ETF Model Portfolios A Growing Trend

ETF Model Portfolios A Growing Trend

They can be a win for advisors and clients alike.

Reviewed by: Jessica Ferringer
Edited by: Jessica Ferringer

Ryan KrystopowiczRyan Krystopowicz, CFA, is an associate director and product solutions strategist at WisdomTree Asset Management. WisdomTree offers over a dozen model portfolios that span various risk tolerances and use an open architecture format.

WisdomTree launched its Model Adoption Center earlier this year, with the goal of providing tools to help advisors better understand, apply, tailor and communicate the benefits of third-party ETF model portfolios to their clients.

The following transcript has been edited for clarity and brevity. You’ve stated that ETF model portfolios are an underrated trend. Would you elaborate on what you mean by that?

Krystopowicz: It comes down to three points: 1) the evolution of our industry; 2) the market size; and 3) the asset manager focus. If we think about the evolution of our industry, it went from stocks to mutual funds to ETFs. And [now] we’re seeing this migration into ETF model portfolios.

The number of services that RIA firms have been providing went from nine to 16 in the past five years. But the number of hours in a day obviously remain constant. As an evolution of our industry, clients are expecting more from advisors. How do you make that time? Model portfolios are one of those dimensions.

The second point I mentioned was market size. Broadridge estimates that the current market size [for model portfolios holding ETFs, stocks and mutual funds] is around $4 trillion, and that could potentially go to $10 trillion in five years.

You have a $9 trillion asset manager [BlackRock] driving for 50% of U.S. flows to come from model portfolios over time. That’s a mic drop right there. You have to believe that stat definitely came across every asset manager’s desk. With the first point, you’re talking about the benefit for an advisor of freeing them up to do other types of work and outsourcing the investment management. Could you explain that?

Krystopowicz: WisdomTree created a model portfolio research study that we believe is the most comprehensive in the industry. [It includes] insights on the actual application of models, what advisors think of them, where the hurdles are and then the perceptions of individual investments.

It comes down to being able to leverage the expertise and the resources at a firm. Overall, it’s a tremendous benefit to end clients.

In our survey of  over 2,000 individuals, 90% of millennials were accepting of their advisor using models, and 87% of GenX. That shows you that leveraged expertise in models really resonates.

As far as a win for advisors, we found that models improve client retention by 33%. We found it helps advisors potentially attract 20% more clients. And it had an improved perception among two-thirds of an advisor’s clients.

Lastly, it’s a win for asset managers. Models tend to be stickier, and part of that is because you have better relationships with advisors. The advisor might also get access to the research team. It embeds a lot of trust and partnership within the firm, within the asset manager and then the client. What should advisors be thinking about when they’re doing due diligence on various models?

Krystopowicz: It comes down to the four P’s: people, philosophy, process and performance. When you think about performance, it’s not just outperforming a benchmark. It’s consistency in returns and knowing what to expect.

From a people standpoint, it’s critical to understand who’s making these decisions: how are they made, the timing of these decisions, when you're making rebalances, things of that nature.

As far as philosophy and process, it’s important to talk about cost. You have the underlying expense ratios as one of the costs. The mean expense ratio of an ETF model can be half the cost of a mutual fund model, or even more.

But what you get with the underlying expense ratios is how asset managers like WisdomTree make their money from these model portfolios. That’s why with most asset managers, when you go to their model portfolios, you just see 10-15 line items and it’s all their name: Fund Company A, Fund Company A, Fund Company A, all down the line. If they go open architecture, they lose out on revenue.

Wisdom Tree made a conscious decision. If we’re going to be playing against these $9 trillion asset managers, what’s our competitive advantage? Open architecture is what advisors expect. We have 80 phenomenal ETFs, but we don’t have every great ETF that’s out there in the market. To create the best model portfolio, you need to pull from outside asset managers that have their own sweet spots.

It’s important to understand whether asset managers charge strategists’ fees or not. If you don’t have a proprietary product, usually you're going to charge a strategist fee; that’s how you make your money. And then there’s a platform fee. That ranges, depending on the platform and what you're getting as far as the value-add from the platform. What metrics are being looked at when ETFs are being chosen to fill out the models?

Krystopowicz: First, we’re coming up with the investment objective. Then we’re doing the asset allocation and model portfolio construction.

Let’s say we believe valuations in Japan are very compelling. Do we have a WisdomTree fit? Or are we just trying to get beta exposure? Is there an asset manager our radar caught? Was it performance or just index methodology we want to tap into? We’re really making sure the ETF we’re selecting has the factor exposure we want and consistency in performance.

We have analytical tools and things of that nature, just like has, as far as getting the underlying exposures and looking under the hood, to make sure that it fits well not just as a star player but as a team. We’re looking at fees. We’re looking at track record. We’re looking at liquidity. We’re looking at AUM. We’re looking at all of those things any advisor would in selecting a portfolio; we hold ourselves accountable to that, because at the end of the day, these models need to be investable. Can you talk about the asset allocation process?

Krystopowicz: These are strategic model portfolios. We have over 40 different models [across] the different risk spectrums. The annual turnover of these portfolios is around 20%—it could be plus or minus depending on the strategy.

The individual ETFs themselves can rebalance annually, quarterly or monthly. Although we usually only do quarterly rebalances, we’re constantly monitoring these model portfolios every day because the underlying exposures are changing. We need to make sure that it fits in with our overall asset allocation views.

We begin with the end in mind. What is the specific objective of this model? What is it trying to achieve? If I'm using the Wisdom Tree Global Equity Model, we’re going to benchmark to the ACWI or a flavor of that for this particular strategy. We have that investment objective of trying to beat the benchmark or generate a higher yield. The goal is to do so, but in a risk-conscious way.

We are constantly understanding the underlying exposures of that benchmark that inform our asset allocation decisions. We analyze the benchmarks to understand the regional tilts, the country tilts, the sector exposures and how that matches up with our current portfolio.

We’re evaluating the economic and business profit cycle, central bank policies, our views on interest rates. We’re also balancing the global macro conditions and valuations to determine how we feel about developed international against the ACWI value benchmark, how we feel on a country or a regional basis, such as our weight to Japan versus our weight to the U.K., and balancing the valuation with the global macro conditions. Are there any misconceptions out there about model portfolios you’d like to clear up?

Krystopowicz: If you think about our research that we've done, there are several takeaways. Of the retail audience that participated—over 2,000 individuals—65% of those didn’t understand what a third-party model portfolio really was. And nearly half of those investors thought their advisor is probably already using one.

Sometimes we’ll hear from advisors that their clients expect them to do the security selection. But that might be self-inflicted, where you’ve trained your clients to think of that as your value proposition.

What we found is that 90% of investors were open to using model portfolios if it was communicated properly by their financial advisor. Models don’t weaken your value proposition as an advisor. They actually improve it, based on what the research said. Clients expect you to do it.

Jessica Ferringer, CFA, is a writer and analyst for She has 10 years of experience in investment research and due diligence, including helping to manage ETF portfolios. Jessica has a bachelor’s degree in economics from Lafayette College and an MBA from the University of Pittsburgh.