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Model Portfolios Are on The Rise; Don’t Be Left Behind

Many advisers are now using model portfolios and describing their value proposition less as a money manager and more as a wealth manager.

Time was when an adviser’s value proposition was about their stock- and mutual-fund-picking abilities.

Then over time, the value proposition changed: As wrap accounts, separately managed accounts (SMAs) and unified management accounts (UMAs) became the product de jour, the adviser became the quarterback of those relationships, the manager of managers.

Fast forward to today and the value proposition has evolved yet again.

Enter model portfolios. Increasingly, advisers are using model portfolios and describing their value proposition less as a money manager and more as a wealth manager, attending to what they view as a more valuable offering: providing financial peace of mind. (Of note, 45% of an adviser’s perceived value to clients was due to emotional factors while 55% was due to functional factors, according to recent Vanguard research.)

As for use, more than 40% of advisers report using models created outside their practice as at least a base when building client portfolios, and those models represent $28 trillion in assets, according to a recent Cerulli Associates report.

And the names of the firms offering model portfolios are well known: Envestnet, AssetMark, LPL, Commonwealth, Schwab, Fidelity, UBS, Merrill Lynch, Northwestern, High Tower, Citi, and J.P. Morgan are just some of the names offering model portfolios.

To be fair, model portfolios have been around for a while now.

But what’s changed is this:

More and more firms are now offering advisers the opportunity for advisers to use models with offerings from many different money managers.

For instance, Bank of America now offers investors 140 model portfolios from 17 different third-party investment managers. Read Merrill Adds Vanguard, Goldman to Model Portfolio Lineup. And Envestnet offers more than 140 model portfolios.

What’s going on?

In a recent blog, The Rise of Models, consultant Tony Davidow noted that “asset allocation model portfolios represent a way to leverage the expertise of third-party asset managers, and better align the adviser’s interests with their clients.”

For asset managers, he noted that “models provide a way of capitalizing on their expertise, owning a larger slice of the pie.”

For advisors, Davidow wrote that “it allows (advisers) to align their interests with their clients and tap into the expertise of world-class asset managers.

And investors “gain access to a more specialized team of experts.”

To be fair, Davidow noted that models are not without their limitations. Models must still deliver results. And advisers must take the time to learn how each model works and how best to incorporate models to meet their client needs.

Plus, he said in an interview that model portfolios likely don’t work for the wealthiest of clients who might need private equity and hedge funds.

But for all others, for 99% of clients, models work just fine and the benefits are many.

One, now that transactional costs are at or near zero, clients see little value in this type of advice, wrote Davidow in his blog. In fact, an adviser’s time would be better spent on wealth management issues.

Others, by the way, share this point of view. According to SSGA, for instance, advisers who take advantage of model portfolios can spend more time on client-facing activities, and more time on client-facing activities is highly correlated to increased client satisfaction and wallet-share growth.

Two, advisers using mutual fund wrap accounts will find that these products may be limited in the number and type of funds, performance might lag benchmarks, and costs might be high relative to ETFs.

Three, advisers using wrap programs have had lackluster performance, high costs, and difficulty linking to other types of accounts.

And four, while UMAs do address some of the limitations for SMAs and wrap accounts, the robustness of these models might be limited by the company offering the UMA.

So, what does the future hold for those advisers who embrace model portfolios versus those who don’t?

“We don't know how it will all play out,” said Davidow. “But we as an industry have evolved many, many times over and those who do it well, and see the handwriting on the wall that they have to evolve, they actually flourish. They do really, really well because they're ahead of the curve on it.”

By contrast, those who resist change risk becoming commoditized and left behind, said Davidow.

Ultimately, “models may not be appropriate for every adviser – and every client – but they represent an evolutionary step forward for our industry,” according to Davidow.