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.

David McNatt, senior vice president of product strategy and management at AssetMark, says his firm’s focus is on “enhanced personalization” of model portfolios tailored precisely to the individual end client. The portfolios take into account tax issues and address the client’s investor preferences, such as environmental, social and governance, or ESG, investing.

Ken Van Leeuwen, managing director and founder of Van Leeuwen & Company, a Princeton, N.J.-based boutique financial counseling and wealth management firm, likes both approaches. “Tax efficiency is a big point of interest in these types of models. Some of them do a good job managing taxes, and some do not,” he says. “And with the emergence of ESG investing, it would be nice to see more models focused on that area of the market. More niche models would be a good addition to the lineup. There are plenty of large-cap U.S., international and emerging markets models, but not many niche markets.”

“A single model that uses traditional asset allocation is a nice starting point, but at the end of the day it really is just a starting point,” McNatt says. “In today’s market it is incredibly important to factor in strategy diversification and build more sophisticated solutions that really help the client achieve their goals.”

For example, his firm recently launched Savos Personal Portfolios, which provide personalized features that can be tailored to high-net-worth clients’ specific personal needs, including individual stock selection, automatic rebalancing across allocations and tax-loss harvesting.

But how do you track performance when the portfolio is so personalized? What benchmark do you use?

“As part of our due diligence process, we are certainly monitoring the performance of the investment strategies over a full market cycle,” McNatt says. “However, we help advisors build portfolios that help their clients achieve a goal, so we are less focused on where their portfolio is performing at a given point in time. At the end of the day the real benchmark is, ‘Are we on track to meet the client’s goal?’ That’s really how we think about it.

“It’s so easy to get hung up on what’s happening today, but the real value is to build intelligently constructed portfolios that help clients achieve their goals,” he says. “One of the things we are focused on is helping advisors build better portfolios that will help them build stronger engagement with their clients, help them more consistently deliver on their goals, and give the advisor more time to build deeper relationships.”

Fidelity Investments is a relative newcomer to the model portfolio business, having rolled out its first portfolios in July 2018. It now offers 21 unique investment strategies that include a blend of active and passive funds, proprietary Fidelity products and third-party products.

Matt Goulet, Fidelity’s senior vice president of portfolio solutions, says the fund giant is also focused on “increased personalization” of model portfolios, not prepackaged models.

“The majority of the work we are doing today is starting with the target 60/40 allocation portfolio and tweaking that based on the broker-dealer’s home office expectations or the individual advisor,” he says. “We talk to financial advisors every day. We run customization and personalization requests through our portfolio construction guidance group and make tweaks to our core models. We use a quantitative approach, which is scalable.”

For example, in January 2020 Fidelity launched a suite of four bond-only model portfolios designed only to be the fixed-income portion of a client’s or advisor’s portfolio. Previously, many model portfolios included a mix of both equities and bonds based on the 60/40 core. The new fixed-income model portfolios are designed to maximize risk-adjusted total return as well as accommodate a range of risk preferences, including duration and credit risk, the firm says.

But the idea of “increased personalization” goes beyond actual investments, Goulet says. It also involves enabling financial advisors to establish closer relationships with their clients through enhanced communications.

“The role that models play is more than providing the components for advisors,” he says. “We are taking it one step further, providing more prescriptions, more detail and content that the client can give to the end customer.

“Models tend to lead to a high volume of interaction with financial advisors and their clients,” he says. “They are really intended to keep people invested in the market through market cycles so they avoid market timing and being in and out of the market in a way that might disadvantage their goals over the long term. A big part of that isn’t just the investment choices you make, but the level of engagement and the level of communication.”

With that in mind, Fidelity is also focused on “making it as easy as possible” to make its communications “visible and actionable” to independent financial advisors “in the desktop solution that they use most frequently.” Goulet says about 2,000 advisors subscribe to Fidelity’s commentaries, which include the firm’s take on the market as well as explanations of its recent portfolio changes.

Brooks Friederich, director of research strategy at Envestnet, says the model portfolio industry will see the market opportunity simply because financial advisors will need to outsource more of their investment management to model portfolios if they want to increase the number of clients they can handle and service them properly. Envestnet, which has been offering model portfolios for more than 10 years, offers a variety of model portfolios from companies such as BlackRock, Vanguard and Morningstar through its “Fund Strategist Network” on its wealth management platform.

“A lot of financial advisors understand that, in times like these, their real value is meeting with and spending time with their clients and focusing on their financial plans, goals and budgets, besides their investments,” Friederich says. “There comes a point in time where you have to outsource. You can’t do it all in-house. There comes a tipping point in how many clients you can handle. Advisors who use model portfolios free up more time to service their clients and show them their unique value-add.”

While most clients “will most likely be fine with standard passive model portfolios, financially more literate clients who put a stronger emphasis on wealth management will most likely expect portfolios to reflect more recent approaches to investing,” says Felix Bertram, founder of Bertram Solutions LLC in Kirkland, Wash. “Many of these approaches are based on the idea of first improving risk-adjusted returns, and then using leverage to scale risk and performance until the investor’s objective is met. Unfortunately, the available model portfolios currently do not reflect these needs, yet. However, in the light of bond returns diminishing in the foreseeable future, we anticipate that future software releases will include more sophisticated models to address these needs.”