Most advisory firms are not big enough to justify handling their own portfolio construction and should be using model portfolios instead so they can free up time for client service business building, a survey by Cerulli Associates found.

But for many such firms, the number one impediment to adopting model portfolios is the misconception that clients hire advisors for their portfolio construction skills.

“Based on our extensive conversations with retail investors, the nuance regarding the details of how an advisor manages a portfolio and how that is differentiated from other portfolio construction and management approaches is lost on the average retail investor,” Michael Rose, an associate director of Cerulli’s wealth management research team, said in an email. “Therefore, while an advisor may consider their approach to investment management to be meaningfully differentiated from their competitors, that differentiation is not understood by many, if not most, clients.”

Instead, Rose said, the two most important factors that clients consider when choosing an advisor is whether they trust the advisor and whether they deem them to be competent.

The survey found advisors who do not use model portfolios spend as much as 29.5% of their time customizing portfolios for clients. With an appropriately used model portfolio, that time commitment can be reduced to less than 10%, Cerulli said.

In the firms that use model portfolios, younger advisors tended to spend more time building their client list and gathering assets, the survey found, while older advisors deepened their relationships with important clients and worked with younger, less affluent adult children who will eventually inherit an older client’s assets.

And in bigger practices, advisors were using model portfolios for the clients who had the least in assets under management (AUM), reserving more time to focus on larger AUM clients who may have more complex needs.

Cerulli slotted advisor practices into three categories: insourcers, which represent 68% of client assets in the industry and who customize portfolios on a client-by-client basis or use practice-designed models; modifiers, which represent 25% of client assets and who primarily rely on external sources for models but make modifications to fit client needs; and oursourcers, which represent 7% of client assets and who use models provided by a broker-dealer, an advisory asset management program, or an external asset manager or third-party strategist, without modification.

To be effective as an insourcer, an advisory firm would have to have to have enough critical mass to make the expense of an in-house investment group feasible.

“There are no hard/fast benchmarks per se. We believe that team-based practices with expert specialized staff dedicated to the investment management function, separate from other practice functions, and with sufficiently trained and credentialed personnel (such as CFA charter holders) are best positioned to insource investment management,” Rose said. “Practices need to be of sufficient size, in terms of assets under management, in order to support an organization of this size.”

Supporting this, the survey found a strong correlation between model users and younger, smaller advisory practices, with 87% of outsourcer practices operating in a core market of clients with less than $2 million in assets.  Meanwhile, more than 22% of insourcer practices had the heft required, operating in a market of clients with more than $2 million in assets.

Seen through the lens of average portfolio size, Cerulli found that the firms that use models have average client portfolios of $703,720, and the firms that do not use models have average client portfolios of $4,679,446.

Over time, the research firm said it anticipates the average client size for model users will grow as those advisors will have more time to focus on relationship management.

“This creates a competitive advantage for younger advisors by allowing them to service more clients than more traditional older advisors,” the survey noted.

Another trend bolstering model portfolio use is the advisory industry’s transition to a financial planning-oriented service model from a stock-picking, investment-focused model, the survey said.

“We do believe there remains a place in the marketplace for purely transactional, brokerage-based relationships, but we have observed and believe it will continue to be a shrinking market opportunity,” Rose said. “Many advisors’ time would be more effectively spent developing deeper relationships with their clients through financial planning, where they can expand the extent to which they are seen by their clients as a trusted advisor by offering a wider range of advice services to include the core financial planning elements such as retirement income planning, insurance planning, education planning, and budgeting.”

In fact, as of 2023 Cerulli said it expected 82% of clients will be receiving either comprehensive or targeted financial planning advice along with investment advice.

“The effective use of model portfolios can increase advisor efficiencies and service offerings in both maturing and fully mature practices, in a variety of ways depending upon the preference of the practice,” the survey said. “We anticipate this trend will gain traction among advisors in the future as they seek to improve their scale and service differentiation.”

Cerulli said the data for the survey was gathered in the fall during the firm’s annual advisor survey of more than 1,200 firms, and the added insights gleaned over time through the firm’s ongoing research in financial services.