Model portfolios continue to gain ground with financial advisors, who can select from a growing number of models to help manage their clients' investments.
A Boost for Small Firms
Erik Nero, founder and president, First Step Wealth Planning LLC:
I use them for pretty much all of the implementation for the investment management for my clients. I say almost all simply because for client portfolios that need a little more customization specifically for non-IRA or retirement type accounts, I'm going to work on that a little more closely with the client to take a little bit more action between the client and myself to get that implemented.
But for portfolios that are typically retirement-based and are for a longer-term time horizon, models work perfectly. They are scalable, they have the opportunity to leverage tremendous resources on behalf of whatever firm is offering them, and then the trading resources are second to none. So for small firms such as mine I'm able to leverage tools and resources that I ordinarily would not be able to gain access to with respect to the trading and implementation of these portfolios, and it gets done seamlessly.
So it saves me time to help my clients on what really matters to them, which is how that money's going to support their goals, dreams and aspirations, and I use a number of different types of providers. I've narrowed it down to three.
There's so many out there and at the end of the day it really comes down to asset allocation, and that's going to drive the vast majority of the performance, and I like to have low-cost exchange-traded fund types of portfolios that are put in place. So I believe more passively but strategically indexing to the various aspects of the market so that my clients can participate rather than anticipate the market.
The pros obviously are the scalability, access to the resources and the brain trusts of the firms that are putting them together so I can really leverage my time and resources. The cons are it may come down to one size fits all. I use a number of different types of allocations based upon time horizon and tummy tolerance that each client has, but it's hard to use half sizes, if you will, with these types of portfolios.
So it takes a little bit of creativity with respect to what types of models are going to be employed in which types of accounts to get to an allocation that's going to be perfect for that client.
When Not to Use a Model Portfolio
Kyle Simmons, lead financial planner, Simmons Investment Management:
I do use a model portfolio in my business. Many advisors outsource model portfolio creation to a TAMP (turnkey asset management program) or use one from a model marketplace provided by their custodian.
I personally have my own model portfolio that I review monthly and make changes to maybe once or twice a year. Having a model portfolio allows me to actualize my investment philosophy and best investment ideas into a single cohesive portfolio and implement it across my entire client base.
It's important that advisors don't get too attached to their model, as clients will come in with legacy holdings and you want to be able to make investment decisions with tax consequences in mind.
For every incoming holding, I evaluate the cost basis and assign an equivalent holding in my model. Sometimes that legacy holding will be a highly appreciated individual stock that selling would have serious tax consequences. Other times the holding will be a low-cost ETF that's equivalent to a position in my model and it could make sense to continue to hold that fund going forward.
Another common deviation from the model is for clients with 401(k)s that have limited investment options. In these cases, advisors need to determine how they can implement their models within that limited subset of options.
My model does tend to use ETFs from a single family (Vanguard), but it also contains funds from other families such as from iShares and SPDR. I think it's important to be open to the best options for the sectors you want to target, but also understand that certain families tend to provide more value.
The number one pro is the ability to implement your best ideas across an entire client base. For those that outsource, I'm sure they appreciate taking part of the investment management piece off their plate in terms of the amount of research that is needed to do a good job as a fiduciary.
The con is simply the potential to be over-reliant on a model and selling client assets just to move them into it. If this happens, the client's investments could be jerked around and result in significant taxes and trading costs, which reduce their overall performance.
A Good Starting Point
Jan Pevzner, principal, Gotham Block LLC:
A model portfolio is a good starting point for a "generic" client. If you don't have an in-house investment management team, starting with a model portfolio will save you a lot of time. Once you have a model, you can customize it by adjusting the specific exposures built into the model to the household you are working with.
Suppose your client is in tech and has a significant employer equity grant. It could be options, RSUs (restricted stock units) or other forms of equity. In that case, reducing the portfolio's allocation to technology might make sense to balance off the overall exposure.
I work with several models from the same provider, Vanguard, which offers different series that each can be adjusted for a client's risk tolerance to produce a custom model.
The model's choice depends on the portfolio's size, the degree of customization required, and the location of the assets. A simple model with fewer components is best for clients with simple portfolios. Other clients might need more complex allocations with finer control over the factors they are exposed to. For example, two separate ETFs for value and growth instead of single equity ETF will let you increase your exposure to value stocks.
The pros are that they save time and allow you to deliver quality products to your clients. The cons are that those model portfolios are generic and inflexible and don't consider a specific client's financial situation.
