As we begin the second decade of the 21st century, looking back on the prior decade, disruptive change is a common thread across sectors. Seemingly entrenched businesses evolved, drastically altering everything from content to commerce. Financial services evolved too, with numerous businesses turning their sights toward wealth management due in part to millennials coming of age and being expected to receive a large intergenerational wealth transfer. A byproduct of that shift was a surge in exchanged traded-funds (ETFs) and subsequently ETF model portfolios. And that’s a trend we expect to continue. Here’s why.
New market dynamics help model portfolios become standard
Clients ask more of their wealth advisors today, including commission-free trades, enhanced software suites and fortress-like cybersecurity. Financial advisors feel these pressures.
Model portfolios can help solve some issues pressing advisory practices and help them survive in this new environment. According to Broadridge Financial Services, model portfolio investment solutions have grown 19% annually since 2016. By 2023, the market could more than double, adding $1.9 trillion to the $1.4 trillion currently in model strategies.1 More than half of advised assets are invested in a form of model, with 70% of advisors using a combination of model and custom portfolios.2
Within models, 90% of assets are allocated to core equity and fixed income products.1 That suggests advisors use models as the backbones of their portfolios and tack on tactical satellite holdings.
Model portfolios an important addition to the advisor’s playbook
Technology assures that disruption will continue. Notably, changing market landscapes will coincide with the greatest intergenerational transfer of wealth in history. Advisors need investment vehicles capable of capturing this evolution to service clients who are increasingly savvy about how they want to invest their capital.
By nature, model portfolios are:
A cost-effective strategy to scale a business
Several factors work on their own, and in tandem, to make the model portfolio space increasingly accessible.
- Commission-free. A big new talking point across the market is commission-free trades. Model portfolios target specific weights and sometimes make reasonably small trades to their target weights. Removing commission makes it more cost-effective for model portfolios to rebalance, and more attractive for financial advisors to incorporate them.
- Zero strategist fee. Typically, model portfolios created by ETF providers using their own products do not have strategist fees. The majority of free model portfolios only use the issuing provider’s ETFs. That may lead some to question whether that provides optimal exposure. But at Global X we have a robust due diligence process to select optimal ETFs for each exposure – even if that ETF is not a Global X ETF.
- Efficiency of the ETF structure. ETFs are a low-cost way to get different exposures, particularly beta exposure. The expense ratios on the 2,197 U.S. listed ETFs range from 0 to 962 basis points with a weighted average of 19 basis points. This is significantly lower than the 52 basis point weighted average expense ratio on mutual funds.3 In addition, ETFs are an efficient structure due to their in-kind creation and redemption. This results in fewer taxable gains relative to mutual funds.
- Fractional shares (less than one share). The fintech revolution helps make dynamic investment strategies more accessible. Fractional shares are one example. Typically, investors can’t buy fractional shares on their own, but many model portfolios incorporate them, allowing for additional layers of diversification and combination of strategies, especially for smaller accounts.
A way to increase client interaction
Ninety-one percent of advisors say that incorporating models gives them more time spent on client-facing activities.2 Outsourcing portfolio creation and management can help advisors find time and reallocate it to client acquisition and retention.
This is especially true for smaller advisory relationships that provide less value per unit time spent. Seventy-three percent of advisors see models as the preferred approach for client accounts below $500,000 in asset size vs 31% for the $1 million-plus segment.2
A path toward more meaningful Conversational Alpha®
Fee-conscious investors who are retired or close to it, sophisticated and high-net-worth investors, and investors interested in a thematic investment approach can all benefit from model portfolios. But no matter the client, advisors need a way to make investment performance relatable. Incorporating thematic investing into a model portfolio offers a path to deeper, more relatable portfolio and performance discussions.
What we call Conversational Alpha is a starting point to help frame the elements that could contribute to an investment adding or subtracting from returns. The concept is a natural fit for an increasingly diverse thematic growth strategy.
ETFs and model portfolios go hand in hand
Model portfolios promote ETF adoption. Since 2016, retail ETF sales have grown at a compound annual growth rate of 21% and ETF sales derived from models are 37%. As of 2018, 42% of model assets were invested in ETF products.2
Within model portfolios, ETFs are growing at three times the rate of mutual funds. Assuming trends continue, ETFs are set to surpass mutual fund model assets under management (AUM) in 2020.1
Product suites are expected to grow too. Seventy-four percent of advisors say that asset managers are their top resource when developing in-house models.2 As advisors work to meet the complex needs of affluent clients and strengthen their relationships with asset managers, additional opportunities for managers to leverage their product mix and create sophisticated portfolios are likely.
More disruption is ahead, whether brought by late-cycle uncertainty or the contours of changing sector landscapes. For advisors, that means finding investment strategies that can keep pace with shifting markets. ETF model portfolios are as dynamic as they are efficient. They are multipurpose, equally adept at addressing client needs and creating space for advisors to scale their business strategically. That many of them are now fee-free is not an insignificant bonus.
1. Broadridge, Model portfolio market grows 19 percent annually, 14 October 2019
2. Broadridge, Distribution in a model driven age, 2019
3. Morningstar data as of January 31, 2020
Investing involves risk, including the possible loss of principal. Diversification does not ensure a profit or guarantee against a loss. This information is not intended to be individual or personalized investment or tax advice and should not be used for trading purposes. Please consult a financial advisor or tax professional for more information regarding your investment and/or tax situation.
Information provided by Global X Management Company, LLC (Global X) and SEI Investments Distribution Co. (SIDCO). Global X and SIDCO are not affiliated.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.