Model portfolios have been in existence for more than 10 years. Yet Eve Cout, director of BlackRock’s model portfolio pillar, believes the business is “still in early innings.” The asset management giant, which currently has $81 billion of model portfolio assets under management globally—about a quarter of it in the U.S.—believes the business is poised for rapid growth over the next few years.
“We forecast model adoption to increase by 10% to 15% over the next two years, which will take us to 80% of all advisors using models as some part of their business,” says Cout. Assets in advisor-managed models have reached $2.8 trillion, according to BlackRock estimates, while Cerulli Associates forecasts that there are $6.5 trillion in assets that could be addressed by models—meaning the industry has yet to tap even half the market opportunity.
Model portfolios are prebuilt portfolios, usually comprising mutual funds and exchange-traded funds—and, depending on the provider, individual securities. They are designed to meet the end client’s investment objectives according to their risk tolerance and investment goals. Depending on the investment manager, model portfolios invest in either actively managed or passive funds, although many invest in a mix of both.
Essentially, by choosing to put all or some of their clients’ money into a model portfolio, financial advisors are outsourcing asset management functions to free up their limited time in order to focus on other things that require a more personalized, hands-on involvement, such as financial planning, estate planning and tax advice.
For model portfolios to reach their full potential, BlackRock expects to see a much broader set of offerings than the traditional 60% stocks/40% bonds core offering. The firm sees several avenues of specialization that will get more advisors to move more of their clients’ money to model portfolios managed by outside companies.
“Tax optimization will be essential to the advancement of models,” Cout wrote in a recent blog. “Taxes are the biggest hurdle for advisors seeking to transition clients to models, particularly for nonretirement assets with embedded capital gains. The winners will be those who can unlock taxable assets without exposing their clients to hefty tax bills.”
Currently, many if not most advisors address clients’ tax issues themselves, basing their choice of model portfolio on the client’s tax situation. However, BlackRock believes that model portfolios themselves can address tax issues. The firm recently partnered with 55ip, an investment strategy platform, “to help advisors evaluate and manage tax liabilities in a highly scalable way,” Cout wrote. “The partnership provides a full menu of low-cost, tax-efficient ETF models; monthly automated tax optimization such as loss harvesting and capital gain reduction; and clear client reporting.”
“The opportunity is massive,” she said. “Roughly 70% of the assets in advisor-managed models, or $2.5 trillion, are in tax-advantaged retirement accounts. That’s easy money to move to models.”
There’s also a demand for income-oriented models, Cout says. “Market uncertainty and the persistent low-rate environment have made income generation a key objective for many advisors,” she said. “While income-oriented models are still relatively ‘niche-y’—they account for just 12% of Morningstar’s models universe—we believe the category is set to grow as more advisors look to embed downside protection in client portfolios. That’s particularly true as you think about the 10,000 Americans entering retirement each day.
“With fewer sectors offering attractive yields, models have stepped in with multi-asset solutions designed to generate income while mitigating risk,” she said in the blog. BlackRock’s Multi-Asset Income strategies, for example, “take a dynamic, risk-aware and unconstrained approach that sources income across asset classes, while also protecting against stock and bond declines.” The firm claims this approach can “deliver competitive yields of 4% to 5%,” although that was before the coronavirus-inspired market meltdown.