Model portfolios are increasingly using more separate accounts in their lineup while turning away from ESG-related investments, according to an analyst from Cerulli Associates.
In a webinar this week entitled “U.S. Asset Allocation Models: Differentiation and Distribution,” Matt Apkarian, associate director of product development at Cerulli, unveiled a list of the most important asset allocation model portfolio initiatives based on a survey of model portfolio builders.
One of the top two was incorporating different investment vehicle wrapper options such as active ETFs and separate accounts. In its research, Cerulli found that 61% of portfolio builders classified it as an important initiative as opposed to the 37% that did last year. Separate accounts have become one of the most important building blocks being used in model portfolios, according to Apkarian.
In the past three years, the amount of assets that portfolios have placed in separate accounts has risen significantly year after year, he said. By the end of 2020, less than 1% of total assets in a portfolio went into separate accounts. By the end of 2021 it was up to 1.4% and by the end of 2022 it was at almost 3%, Apkarian said.
“I wouldn’t be terribly surprised to see it continue at that pace in the near term,” he said. “I think it can maintain a pretty steady growth rate because there’s so much focus by model providers to be able to use separate accounts and to push model use market to the higher net-worth clients and segments.”
Sharing the top spot on the list of important model portfolio initiatives was finding products that were tax efficient. Sixty-one percent found it to be important this year, which is up from 50% last year, the research said. One of the reasons active ETFs and separate accounts have been so popular is due to their tax efficient status, Apkarian. said
“The incorporation of ETFs as well as separate accounts is really helping to facilitate … tax efficiency,” he said.
Another factor making separate accounts easier for model portfolios is their minimums. The minimum for an equity separate account is about $2,000, Apkarian explained to the audience. By featuring such low minimums, it brings them down to the more mass affluent segment of investors, he said.
While the use of separate accounts is on the rise, the demand for ESG investments is falling significantly, he said. Last year, it was ranked third on the same list with 37% of portfolio managers listing it as an important initiative. This year it is ranked eighth with only 15% saying it is important.
A primary reason for this dramatic slip in demand is advisors are no longer requesting it as they once were.
“Advisors … are choosing not to have conversations with their clients about ESG products unless their clients are bringing it up in the first place,” Apkarian said. “Due to the political nature surrounding ESGs and sustainable investing, advisors don’t want to risk alienating their clients by offering products they fear their clients won’t believe in and that may jeopardize their client’s confidence in their services.”
The use of model portfolios has become a popular option for advisors recently. They have begun to rely on them more as they perform less asset management services and more financial planning services for clients, Apkarian told the audience. That means there is more pressure on portfolio builders to put together a model that suits the needs of the advisor.
There are other ways that portfolio builders are making their models more attractive to advisors. While it might appear counterintuitive, Apkarian said there is a demand among advisors for more customization within model portfolios. Many model creators are making efforts to provide it. For advisors, the opportunity is there to offer a tailored product that fits the specific needs of their client base.
“Advisors often think that the needs of the clients in many cases are more unique than they really are,” he said. “They want to be able to add customization or in many cases advisors still feel that part of their value proposition is to add that level of customization to a client’s portfolio.”
Providing that level of customization helps model creators usher in more advisors who would not otherwise be model users, according to Apkarian.
Assisting with that customization has been the incorporation of technology. Asset managers are pushing for more technology to allow for customization including direct indexing.
“Advisors want capabilities to be able to target tailor modeling portfolios to their individual clients and they can add value through various types of customization,” Apkarian said.
Those customizations can include do not sell or do not buy restrictions. The former could be in place because a client may have stocks they do not wish to part with because they have sentimental attachments to them. The latter tool helps in case a client does not wish to invest in a company for moral or political reasons, Apkarian explained.
In response, technology providers are rolling out tools to help model portfolios create the level of customization that advisors are looking for.
“Technology platforms and marketplaces are enabling for model users to be able to do that and continue to see that develop and change the way models are being delivered,” Apkarian said.