Model portfolios: a changing landscape that benefits advisors

Model portfolios—asset class holdings that financial professionals use to guide asset allocation for their clients—are undergoing rapid growth. Assets under management in model portfolios are projected to reach $10 trillion by 2025.¹ At the same time, there’s a growing trend toward customized solutions. We explore the current models landscape, how it’s becoming more customized, and the potential advantages for financial professionals.
 

1 Asset allocation: emphasizing open architecture

Asset allocation models are what most people think of as model portfolios. They constitute the bulk of model portfolios—accounting for around 70% of assets listed with Morningstar—and allocate across key asset classes to provide a diversified investment portfolio. An important distinction in these models is a choice between open and closed architecture. This choice depends on whether an asset manager uses exclusively in-house funds (closed end) or includes external managers (open end). Despite debates over these approaches, open architecture has by far the greatest traction. Driven by advisor and home office demand, 92%² of asset managers offer at least one open-architecture model. Its popularity aligns with how financial professionals would typically build portfolios in-house and what they look to replicate with a model portfolio, namely diversifying across managers and combining active and index strategies to diversify investment styles, while aiming to reduce costs.

Advisors have typically used asset allocation models to outsource all investment management. However, a hybrid approach is becoming more commonplace where smaller client accounts are managed within an asset allocation model while larger accounts remain discretionary. This allows for customized management of larger accounts while ensuring smaller clients have the potential to benefit from a professionally constructed and managed solution. This isn't to suggest that model portfolios are limited to smaller accounts; in fact, outcome-oriented solutions represent a move toward more tailored options that are equally applied across large and smaller client accounts.
 

2 Customizing with outcome-oriented models

Outcome-oriented models are a relatively newer addition to the models landscape and focus on specific needs, such as income replacement. There’s strong and growing demand from advisors who recognize the flexibility that outcome-oriented portfolios provide—allowing them to retain discretion over investment management while grouping clients with similar objectives into a goal-specific portfolio. Unlike asset allocation models that address the entire portfolio, outcome-oriented models introduce increased customization. Their popularity is rising among financial professionals, especially for portfolios aiming for downside risk protection, income generation, and tax optimization.

3 Models as building blocks

Building block models, also referred to as completion model portfolios, offer specific asset class exposure and serve as components in broader portfolio construction. Currently, 24%² of model providers feature these models, with rising interest from advisors for fixed income and alternative sleeves. One advantage building block models may offer advisors is greater control in shaping portfolios and complementing their core areas of expertise. For example, a practice skilled in stock selection might integrate a fixed-income building block into a wider client strategy while actively managing clients’ equity portfolios.

From customization to personalization

Model portfolios’ rapid growth can be attributed in part to their evolution from simple portfolios to sophisticated solutions with multiple variations beyond the traditional asset allocation model. Given the array of model choices, advisors have considerable flexibility in how to incorporate different approaches into a practice that offer efficiencies for how they manage their business and the type of clients they serve. When choosing a model portfolio provider, financial professionals should aim to partner with a firm that has demonstrated capabilities across distinct model structures to gain the greatest potential benefit from asset allocation and investment management expertise.

Knowing what to expect from asset classes is essential in building robust portfolios. Read the latest asset allocation views from the Multi-Asset Solutions Team.