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.”