Model portfolios, which provide financial advisors with a prebuilt framework for investment portfolio design, are surging in popularity. Assets following model portfolios grew to $349 billion as of March 2022, according to financial services firm Morningstar. That’s an estimated 22% increase between June 30, 2021, and March 31, 2022. Here’s what financial advisors should know about the model portfolio landscape and the pros and cons of these financial vehicles.
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What Is a Model Portfolio?
Model portfolios typically provide a framework for asset allocation based on clients’ risk tolerances. Financial advisors may use models to outsource some investment management duties, freeing up time to focus on other client needs. Model portfolios often include asset-allocation or fund-selection recommendations for multiasset portfolios, according to Morningstar. Some may offer security selections in certain asset classes to complement preexisting portfolios. Additionally, model portfolios may operate with an eye toward tax efficiency.
Advisors access model portfolios through a variety of channels. Sources include wirehouses, independent technology platforms and paper portfolios, Morningstar says.
BlackRock is currently the top provider of model portfolios, according to Morningstar research. It directs $50 billion of assets through its models. Close behind are Wilshire Associates ($46 billion) and Capital Group ($41 billion).
Model Portfolios’ Rising Popularity
Despite market volatility, assets following model portfolios grew an estimated 22% to an estimated $349 billion during the nine months ending March 2022, according to Morningstar’s “2022 Model Portfolio Landscape” report.
Companies aren’t launching model portfolios at the same rate they were in the late 2010s, Morningstar says. But they’re still rolling them out at a good clip. In 2020 and 2021, more than 150 individual launches took place. Through the first quarter of 2022, more than 50 models have debuted.
Asset-allocation models continue to dominate the market. But equity and fixed-income offerings are gaining popularity. Those categories have gone from accounting for 21% of new launches to 31% over the last three years.
The Tradeoffs of Using Model Portfolios
For financial advisors eyeing the pros and cons of model portfolios, there are a few factors to consider.
Costs. Low fees may give model portfolios a competitive advantage over peer mutual funds. For example, “the median expense ratio for models favoring active underlying funds is 13 basis points lower than similar mutual funds,” Morningstar says. “For blend and passive-focused portfolio buckets, the models cost less than half and less than a third of the cost for comparable mutual funds, respectively.”
Outsourcing. By outsourcing some, or all, of their investment management responsibilities, financial advisors may focus on other aspects of their businesses. That may mean more time to direct toward client communications, marketing, compliance and other time-consuming tasks.
Tax efficiency. Because model portfolios offer individual ownership of their underlying holdings, advisors can manage a client’s tax bill through making trades. This is not available through asset-allocation mutual funds, Morningstar says. This approach, however, can be difficult to implement at scale.
Additionally, portfolio providers may have offerings that focus on tax-efficient holdings. Approximately 16% of the models in Morningstar’s database focus on tax efficiency.
High-net-worth clients. On the flip side, advisors may be wary of outsourcing the important task of investment management. They may need to take a more customized approach with certain high-net-worth clients, integrating private equity or hedge fund investments, for example.
Implementation vs. customization. Morningstar notes that more assistance in rebalancing, trading and monitoring, also called implementation, can “hamper” a model portfolio’s ability to offer customization.
Model portfolios continue to gain traction due to ease of use, low fees and time-saving characteristics. As they grow, advisors should keep an eye on the upsides and downsides of using these financial tools and stay ahead of emerging trends.
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