3 Trends Shaping Model Portfolios

It’s easy to see the appeal of third-party model portfolios. These allow advisors to outsource some, or all, of their investment management responsibilities to free up time for serving clients and managing their businesses. The same could be said of any mutual fund, but models allow the advisor to retain discretion over the underlying investments. The flexibility to customize models and to set their own rebalancing schedules is what sets model portfolios apart.

The largest wealth management firms, like Bank of America’s Merrill Lynch, began adding third-party model portfolios as options for their advisors in the last couple of years. That’s sparked a surge in the number of model portfolios being reported to Morningstar. As of March 1, 2021, there were almost 1,500 model portfolios reported to Morningstar Direct, about a 50% increase compared with the same time last year.

But as is the case with any hip new trend in asset management, there’s going to be some trial and error to see what clicks with advisors. To get a sense of what kind of model portfolios asset managers are seeing the most demand for, we asked them.

We surveyed 18 leading model portfolio providers and asked them to rank 10 attributes of model portfolios from most important (10) to least important (1) for advisors choosing models over the next three years. We’ve aggregated the responses below.

The top three answers--fees, open architecture, and active/passive portfolios--could arguably be combined into a single trend. Using an open architecture (using other firm’s mutual funds and exchange-traded funds) and combining active and passive funds are both ways to keep fees down. Cheap efficient exposure to asset classes paired with in-house active funds is the most common way we see open architecture being used. For example, it’s not uncommon to see ETFs like Vanguard Total Stock Market VTI, which has a Morningstar Analyst Rating of Gold, in asset managers’ model portfolios. The ETF costs just 0.03%, so adding it to a model portfolio is an easy way to bring costs down; the average active U.S. large-cap blend fund costs 0.98%. It’s also a savvy investment decision, given less than 15% of active U.S. large-cap blend funds survived and beat their Russell 1000 category benchmark over the past 10 years, according to Morningstar’s Active/Passive Barometer.

Exhibit 2 shows the large cost advantage asset-allocation model portfolios already have versus comparable mutual funds. The exhibit shows the average asset-weighted underlying fund fee for model portfolios and the average mutual fund fee using the cheapest share class and using all share classes.

Across Morningstar’s five allocation categories, the average model portfolio’s underlying fund fees are about 30 basis points less expensive on average than the average mutual fund using the cheapest share class. Some passive-based model portfolios can even be as cheap as 0.04% for the total portfolio.

Considering the three attributes asset managers believe will be most important to advisors going forward, model portfolios’ fee advantage versus mutual funds will likely remain secure. Combined with the other appealing features of model portfolios, like more time for clients and the opportunity to customize, we expect continued rapid adoption of model portfolios.

(1) Respondents: American Funds, BlackRock, Calvert, Charles Schwab, Columbia Threadneedle, Dimensional Fund Advisors, Fidelity, Goldman Sachs, Invesco, John Hancock, J.P. Morgan, Morningstar Investment Management, Pimco, Putnam, Russell Investments, T. Rowe Price, Vanguard, and WisdomTree.

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.