Model Portfolios’ Role In ETF Access

September 03, 2020

Editor’s Note: This article is the fifth and last in a five-part series addressing the distribution challenge across the ETF ecosystem, from issuers to advisors to home offices and end investors. Jillian DelSignore is principal at Chicago-based Lakefront Advisory, a firm focused on improving and scaling distribution strategies in the ETF industry.

 

Over the course of this series, I’ve addressed the distribution and access challenges that face the ETF industry from three different viewpoints—the ETF issuer, the advisor and the home office. In this final piece, we will dive into the rapidly growing world of model portfolios and discuss how they can help address, in part, these challenges.

The term “model portfolio” is used in a lot of different ways, but in this conversation about distribution, we are talking about a portfolio of ETFs, some of which are a blend with mutual funds, that serves as a blueprint or outline for a particular asset allocation.

Models differentiate themselves from other types of investment vehicles by giving an advisor discretion over the specific underlying ETFs or funds, rebalance frequency and trading. An advisor can choose to stick with what is recommended in a particular model or make any changes they see fit. This level of customization and the opportunity to outsource some or all of one’s investment management have aided in the increased usage of these strategies.

Early on, model portfolios were largely strategic asset allocations, but have evolved to include everything from value and growth to tactical and even thematic strategies like ESG. As you would imagine, there has been an explosion in the number of models in market. According to Morningstar’s 2020 Model Portfolio Landscape Report, asset managers and strategists have launched more than 400 model portfolios since the start of 2018.

 

A Growing, Difficult-To-Assess Space

That said, it is actually quite difficult to track the true number of model portfolios in the market. Depending on the source, you can see the total number of models quoted anywhere from 500 to several thousand. Tim Clift, chief investment strategist at Envestnet PMC, said in a March 2020 interview that they have about 1,500 models in their platform offered from 150 firms. That is just at Envestnet, so you can imagine that the number across the industry is much higher.

Asset managers continue to look for ways to quantify the usage of model portfolios and precisely the assets invested across the industry. While it is very difficult to measure, Broadridge has begun to track approximately $1 trillion of model assets. It projects the full model market is far larger, at nearly $3 trillion. Regardless of the estimations on market size, it is clear that model portfolios are driving growth in the asset management industry, and much of that recent growth has been in ETFs, as they serve as building blocks for the majority of the models coming to market.

The question I want to answer is, How does this growth in model portfolios help address the ETF distribution challenge? Are model portfolios providing solutions for ETF issuers, home offices and advisors?

 

Model Portfolios & ETF Issuers

Let’s start with the ETF issuers. Their primary challenge is trying to distribute ETFs in the face of increased competition, as more issuers and products come to market. They are all contending for the same group of advisors, and trying to differentiate enough to gain awareness and ultimately assets. Remember, ETFs are sold, not bought. Taking something from zero to $100 million is increasingly difficult, so there needs to be a commercialization strategy for every product from the start.

Enter model portfolios. They can play an important role in helping ETF issuers commercialize their lineup. That small cap value ETF that your sales team can’t seem to sell on its own may find traction if you could instead sell a model portfolio of which it is a component.

A commercialization plan doesn’t always mean selling an ETF as a stand-alone. That commercialization plan may be that you include some of your ETFs in a model and sell the package, not the pieces. Every dollar that comes into the model drips assets into all of the funds. That not only increases assets, but also trading volume—a little bit every day. The rising tide lifts all boats.

 

Model Portfolios & Home Offices

Home offices face the twofold challenge of addressing the increasing number of ETFs in the market, and many advisors now act as portfolio managers. Some of these advisors may be very adept at that role, but many are likely best served outsourcing some or all of their investment management. The problem remains that the latter group often doesn’t take that approach.

As such, home offices are looking for ways to better control the advisors’ investment process. Model portfolios allow them to offer solutions that have been through their own rigorous due diligence. Most firms offer models managed by their own internal research teams as well as third-party strategists to provide choice to the advisors, and the tie that binds all of those offerings is the ability to maintain the heightened level of control over the investment process.

It’s clear why it’s become so important for ETF issuers to have relationships with home offices, specifically the research teams, in hopes of having your ETF placed in one of their model portfolios—the gift that keeps on giving.

 

Model Portfolios & Advisors

Like issuers and home offices, advisors face multiple challenges—or better yet, responsibilities. There are a multitude of responsibilities that come with being an advisor. Let’s focus on two: investment due diligence requirements, and servicing clients.

Even if some advisors aren’t able to access the entire universe of ETFs, there is still a heightened need for due diligence as more products—complex ones at that—come to market.

How do you do investment research and due diligence, manage client relationships and try to grow your business all at the same time? This quickly becomes difficult to manage. Model portfolios can help advisors solve for this by providing an investment solution, allowing them to focus on clients, both existing and prospects.

There was certainly a time when advisors didn’t want to use models, or at least admit to using them, because it was perceived that their primary role was investment management. While that opinion still exists in many cases, it is starting to fade, as even the largest and most sophisticated advisors see value in providing models for at least some of their clients.

 

Trends Point To More Growth Ahead

So, we’ve come full circle. All of these industry needs and trends have contributed to the significant growth we’ve seen in model portfolios over the last few years. You’re seeing not only more models come to market, but also much more education on why model portfolios exist—a critical piece of this puzzle.

While models don’t completely solve the distribution and access challenges that face the ETF industry, they certainly help, and will continue to gain momentum, especially as models and digital capabilities meet, allowing firms to offer their advisors digital capabilities and models—ETF models specifically—that fit like a glove.

The ETF industry is a unique corner of financial services where innovation thrives, and access to nearly any asset class has been democratized for all investors. But in this five-part series, one thing is clear: There are many nuances to ETF distribution, and plenty of challenges that we as an industry have to address. Continuing to talk about these challenges is the best way to face them and to spark innovation to meet them—that’s the hope.

 

If you want a quick recap, below are the four other articles in this series:

ETFs Are Sold, Not Bought

Distribution Challenge ETF Issuers Face

When Advisors Can't Access Your ETF

Home Office ETF Adoption Hurdles

 

I’d love to hear your thoughts and concerns about ETF distribution. Reach out to [email protected].

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