outlook hasn’t changed and equities suddenly become cheaper, it may make sense to consider adding to your allocation. However, we don’t often hear a similar response in fixed income markets when yields rise or spreads widen – even though that is often when we find future return prospects are brightening and it may be an advantageous time to buy. In reality, the reaction is typically quite the opposite: We often see investors selling core bond allocations after rates have risen or selling credit allocations after spreads widen. Model portfolios that emphasize forward-looking return potential when allocating across fixed income sectors may help avoid this tendency. “Timing traps” are hard to resist, and can potentially have significant implications for returns. Flow data from Morningstar bears this out: Across a variety of fixed income sectors and time periods, the performance of the average fund in a given category beat the average investor’s return, inclusive of flows (see chart). This means investors’ timing decisions cost them on average anywhere from one to three percentage points of returns annualized – a meaningful portion of the total return potential of their fixed income allocations.
The PIMCO Models described in this material are available exclusively through investment professionals. All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification does not ensure against loss. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement. Bloomberg Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. The Barclays U.S. Corporate High-Yield Index the covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. The index excludes Emerging Markets debt. It is not possible to invest directly in an unmanaged index. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2019, PIMCO. For financial professionals: The implementation of, or reliance on, a model portfolio allocation is left to your discretion. PIMCO is not responsible for determining the securities to be purchased, held and sold for a client’s account(s), nor is PIMCO responsible for determining the suitability or appropriateness of a model portfolio allocation or any securities included therein for any of your clients. PIMCO does not place trade orders for any of the your clients’ account(s). Information and other marketing materials provided to you by PIMCO concerning a model portfolio allocation –including holdings, performance and other characteristics -may not be indicative of a client’s actual experience from an account managed in accordance with the model portfolio allocation. CMR2019-0926-416545
JUSTIN BLESY SENIOR VICE PRESIDENT ASSET ALLOCATION STRATEGIST RYAN MCMAHON VICE PRESIDENT GLOBAL WEALTH MANAGEMENT MARK THOMAS EXECUTIVE VICE PRESIDENT GLOBAL WEALTH MANAGEMENT
“Timing traps” are hard to resist, and can potentially have significant implications for returns. Flow data from Morningstar bears this out: Across a variety of fixed income sectors and time periods, the performance of the average fund in a given category beat the average investor’s return, inclusive of flows (see chart). This means investors’ timing decisions cost them on average anywhere from one to three percentage points of returns annualized – a meaningful portion of the total return potential of their fixed income allocations.
POOR TIMING DECISIONS MAY DENT RETURNS Part of the challenge is that investor flows into fixed income typically follow attractive trailing returns, after yields have fallen and spreads have tightened. However, lower yields and tighter spreads have often been indicators of weaker returns to come. For example, the long-term forward returns of the Bloomberg Barclays U.S. Aggregate Bond Index have been tightly tied to starting yields, regardless of the path of interest rates. While the 10.17% one-year trailing return on the aggregate index as of 31 August may look quite attractive (as 10-year Treasury yields fell 123 basis points (bps) over the same period), today’s starting yield of 2.13% is likely a much better indicator of long-term future returns, if historical trends hold. Breaking down the flow patterns demonstrates how some investors may have missed out on the full upside of core bonds over the past year. Investor flows into core bond funds started to turn negative just after yields reached their peak in September 2018, and continued to flow out even as equity markets began to sell off in December. Inflows then returned in 2019 after performance had already rebounded. The result of this behavior, according to Morningstar, is that returns for the average core bond investor were just 8.33% inclusive of flows over the past year, versus the 10.17% return for the U.S. aggregate index. A similar pattern occurs in credit markets. As credit spreads widen (and bond prices decline), performance often suffers, making trailing returns look weak. However, future return prospects typically improve as investors receive greater compensation for taking on risk. For instance, following the December 2015 oil price plunge, high yield spreads widened 370 bps to reach 839 bps as of 11 February 2016, and one- and three-year trailing returns fell to -10.90% and -0.44%, respectively (as measured by the Bloomberg Barclays US Corporate High Yield Index). However, as markets recovered from the 11 February 2016 trough, forward returns followed, with a one-year return of 25.96% and a three-year annualized return of 10.89%. Of course, past performance is not a guarantee of future returns. MODEL PORTFOLIOS PROMOTE DISCIPLINE That said, knowing it may be advantageous to invest in sectors with negative trailing returns and actually doing it are two different things: It takes discipline to invest in assets that have underperformed. We believe fixed income model portfolios that emphasize forward-looking return potential when allocating across fixed income sectors promote a strategic approach that may help avoid the tendency to jump into or out of positions in ways that could potentially hurt future performance. Lower starting yields and the potential for renewed volatility make fixed income portfolio construction particularly challenging today, and missteps can be costly. The right tools and a sound framework may be able to help financial advisors navigate the current fixed income environment and seek to avoid the timing traps that may cut into their clients’ returns. TO LEARN MORE, VISIT PIMCO.COM/EXPLOREMODELS
Model delivery gives advisors flexibilty, efficiency
AMY SCUPHAM, CFA PRESIDENT IVY DISTRIBUTORS, INC.
WHY DID YOU LAUNCH THE IVY MODEL DELIVERY PORTFOLIOS - IS IT A RESPONSE TO CLIENT DEMAND? As part of our evolving product and distribution strategy, we continue to explore ideas around how and what we bring to market. We continuously review our product line for competitiveness in many areas, such as fees, performance, and the quality of the investment philosophy and process. Additionally, we look at the vehicles themselves and ensure we have the appropriate structures available to meet the demands of our evolving client base. I think it’s important to note that we have been offering model delivery since 2014, so we have been in the business of providing models for some time. However, as we started looking at the usage of model delivery across different channels and buyer types and the due diligence processes for placement, we recognized the need for a more formalized model delivery program.
The Envestnet platform offered us the ability to create that, which meant we could extend the offerings into some of our broker dealer partners and other registered investment advisors (RIA). So, while we have been in the space for a while, we are now doing it in a larger, more organized way. Model delivery has been around for a long time, but it is still a fast-growing market. That is especially true in the domestic equity market, where model delivery solutions have experienced around a 25% compound annual growth rate over the last five years. This is set to continue. According to a FUSE Research Network’s Benchmark Series study, more than 60% of surveyed firms said model-delivered separate accounts would be a key strategy over the next 12 months as investors’ demand for customized investment strategies increases. It was natural for us to offer them as an extension or subset of our domestic equity strategies, which make more sense for some RIAs than our traditional equity offerings. Our model delivery products provide key Ivy Investments equity strategies at an attractive price and help us remain competitive and adaptable to advisor and investor needs. CAN YOU EXPLAIN YOUR MODEL DELIVERY SOLUTIONS? Ivy Investments offers seven strategies in a model delivery format. These portfolios are available in third-party, retail separately managed accounts (SMA) and unified managed accounts (UMA). Each model portfolio uses the same investment process and approach as similar respective strategies managed by Ivy Investment Management Company, including retail mutual funds in the Ivy Funds family. Our current seven model delivery strategies are: concentrated large cap growth; concentrated large cap value; mid cap growth; mid cap income opportunities; small cap growth; science and technology; and energy. We have corresponding mutual funds for all those strategies, except for the two large cap portfolios. Essentially, they are the same as our managed funds, with the same management team, philosophy and process. However, they are different in that they are not allowed to invest in non-US listed securities. So they are primarily domestic equity portfolios, but if there is a place in the international markets where we might own the local shares of a stock inside the mutual fund, we would have to own either the corresponding American depository receipt (ADR) that trades in the U.S. or just not own that share. Also, we don’t invest in initial public offerings (IPOs) inside these models as we do not have control over the trading. Where we have discretion, the model provider might not have the same access to that IPO. In contrast, we might have access to an IPO inside some of our other strategies. We believe the model portfolios give many investors broad access to our mutual fund strategies at a very attractive price. HOW ARE ADVISORS USING THE STRATEGIES TO BUILD THEIR PORTFOLIOS? IS IT SIMILAR TO THE WAY IN WHICH THEY USE THE MUTUAL FUNDS? Model delivery is generally available inside SMA and UMA platforms. So the portfolios offer a way for advisors to build more efficient outcomes for their clients. It is similar to the way they use mutual funds - it can offer cost efficiencies. Another option is we might send our model, such as mid cap income opportunities, to one of our distribution partners and they could create their own subset utilizing multiple strategies to create an income product, so it can be part of a white label model. It can also be a stand-alone product inside an advisor’s client portfolio. There is a lot of optionality, and they can use it in multiple ways. YOU HAVE PARTNERED WITH THE ENVESTNET PLATFORM. WHAT KIND OF PLATFORMS ARE YOU LOOKING TO PARTNER WITH IN THE FUTURE? HOW IS YOUR MODEL PORTFOLIO SERVICE GROWING? We are available on the Envestnet SMA and UMA platforms, which allows us to be widely available in multiple places. We also have a model available in our core equity strategy on an aggregator platform. But our goal is to grow our platform placement further. As we’ve discussed, model portfolios are an important delivery vehicle for our partners. So our national accounts team has been working closely with the firms to communicate the availability of our models and our capability in this space and to get placement on the different distribution platforms. We only launched earlier this year and already the pipeline is growing. We are having good, robust conversations and we are excited to partner with more firms in this format in the future. As we think through our distribution strategy, we look at the market and ask ‘how can we offer investment solutions to our clients in the most efficient manner and in the way they prefer to consume them?’ Model delivery is a great, natural extension to our traditional offerings, which have a very strong track record, and we are excited about the opportunities it brings.
The Model Portfolios do not invest in derivatives or non-U.S. listed securities. Strategies are only provided through separately managed accounts program sponsors. Check with your financial advisor for availability. Clients should consult their financial advisors before making any investment decisions. Financial advisors should consider the suitability of the manager, strategy and program for its clients on an initial and ongoing basis. Past performance is no guarantee of future results. Investment return and principal value will fluctuate, and it is possible to lose money by investing. Please refer to Ivy Investment Management Company’s Form ADV Part 2A for additional risk information concerning the investment strategies offered by Ivy. IVY INVESTMENTS refers to the investment management and investment advisory services offered by Ivy Investment Management Company, the financial services offered by Ivy Distributors, Inc., a FINRA member broker dealer and the distributor of IVY FUNDS® mutual funds and IVY VARIABLE INSURANCE PORTFOLIOS®, and the financial services offered by their affiliates. Ivy Distributors, Inc. IVAD-MDP-AS/43750 (10/19)
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From a business perspective, advisors are the primary targets for model portfolios. They are designed to save the advisor time and remove a lot of the guesswork from the asset management process. In many cases, the models themselves are provided by asset managers, brokers or wirehouses – but not always. Often, advisors opt to create the models themselves and may look to off-the-shelf portfolios for guidance. However, the RIAs that Citywire spoke to said they plan to keep the bulk of their model portfolios work in-house, saying it ensures consistency and allows them to build models that highlight areas of expertise.
Model portfolios are giving advisors the chance to save valuable time and help them build out their businesses, but many RIAs still want to maintain a level of control over the models they offer clients rather than hand their management to third parties
Intellectual capital
In the case of Max Mintz, chief investment officer of ESG investing at specialist RIA Common Interests, he said his advisors keep their model portfolio work in-house because they are ‘control freaks.’ It is important that his firm knows what it owns and that it is aligned with its ESG focus. Common Interests offers a mix of ESG-screened passive models and active models that include fund managers who run ESG strategies and engage with the companies in their funds on ESG improvements.
Because ESG is broadly defined by managers and companies, Mintz believes that it’s important to bring a very hands-on approach to portfolio creation to ensure consistency. His firm pays close attention to its managers and their performance and isn’t afraid to remove a manager after a few quarters of bad performance. ‘I see myself as a manager of managers,’ Mintz said. ‘We want to be able to make adjustments when we see problems crop up. It is also important to us to know at a very granular level how managers are engaging with the companies they invest in.’ Common Interests uses that granular detail as part of its portfolio construction process, creating models that allow investors to align their values with their investment portfolio. Its clients can already choose a faith-based portfolio – one that aligns companies and religious values – or a fossil-fuel-free portfolio for those concerned about resource sustainability. The firm is also working on a capability that lets clients understand the direct social or environmental impact of their investments and it has also developed a way to bring down some of the minimums for investing in ESG strategies in order to make them available to more people. The desire to retain most of the model portfolios work in-house is not limited to specialist firms like Common Interests. Jim Sinegal, senior investment analyst at Fragasso Financial Advisors, uses a core and satellite model portfolio construction and also views himself as a manager of managers. He said the core/satellite approach helps to diversify client portfolios by folding in active managers where prudent. ‘There is more and more evidence that the vast majority of markets are getting difficult to beat,’ said Sinegal, adding that a core portfolio can be created from low-cost passive products. Around that base, he identifies alternative investment strategies that can help a client meet their investment objectives. ‘We’re spending more time on private equity and on alternatives in general,’ he said.
For Sinegal, model portfolios help scale his business by saving time and allowing him to focus on financial planning. But rather than farm model construction and implementation out to a third party, he said that maintaining a hands-on approach ensures that the models are aligned with individual client needs. It also helps with client service, with Sinegal saying that his firm works with a few clients that were disenchanted with the robo-advisory space. ‘Big market moves can raise questions for people in model portfolios,’ he said. ’They want to know what contingencies are in place if markets get volatile or if there is a correction. If you’re in a pure robo, it can be hard to get answers to those questions. It’s a differentiator for us to be able to talk clients through that and answer any questions they might have.’ Knowing what’s in the model and how it came together also helps from a compliance perspective. ‘It’s important for us to know what we own and to put consistent, repeatable processes in place,’ Sinegal said.
Risk control
Independent RIAs are also opting to keep model portfolios in-house in order to maintain control over risk management and cost. Off-the-shelf model portfolio ranges are usually tied to a basic risk questionnaire. Clients will answer a few basic questions about their overall risk tolerance, expected return and investment time horizon, and from there they are routed to a corresponding portfolio. Advisors that work with third-party providers may tweak the resulting portfolio around the edges. They could swap out funds in the menu for something else or recommend additional complementary funds, for example, but for some advisors such a process doesn’t always go far enough. Scott Cadwell of Cadwell Wealth has created a family index that goes alongside the risk questionnaire and is designed to provide more information about an individual’s investment goals than a few questions about how aggressive or conservative they may want their portfolio to be. The additional information can significantly impact which model portfolio is chosen. ‘We might meet with a client that wants a very conservative portfolio, but we also know from their family index that they have several financial goals that aren’t going to be met with a conservative portfolio. So that gives us a better starting point than the basic risk questionnaire,’ Cadwell said. ‘From there we can show them where they would have to go up the risk curve to meet their goals and if they aren’t comfortable with that, we can talk with them about other options, including pointing out where they might have to scale back their goals.’
For Cadwell, this process is a form of active risk management. Rather than just assigning conservative investors basic conservative portfolios, he can show them how they might be better served with a few tweaks. Both the advisor and the client come away from the process with more information and those conversations lead to portfolios that are better aligned with what an investor wants over their investment lifecycle. Creating more customized models in-house also means that Cadwell can make adjustments over an investor’s life to ensure that the portfolio is still representative of their needs. ‘We don’t believe in planning for a single circumstance like retirement,’ he said. ‘Instead, we’re building plans and portfolios that will be with someone for their whole life.’ Building and implementing model portfolios in-house may also be beneficial from a cost perspective. Model portfolios created and implemented by third parties typically come with a strategist fee. So, even if the model portfolio only includes low or no-cost ETFs, the strategist fee can add up over time. If a model portfolio includes actively managed funds or private investment funds alongside a strategist fee, the total cost of that portfolio may rival that of an entirely custom investment strategy. That’s a dealbreaker for Nik Schuurmans, managing director at Pure Portfolios. Schuurmans leans heavily on ETFs for most of his models and plans to keep model development and implementation in-house for the foreseeable future. ‘It’s just better from every standpoint,’ he said. ‘I know what I own, it’s tax-efficient. I’m not paying the strategist fee for it. Everything just makes more sense.’ Schuurmans uses models as a way of expressing his intellectual capital. He’s creating models that have sustainability overlays, ESG overlays and even portfolios that show how much a company spends on lobbying Capitol Hill so that clients can monitor how that impacts financial performance. But the core themes for Schuurmans are risk management and cost. He wants to ensure that the models he builds align to the needs of his investors over the long term and that both risk management and cost efficiency are actively managed. ‘What we want are full transparency and consistent processes in place,’ he said. ‘In our minds, that’s best practice for compliance and there are no surprises for the investor.’
Schuurmans leans heavily on ETFs for most of his models and plans to keep model development and implementation in-house for the foreseeable future. ‘It’s just better from every standpoint,’ he said. ‘I know what I own, it’s tax-efficient. I’m not paying the strategist fee for it. Everything just makes more sense.’ Schuurmans uses models as a way of expressing his intellectual capital. He’s creating models that have sustainability overlays, ESG overlays and even portfolios that show how much a company spends on lobbying Capitol Hill so that clients can monitor how that impacts financial performance. But the core themes for Schuurmans are risk management and cost. He wants to ensure that the models he builds align to the needs of his investors over the long term and that both risk management and cost efficiency are actively managed. ‘What we want are full transparency and consistent processes in place,’ he said. ‘In our minds, that’s best practice for compliance and there are no surprises for the investor.’
Schuurmans added that by using models he is able to remove more human bias from the investment process. ‘We have rigorous quantitative screens in place and we are building rules-based strategies wherever we can. It removes bias from our investment process and that’s important,’ he said.
Better business
When it comes to model portfolios, advisors agree that they are necessary for scaling a business. However, when it comes to transitioning to models as the primary means of portfolio management, advisors are faced with a set of choices. They can farm out the process to an asset manager, broker or wirehouse, they can use third-party portfolios off the shelf and handle the implementation themselves, or they can build and manage the portfolios. Many advisors opt to work with third-parties while they focus on client service and financial planning. Yet, a growing group of advisors is choosing to keep the whole process in-house. Rather than pivot exclusively to financial planning, they view models as additional to their client work. Choosing from a range of models saves time while keeping them in touch with portfolio management. Going this route means investing in the technology to support models, but the advisors that do it say it helps them express their investment philosophies, manage risk and help investors stay the course if markets go sideways. ‘It’s getting harder to stand out if the only thing you have is portfolio management,’ said Fragasso’s Sinegal. ‘But if you take a holistic approach, clients appreciate that. They want to have their questions answered, they want your best investment ideas, they want to work with someone on a whole life financial plan.’
they view models as additional to their client work. Choosing from a range of models saves time while keeping them in touch with portfolio management. Going this route means investing in the technology to support models, but the advisors that do it say it helps them express their investment philosophies, manage risk and help investors stay the course if markets go sideways. ‘It’s getting harder to stand out if the only thing you have is portfolio management,’ said Fragasso’s Sinegal. ‘But if you take a holistic approach, clients appreciate that. They want to have their questions answered, they want your best investment ideas, they want to work with someone on a whole life financial plan.’
Little or nothing: Minimizing tax drag with Russell Investments
ROBERT KUHARIC DIRECTOR TAX-MANAGED SOLUTIONS RUSSELL INVESTMENTS
HOW MUCH ARE TAXES COSTING INVESTORS? A lot. Three numbers from 2018 stand out: 91, 86 and 11. 91% of U.S. equity funds had a negative return.¹ 86% of U.S. equity funds paid a capital gain distribution, which is a gentle way of saying, ‘you lost money, now you must pay a tax bill.’² The average taxable distribution last year was 11% of the investment amount.³ That is the largest capital gain in around three decades. This occurred because the market fell at the end of the year, while earlier in 2018, mutual funds took gains.
Now let’s look at how a client might see this cost, in dollars. We use an illustration of two clients with $500,000 invested—one with an average portfolio and one with a tax-managed solution. The average investor has a tax bill of $14,850. The tax-managed investor has a tax bill of $162.* HOW DOES RUSSELL INVESTMENTS HELP MANAGE TAXES? Often, we hear advisors say things like ‘I buy municipal bonds,’ ‘I tax-loss harvest’ or ‘we focus on long term investing.’ Russell Investments does all those things and more, at a frequency that allows for greater potential impact and opportunity. For example, our process allows us to tax-loss harvest all year long, meaning we can take immediate advantage of movements in markets, sectors and individual stocks. Since we can’t predict when these opportunities arise, we remain proactively ready. We also carefully and consistently manage yield, and the way we use tax-lot-level accounting: constantly considering holding periods, and factors such as the wash sale rule.
Disclosures: 1,2,3,* U.S. equity funds: Morningstar broad category ‘US Equity’ (large/mid/small V/B/G) which includes mutual funds and ETFs (and multiple share classes). Average U.S. equity fund Distribution of 11%: Capital Gains/Share (% of NAV) based on Morningstar U.S. OE Mutual Funds and ETFs. % = Calendar Year Cap Gain Distributions / Year-End NAV. Distribution is assumed to be made at last day of year and reinvested. Tax rate is 23.8% (Max LT Cap Gain 20% + Net Investment Income 3.8%). Hypothetical illustration uses an assumed tax rate of 27%: Assumes 84% of tax=LTCG (23.8%) and 16% =STCG (40.8%). Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. This material is not an offer, solicitation or recommendation to purchase any security. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Mutual fund investing involves risk. Principal loss is possible. Strategic asset allocation and diversification do not assure profit or protect against loss in declining markets. Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management. Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand. Copyright © 2019 Russell Investments Group, LLC. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty. Securities products and services are offered through Russell Investments Financial Services, LLC, member FINRA, part of Russell Investments. First used: October 2019. RIFIS 22037.
WHAT DO YOU HAVE TO GIVE UP TO REALIZE THESE TAX BENEFITS? We believe little or nothing. Our strategies are intended to have a long-term investment horizon. The emphasis is on investment, but also keep tax management top of mind. Our strategies are designed to work in any market environment, by taking advantage of market volatility when it happens. Because in strong up markets you still have down periods. In addition, we believe our tax-managed approach is unique in that we also seek to create value in down markets by actively harvesting tax losses. We believe you CAN have your cake and eat it, too. HOW DO YOU TRANSITION TO TAX-MANAGED MODEL SOLUTIONS? I suggest staging the transition in three steps: First, rather than reinvesting back into that which is causing the problem, redirect it towards the solution. Turn off automatic reinvestment of income, dividends and distributions in these accounts; instead, consider investing those flows into Russell Investments’ Tax-Managed solutions. Step two is to review the remaining holdings and select about half to sell early next year. This tax bill is not due until the following year. Step three is to sell the remaining holdings in the early part of that following year. This tax bill should come due three years later.
We have a long track record of success in tax management and we can help many different advisors and investors keep more of what they make. Visit russellinvestments.com/us/models
A Tactical Approach to Municipal Bonds
The VanEck Vectors® Municipal Allocation ETF (MAAX) is the latest addition to VanEck’s suite of Guided Allocation funds, which are designed to participate meaningfully in bull markets and seek to de-risk in bear markets. In the following Q&A, Portfolio Manager David Schassler discusses the philosophy and methodology behind the fund.
DAVID SCHASSLER PORTFOLIO MANAGER VANECK
WHY MAAX? We have long offered a suite of municipal bond ETFs—each with distinct performance, yield, and duration characteristics. Up until now, we had not offered a vehicle that actually helps investors figure out when to be overweight credit or duration, or, conversely, when to be overweight neither. MAAX was developed to solve this specific problem.
WHAT IS THE CONCEPT UNDERLYING MAAX? MAAX is our fourth offering within the VanEck Guided Allocation Suite, and the idea behind the fund is really quite simple. In most environments, investors are well compensated for taking duration and credit risk. However, there are times when credit risk, duration risk, or both, flare up. During these periods, investors typically need a process for identifying these risks and then avoiding them. These periods of elevated risk are when we would seek to de-risk the portfolio by taking either less credit risk, less duration risk, or both.
IMPORTANT DISCLOSURE This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck. An investment in the VanEck Vectors Municipal Allocation ETF (MAAX) may be subject to risks which include fund of funds risk, high portfolio turnover, model and data risks, management, operational, authorized participant concentration and absence of prior active market risks, trading issues, market, fund shares trading, premium/discount and liquidity of fund shares and non-diversified risks. The fund may be subject to following risks as a result of investing in Exchange Traded Products including municipal securities, credit, high yield securities, tax, interest rate, call, state concentration and sector concentration risks. Municipal bonds may be less liquid than taxable bonds. There is no guarantee that a Funds’ income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax (AMT) rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Capital gains, if any, are subject to capital gains tax. A portion of the dividends you receive may be subject to AMT. Fund shares are not individually redeemable and will be issued and redeemed at their Net Asset Value (NAV) only through certain authorized broker-dealers in large, specified blocks of shares called “creation units” and otherwise can be bought and sold only through exchange trading. Shares may trade at a premium or discount to their NAV in the secondary market. You will incur brokerage expenses when trading fund shares in the secondary market. Past performance is no guarantee of future results. Returns for actual fund investments may differ from what is shown because of differences in timing, the amount invested, and fees and expenses. Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of a fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing. ©2019 VanEck.
“THERE ARE TIMES WHEN CREDIT RISK, DURATION RISK, OR BOTH, FLARE UP. DURING THESE PERIODS, INVESTORS TYPICALLY NEED A PROCESS FOR IDENTIFYING THESE RISKS AND THEN AVOIDING THEM.”
DAVID SCHASSLER
WHAT OUTCOME DOES MAAX SEEK TO PROVIDE INVESTORS? We think MAAX offers a great way to access the municipal market. Investors have long sought the benefits of muni investments not only because they have, historically, offered a very low default risk, but also due to the opportunity they may offer for tax-exempt income. MAAX has been designed to help investors capture potential upside in the market by being overweight credit and duration risks most of the time, while providing downside protection by tactically allocating out of those risks during flare-ups. Ultimately, the fund seeks to maximize long-term after-tax returns, consisting of capital appreciation and income exempt from federal income tax.
MAAX has been designed to help investors capture potential upside in the market by being overweight credit and duration risks most of the time, while providing downside protection by tactically allocating out of those risks during flare-ups. Ultimately, the fund seeks to maximize long-term after-tax returns, consisting of capital appreciation and income exempt from federal income tax.
Take your munis to the MAAX
GUIDED ALLOCATION APPROACH Allocates among VanEck municipal bond ETFs based on interest rate and credit opportunities. SEEKS MAXIMUM TOTAL RETURN AND INCOME Performance oriented strategy offers the potential for capital appreciation plus tax-exempt income. ACTIVELY MANAGED Process uses technical and macroeconomic indicators to guide credit and duration exposure, seeking to avoid market risks when appropriate. Call us at 800.826.2333 vaneck.com/maax
• • •
HOW DOES MAAX WORK? We use objective, data-driven indicators to figure out when either credit risk, duration risk, or both, are high. When they are, we significantly reduce exposure to them. These technical and momentum indicators assess price stability within bond prices, credit spreads, cross-asset correlations, and a whole plethora of risks in order to understand just how much credit and duration risk is in the municipal bond market. Then MAAX tactically allocates among our municipal bond ETFs based on the interest rate and credit opportunities.
Model portfolios seem to exist just about everywhere. You can find them at asset managers, brokers, consultancies, with advisors, on platforms and in wirehouses. Each plays a different role in the creation and administration of model portfolios. As the model portfolios universe gets evermore crowded, consultants and platforms will have to work hardest to show that they provide value over the long term. A common complaint among financial advisors is platform fatigue, followed closely by consultant fatigue. Financial advisors are inundated with new platforms, new middlemen and new models that purport to save time or money. However, advisors are quick to point out that it takes a considerable amount of time to go through all of these platforms or speak with the consultants to find out if any of them make sense from a business standpoint. Against this backdrop, platforms and consultants are taking new steps to try to get noticed and provide value.
Tamps and consultants were early movers in the model game, but the emergence of ‘free’ offerings from asset managers represents a new, competitive force
Supermarkets versus restaurants
Turnkey asset management programs (Tamps) took an early leadership position in the model portfolios universe. These offer a wide range of portfolios for advisors to use, coupled with manager research, portfolio administration and other services that are designed to essentially let an advisor transition to offering model portfolios with little work. Tamps can provide real value to advisors that want to scale their business quickly by providing a model portfolio platform that is ready to use right away. However, these platforms have come under pressure recently from the proliferation of ultra-low cost or free model portfolios being offered by large asset managers. These asset managers are able to provide ready-to-use portfolios using their own fund lineups and therefore don’t need to charge a strategist fee. Vanguard’s ETF model portfolios, for example, use Vanguard’s ETFs and do not require a strategist. The introduction of asset manager-backed model portfolio marketplaces has created a new dynamic that’s a bit like comparing supermarkets with restaurants. You can get dinner from both places, but not in the same way. Asset-manager-backed model marketplaces are a bit like supermarkets. They have all the components advisors need to offer model portfolios to their clients, but the actual work of putting everything together still rests with the advisor. Many advisors like this approach because they can use a model from an asset manager they like and then customize it for individual clients. Tamps, on the other hand, are a bit more like restaurants. Advisors look through a menu of available options and have a complete solution prepared and delivered to them. Tamps haven’t been fully disrupted by the asset manager supermarket model, in part because many advisors want to offload portfolio management. Still, restaurants are more expensive than the supermarket and Tamps are having to reinforce their value in the era of lower-cost investing.
‘We don’t want to be a supermarket,’ said Zoe Brunson, senior vice president of investment strategies at AssetMark. ‘We curate our platform, which means that we aren’t offering every model portfolio that’s out there. The models that are on our platform have been thoroughly diligenced for quality.’ Manager selection and investment research are two ways that Tamps stand out from many providers of ‘free’ models. Because Tamps aren’t hawking their own funds, curation makes them gatekeepers and forces asset managers to compete on quality in order to get listed. Brunson said that AssetMark provides research to the advisory community not only about specific managers and models, but also about how models fit together and can be used as complements within a broader client portfolio. This helps solve problems for customization, without requiring the advisor to take on every step of the portfolio management process. Brunson added that advisors like having a curated list of options because it provides a layer of trust and cuts down on the amount of research that goes into building client solutions.
Brooks Friederich, director of research strategy at Envestnet, said that because Tamps were very early to the model portfolio space, they can provide historical information that isn’t available in the asset-manager-backed supermarkets. ‘We have the history of how portfolios have evolved over time,’ Friederich explained. ‘We’re able to help categorize portfolios and identify peer groups, which helps advisors compare and contrast portfolios.’ Envestnet is an open architecture Tamp, with 145 asset managers offering some 2,000 portfolios on its platform. Like AssetMark, Envestnet provides recommended lists, which are curated lists of portfolios that have made it through a diligence process. However, Envestnet users can also choose any model available on the platform, even if Envestnet’s in-house research team hasn’t placed it on a recommended list. Friederich noted that we’re still in relatively early stages with model portfolios, which is why there has been a proliferation of free model marketplaces. He expects that over time, as the model portfolio space gets even more crowded, advisors and investors are going to expect to see historical performance in addition to being able to compare models.
Forging new ground
Firms that work with advisors as model portfolio strategists and consultants are under similar pressure as Tamps. Advisors may work with strategists and consultants to implement model portfolios or simply provide advice on transitioning to model portfolios. These firms usually offer a range of technological tools in addition to investment solutions, but they will have to continue to innovate new services in order to stand out from the crowd.
‘If asset managers want to see growth over time, they’re going to have to show that a portfolio can outperform,’ he said. ‘We’re investing in technology and investing in our platform so we can start to provide some of that information to our users.’ By providing performance and other metrics early on, Tamps are reinforcing their position over the supermarkets. Still, platform providers will have to continue to find ways to innovate if the broader universe of model portfolio providers starts to provide more data.
Brinker Capital positions itself as a comprehensive platform for RIAs – providing technological tools, market advice, investment solutions and even tip sheets for client conversations. The firm also works with institutions and investors and can provide investment research. Jeff Raupp, its chief investment officer, said that the firm is able to stand out in part because it has one business – designing investment portfolios that align with investor objectives. In this way, Brinker avoids the conflicts that can arise from trying to sell funds alongside model portfolios. ‘We have a long history, a clear business model and we have had a very stable management team,’ Raupp said. ‘Those are differentiators for us and they attract new clients. Advisors and investors appreciate stability.’ Being able to influence other parts of the investment universe can also help a consultant stand out. Wilshire Funds Management provides model portfolio solutions to advisors, as well as a managed account platform and technology services. The funds management unit is one part of the broader Wilshire family that also provides indexing and private market services. Nate Palmer, head of portfolio management at Wilshire Funds Management, said that the firm’s reputation for providing advice to the institutional investor community also wins the trust of financial advisors. ‘There have been many studies about how asset allocation can determine as much as 90% of portfolio outcomes, we’ve been working with some of the world’s biggest institutions for decades and that’s the level of asset allocation support we provide to advisors as well,’ Palmer said. He added that both manager selection and manager attribution are key components of their diligence and consulting process so that portfolios usually have veteran investment managers. Wilshire is also forging new ground. Palmer notes that much of the model portfolio business the firm handles comes through broker-dealers and recordkeepers as they expand retirement solutions. ‘Recordkeepers are increasingly going to be more of a player in the multi-asset space,’ Palmer explained. Multi-asset model portfolios have grown in popularity as investors seek diversification and downside risk protection. Historically, it’s been difficult to have a true multi-asset portfolio via a retirement plan menu, but more recordkeepers are exploring menu expansion where appropriate. As this trend matures, asset managers and consultants may find a new pocket of opportunity for model portfolios. Palmer echoed Brinker’s Raupp, noting that consultants can avoid disruption by continuing to provide unconflicted service. ‘A key difference for us is that we aren’t hawking our wares. We offer model portfolios that include Wilshire funds, but we also offer portfolios that don’t. We’re agnostic about which models people use,’ he said. Wilshire offers some model portfolios that include Wilshire funds with no strategist fee, while others are made up of third-party funds and include a strategist fee.
Multi-asset model portfolios have grown in popularity as investors seek diversification and downside risk protection. Historically, it’s been difficult to have a true multi-asset portfolio via a retirement plan menu, but more recordkeepers are exploring menu expansion where appropriate. As this trend matures, asset managers and consultants may find a new pocket of opportunity for model portfolios. Palmer echoed Brinker’s Raupp, noting that consultants can avoid disruption by continuing to provide unconflicted service. ‘A key difference for us is that we aren’t hawking our wares. We offer model portfolios that include Wilshire funds, but we also offer portfolios that don’t. We’re agnostic about which models people use,’ he said. Wilshire offers some model portfolios that include Wilshire funds with no strategist fee, while others are made up of third-party funds and include a strategist fee.
Despite their ability to provide critical due diligence resources and break into new areas of the market, Tamps and consultants are ultimately outsourced gatekeepers and face some headwinds. With the proliferation of free or nearly free funds, portfolio advisors have more opportunities than ever before to pick something off the shelf and make it their own. Tamps and consultants are hoping that advisors ultimately want a more hands-on partner when it comes to model portfolios – one that can provide a curated experience and sort through the clutter rather than leave them to fend for themselves in a free marketplace. So far, it’s worked. However, as the market matures, these firms will have to find new ways of innovating in order to stay relevant.
Building Better Models Requires A Consistent Risk Framework
Implementing model portfolios into your business has many benefits – from improving scalability and efficiency to increasing client confidence in your process. However, given the level of interest rates and late cycle landscape, it’s imperative to consider which risks to take and avoid, and how to express them consistently across client risk levels. Clearly, risks in today’s markets are weighing on investors’ minds. Almost 75% of institutional investors and professional buyers said they are concerned that the prolonged period of low interest rates has created asset bubbles.¹ Nonetheless, clients need to take some risk to reach their goals and financial professionals need to determine the right risks to take and how to scale it in client models with varying objectives. To that end, whether you are hiring a model provider or seeking the guidance of a consultant, financial professionals should ensure the process is well-grounded in an understanding of risk, correlations and diversification, as well as insights into where the capital markets are headed. MORE MEASURED DECISION-MAKING Model portfolios can offer more disciplined investing to help navigate challenging environments, if designed right. Natixis Advisors, a subsidiary of Natixis Investment Managers building customized multi-asset solutions, believes putting risk first is the only way to deliver more consistent outcomes. “Risk tolerance is the driving force behind investment decision making. Therefore risk is always the starting point for all portfolio construction and asset allocation decisions we make,” said Marina Gross, Executive Vice President and Portfolio Manager at Natixis Advisors.
¹Natixis Investment Managers Professional Investors Survey includes Global Survey of Institutional Investors, conducted by CoreData Research in October and November 2018, including 500 institutional investors in 28 countries. ²Assets under Administration may include assets for which non-Regulatory AUM services are provided (including assets serviced and/or administered). Non-Regulatory AUM includes assets which do not fall within the SEC’s definition of Regulatory AUM in Form ADV, Part 1. As of 6/30/19. For Financial Professional Use Only. This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary. The views and opinions expressed may change based on market and other conditions. Net asset value as of [6/30/2019]. Assets under management (“AUM”), as reported, may include notional assets, assets serviced, gross assets and other types of non-regulatory AUM. CFA® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute. Natixis Advisors, L.P. provides analysis and consulting services to investment professionals through its Natixis Portfolio Clarity® (“NPC”). The Portfolio Clarity Model Program is offered through NPC. Natixis Advisors, L.P. provides discretionary advisory services through its divisions Active Index Advisors® and Managed Portfolio Advisors® and non-discretionary advisory services through its Natixis Portfolio Clarity®. Natixis Distribution, L.P. is a limited purpose broker-dealer and the distributor of various registered investment companies for which advisory services are provided by affiliates of Natixis Investment Managers. 2672920.1.1
CUSTOMIZED DIVERSIFICATION More than 20 independent affiliated managers with diverse asset class expertise in Natixis Investment Managers’ multi-affiliate structure, along with over 15 years of model construction experience, puts Natixis Advisors in a unique position to build better models. Its offerings include multi-asset mutual funds, ETFs, and SMA portfolios. Core, completion, and thematic models are designed to align with specific client objectives. Customization can occur with any model type to fit platform or client needs or constraints, such as lower costs, tax-aware vehicles, and overlays. In fact, the Natixis Advisors team, which has $37 billion assets under administration², is working closely with several investment advisory firms to develop core models that align with clients’ risk tolerance and designed to be a fully asset allocated, one-stop solution.
ADVANCED ASSET ALLOCATION Despite the growing demand for ETFs in modern model portfolios, actively managed mutual funds continue to play a critical role, especially flexible fixed income products in today’s uncertain markets. Christopher Sharpe, Chief Investment Officer and Portfolio Manager for Natixis Advisors, believes combining active and passive allows firms to maximize efficiency and flexibility. “We see several benefits to this approach. It enables you to modulate price, mix time horizons, use passive for short and active for long, as well as manage beta, exposure and diversification more finely,” said Sharpe. Optimal portfolio design also requires two-dimensional decisions, believes Gross. This is why asset allocation within Natixis Advisor models is determined not only by asset class but also by risk and style factors, while investment selection is driven by strategy, manager, and time horizon. Gross co-leads the firm’s multi-asset solutions business and is responsible for the Natixis Portfolio Clarity® consulting team, which specializes in analyzing model portfolios for financial intermediaries and asset allocators. Since 2012, the team has evaluated more than 10,000 model portfolios. “The data and analysis Portfolio Clarity® captures provides us with a deeper understanding of portfolio trends and tendencies – helping to inform and validate decision making and construct better models,” said Gross. ALTERNATIVE WAYS TO DIVERSIFY To add a greater level of diversification into model portfolios, many advisory firms are introducing alternatives into their models. Natixis’ alternative completion models are designed to match the risk profile of a more traditional conservative, moderate, or aggressive portfolio. They’re intended to provide a seamless fit, allocating assets to a range of liquid alternative funds from Natixis affiliates, including AlphaSimplex Group, Gateway Investment Advisers and Loomis, Sayles & Co. At the end of the day, putting risk first in model portfolio construction and maintaining a rigorous asset allocation framework may lead to more consistent outcomes – and give clients peace of mind.
PORTFOLIO CONSULTANCY: SERVICE VS. SOFTWARE Natixis Portfolio Clarity® consultant David Reilly, CFA®, offers customized portfolio analysis and capital market insights to financial professionals every day. With the help of institutional-level analytical tools and proprietary software, he looks at clients’ model portfolios through multiple lenses – searching for gaps, redundancies and unintended exposures that may lead to unpleasant surprises. But it’s not the advanced technology that Reilly believes differentiates the Portfolio Clarity® service from other portfolio consultancy providers. It’s the purely objective, personalized experience he and his team deliver. “We walk each financial professional through the Comprehensive Portfolio Evaluation report and point out the inefficiencies, risks, and opportunities we find. We are available to help you make sense of it all, and answer as many follow-up questions as you have,” said Reilly. What should I do with my fixed income? Among the more popular model portfolio diagnostics Reilly is asked to perform is the Fixed Income Sensitivity Analysis, which can include yield curve/rate stress tests. This in-depth analysis helps professionals understand if their fixed income allocation will continue to act as ballast in the portfolio under different scenarios, including when yields normalize, if rates go lower, or if long rates go up. Learn more about building better models. Visit im.natixis.com/clarity
How do clients really feel about model portfolios?
Some advisors worry that outsourcing investment management might hurt their value proposition. Our research suggests that using model portfolios may actually boost client satisfaction.
BRIE WILLIAMS HEAD OF PRACTICE MANAGEMENT, STATE STREET GLOBAL ADVISORS
With the financial services industry facing transformational changes in regulations, technology, investment products and fee structures, many advisors understand that their success depends on something they can still control: Creating strong client relationships. In new research from State Street Global Advisors, advisors say that their top two business goals for the next three to five years are acquiring more clients and deepening relationships with existing ones. Yet the day-to-day demands of running a practice may make it difficult to focus on those goals. In fact, advisors surveyed report spending more time on investment management than on either client-facing activities or prospecting. One potential solution for this challenge is to outsource investment management by putting client assets into model portfolios—investment strategies created and maintained by large asset managers that employ teams of experienced investment professionals. And in fact, more than 50% of advisors are using model portfolio solutions to help them scale their businesses and serve more clients more efficiently.¹
Still, many advisors are reluctant to adopt model portfolios. Some advisors believe that models may limit their ability to customize and personalize client portfolios. Likewise, many advisors are concerned that outsourcing investment management means ceding a critical role to someone else, thereby diminishing an advisors’ value proposition for clients and prospects. Client sentiment and satisfaction are critical factors in a firm’s success, so we sought to understand clients’ perception of—and experience with—model portfolios. The results are surprising. INVESTORS UNDERSTAND MODEL PORTFOLIOS AND APPRECIATE THEIR BENEFITS Our survey explored a key question: Are investors familiar with the concept of model portfolios? It turns out that the majority of investors (62%) know what model portfolios are, and half of that group says their advisors have some or all of their assets invested in a model portfolio.² Even investors who don’t have assets in model portfolios are overwhelmingly open to using them: Only 10% say they don’t like idea and would seek another advisor if theirs suggested investing in a model portfolio.² We went further to investigate how outsourcing investment management affects the client experience. Again, clients with assets in model portfolios strongly support their use and report positive impacts. It seems that these investors see the big picture: Using model portfolios frees their advisors to dedicate more time and energy to client relationships, resulting in a better understanding of each client’s unique circumstances.
¹Cerulli Associates, The Cerulli Report | U.S. Exchange-Traded Fund Markets, 2017. ²State Street Global Advisors’ Practice Management Global Study, Advisor Productivity: Embracing Asset Allocation Models, 2019. Our “Advisor Productivity: Embracing Asset Allocation Models” research was conducted in Q1 2019 in four regions (United States, United Kingdom, Australia and Japan) among individual investors and financial advisors in traditional advisory firms or other intermediary channels. 24 in-depth telephone interviews were conducted with State Street Global Advisors’ advisors). A global online survey was conducted among 809 State Street Global Advisors’ advisors and 826 individual investors.* Two tailored interviews provided context for the data and insights. * Advisors were required to have $25M+ in AUM (U.S. and equivalent in other countries). Investors were required to at least share in the financial and investment decisions in their household, have investable assets of $500K+ (U.S. and equivalent in other countries), and use a financial advisor. Investing involves risk, including the loss of principal. ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. The views expressed in this material are the views of the State Street Global Advisors Practice Management Group and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Intellectual Property Information: Standard & Poor’s, S&P and SPDR are registered trademarks of Standard & Poor’s Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation’s financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third-party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index. State Street Global Advisors Funds Distributors, LLC, member FINRA, SIPC. 2753587.1.1.AM.RTL | Exp. October 31, 2020
What’s more, investors are sophisticated enough to recognize specific benefits related to performance, risk and fees. Below is a list of statements about model portfolios that 80% or more of clients agree with. The combination of greater personal attention from their advisors and high confidence in their investment portfolios generates strong feelings of trust and satisfaction among clients. Clients with assets in model portfolios are far more likely to say that their advisors understand their goals, that they trust their advisors and that they see them as integral partners in their financial wellbeing.
Finally, we asked the investors a simple question about their overall satisfaction with their advisor. Once again, clients with assets in model portfolios give higher marks: 85% say they are very or extremely satisfied with their experience, compared with just 73% of clients with no assets in a model portfolio.² FOCUSING ON RELATIONSHIPS FOR THE GOOD OF THE CLIENT—AND YOUR PRACTICE Taken together, these survey results indicate that outsourcing investment management doesn’t diminish an advisor’s role in the eyes of clients. In fact, it may help strengthen a firm’s value proposition by allowing for deeper advisor-client relationships. Most advisors understand that clients want more than portfolio management. Offering better financial planning services and helping clients manage and modify their behavior in the face of market movements are just two ways that advisors can deliver meaningful improvements in clients’ financial results. For their part, advisors tell us they are in this business to do more than manage investments. Many say that building long-term relationships with clients in their favorite part of the job. Adopting model portfolios can help advisors spend more time on those critical elements of their practice that result in better client service and deeper, more fulfilling relationships. It’s a simple equation: Creating economies of scale in investment management allows advisors to spend their time on what matters most to their clients and to their practice. LEARN MORE AT SPDRS.COM/MODELPORTFOLIOS
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