As market volatility continues to challenge traditional investment approaches, the demand for personalized solutions that cater to specific client requirements could continue to rise. This likely shift could be driven by the need for better risk management and downside protection, but also by the potential economic advantages customized models can offer advisors, their clients, and their businesses. With a retention rate 30% higher and an average investment size 12 times larger than mutual funds,1 model portfolios are proving to be a robust tool for navigating increasingly complex portfolios and scaling advisory businesses. And by customizing models to meet the unique needs of advisory firms and their clients, model developers are providing a powerful, economically sound, and scalable solution for advisors and investors.
Demand Drivers
Custom model portfolios have become one of the most rapidly expanding segments within the broader model universe, which is undergoing tremendous growth. Custom model assets have grown to more than $125 billion as of September 20, 2024, up almost 50% from June 2023, based on Morningstar’s survey of leading model portfolio providers.2
Increased demand for model portfolios has likely been driven by several factors says Rob Eckrote, vice president of institutional consulting at BlackRock, “Models can help advisors save time, improve economics, and improve scalability and portability all without having to sacrificing performance.”
Giving time back to advisors to spend on high-value services and portfolio management tasks can bring greater efficiency to an advisor’s practice, ultimately improving the ability to scale. “We estimate that advisors spend about a quarter of their day on investment management,” which equals about 300 hours a year, says Eckrote. Investment management tasks may include the rebalancing of portfolios, tax-loss harvesting, trade clearances, and overall compliance checks to name a few. Such tasks were often delegated to advisors and other members of a firm, which accounted for a considerable amount of time in an advisor’s day-to-day activity, but model portfolios offer an attractive alternative.
Freeing up time to spend on existing clients and develop relationships with new ones allows for advisors to expand their books of business and lean into more financial planning.
“The combination of more clients who are generally more satisfied with the advice and service they are receiving can lead to increased client retention – and that may lead to better economics all around,” adds Eckrote.
Such an improvement in economics is arguably a primary driver of higher model AUM. “We find the average ticket size for the typical model purchase is about $120,000 compared to a typical mutual fund ticket of only about $10,000,” adds Eckrote. Combined with a higher overall retention rate, models are proving to produce tickets that are overall larger and held for longer.3
Portability may also be significantly driving demand for model portfolios and facilitating growth in asset management models. As advisors grow their books of business, their practices should become increasingly valuable, and the probability they get acquired by a competitor can also increase. Advisors who have placed clients in proprietary models from a home office or firm may experience frictions when transferring their accounts. For advisors transferring clients within a third-party model, the process can be more streamlined and can help client assets travel with the advisor’s practice.
Karl Desmond, lead client portfolio manager for Model Portfolios at Invesco says, “Custom model portfolios offer advisors the opportunity to co-develop and co-brand model portfolios, which is what’s driving the demand in this space. This means the marketing materials and the portfolio itself may reflect the advisor’s firm logo and name, making it feel like a more personalized experience to the advisors and their end clients.”
What Makes It Custom?
Customized models are tailored to target specific client needs and preferences, unlike standard models which are identical in each instance. Custom models can allow for personalization like the ability to select specific fund families or individual assets that align with an advisor’s or client’s preferences. This can be particularly useful when transitioning model providers or transferring a book of business.
“We know most financial advisors are using model portfolios today, whether they are provided by an asset manager or managed on their own. And so, if they’re going to transition to custom portfolios from a firm like Invesco, they typically want to do so in the least disruptive way possible. One of the ways to do that is to keep the handful of tickers the advisor currently holds, and we can easily do that with our custom model portfolio platform,” says Karl Desmond, lead client portfolio manager for model portfolios at Invesco.
Another primary advantage of custom model portfolios is the ability to have more control of potential tax impacts for the advisor’s end clients. This control includes the ability to dictate how frequently the portfolios are traded and the use of new tax-loss harvesting technology. “We have strategic asset allocation views and tactical, shorter-term views that we can utilize in our custom model portfolios. This is often relevant in custom model conversations, in terms of how frequently the advisor wants their portfolios to rebalance. We can back into what asset allocation approach we take, based on what the advisor preferences are,” says Desmond. In addition to tax-loss harvesting features, other tax-related customizations include tax-free fixed income strategies, which can be particularly beneficial for clients investing in non-qualified accounts.
Custom model portfolios have increasingly included the integration of alternative and semi-liquid investments, which are generally not available in standard models. This allows for broader diversification, but also the potential to cater to the needs of higher net-worth clients. A 2022 survey by PwC found that upper-tier clients (defined as those with $5 million to $10 million and over in assets) were most inclined to invest in alternative investments.4 The same survey also found that 62% of high-net-worth individuals were moving outside of their primary wealth management relationships to invest in nontraditional assets and suggested that wealth managers develop an alternative asset platform in an attempt to retain this level of clientele.
Another crucial feature for asset managers include SMAs (Separately Managed Accounts) offered in customized model portfolios. SMAs allow for more flexibility and opportunity for customization compared to traditional building blocks like ETFs or mutual funds. SMAs can also offer strategic diversification against concentration risk, an ever-present concern which has only intensified as the influence and market capitalization of the Magnificent 7 stocks grow.
Ryan Sullivan, head of Americas buy-side relations at FTSE Russell pointedly states, “If clients are coming to advisors or brokers looking for customized solutions, and they’re bringing in portfolios that are heavily concentrated, especially in the Magnificent 7, and generally the broader U.S. equities markets, the SMA wrapper offers a way to unwind some of that concentration risk.” Unlike mutual funds and ETFs, investors within an SMA own the individual underlying securities within the SMA rather than through a fund, allowing for investors to customize their allocations and control the risk exposure. Investors can own hundreds of assets within one SMA, but unlike with mutual funds and ETFs, they’re able to add or remove certain assets to their liking. For example, an employee with stock restrictions might choose to opt-out of a certain competing industry’s stocks or a government employee might not want to be invested in certain municipal bonds.
Advisors are finding the SMA add-on to customized models particularly useful. “Results from one of our surveys found that almost 40% of advisors that were using more of these customized solutions claimed their primary benefit was reducing that equity concentration risk,” adds Sullivan.
Where Customized Models Resonate
Customized models are popular among independent broker dealers and RIA channels, says Desmond of Invesco. “Those firms tend to have a little more flexibility with accessing these types of services versus what we’ve seen at the wirehouses and certain broker-dealers, where individual advisors’ teams are not able to onboard custom model portfolios,” says Desmond.
Further, the ability to personalize model portfolios is forcing advisors to think about their business and how they allocate costs. “What we’re finding within the RIA/ broker-dealer community is the firms that do not have a CIO today, are weighing the option of hiring one in-house to manage the portfolios or saving on that cost and outsourcing. The advisor teams in this type of situation is where we’re seeing a lot of interest and growth in our custom model portfolio offering,” says Desmond.
An internal FTSE Russell survey looking at certain trends and adoption rates of models within the RIA and broker-dealer community found an increasing interest in customization, especially from firms with significant client AUM. “With advisors of AUM between $50 million and $200 million we are seeing rates of planned adoption upwards of 60% over the next three years. That rate goes up to 75% looking out over five years,” says Sullivan.
As innovation in the financial services industry continues, the appeal of custom models is likely to grow. The potential for making private markets more accessible further strengthens the future ahead of model customization. With these advancements and the advent of integrated tax optimization features, advisors are better positioned to deliver tailored solutions that can align with client goals and manage the increasing complexity and diversity of assets, especially among sophisticated investors. Advisors that choose to customize their model offerings may be aligning their businesses for more efficient investment management and ultimately, growth.
2 Morningstar Model Portfolio Landscape 2022 — https://www.morningstar.com/lp/model-portfolio-landscape
3 BlackRock, “Which advisors had a smoother ride during COVID-19?” 2021
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