Model portfolios have become more than just a buzzword and repackaging of existing strategies. Investors and advisors of all sizes have continued to adopt and use portfolios to simplify asset allocation, provide strong returns, and reduce volatility. And while there are many vehicles that investors/advisors can use to build a model, one low-cost vehicle has become dominant.
We’re talking about ETFs.
Together, ETFs and model portfolios have formed a sort of perpetual motion machine, as each has furthered the growth and adoption of each other. Investment data researcher Cerulli now has the data to back that up. All in all, model portfolios and ETFs go hand in hand.
Model Portfolios’ Growth
When it comes to investing, asset allocation is everything. Modern Portfolio Theory tells us that building a portfolio of diversified asset classes and investments leads to better outcomes. When one asset class zigs, another will zag. This smooths out returns and provides more stability to a portfolio.
Model portfolios have risen from this idea. By its basic definition, a model portfolio is simply a collection of assets and investments designed to meet end goals. They can serve as a framework for asset allocation and diversification. Here, investors can use a model to build this collection of asset classes following a framework developed by the underlying asset manager or financial advisor.
And they are most effective when followed via a hands-off and rebalancing approach. This allows the model to work its magic and match risk tolerances and timelines.
Investors like them because they create simplicity among their asset allocations and ultimately reduce fees and costs. Advisors like them because they make the job of portfolio construction, rebalancing, and checking on clients that much easier. The result is better outcomes for everyone.
So, it’s no wonder why, according to BNY Pershing, more than $3 trillion in assets now sit in model portfolios.
ETFs Enter the Chat
ETFs have only enhanced model portfolios. ETFs offer low costs and the ability to own wide swaths of asset classes with one ticker. With that, investors and their advisors can build a basic asset allocation quickly and effectively. Need an equity allocation? A total market ETF makes short work of that. Looking for income? The iShares Core US Aggregate Bond ETF (AGG) can be purchased easily.
ETFs have also allowed advisors and investors to get a bit more exotic with their allocations. Because ETFs have continued to democratize asset classes, average joes, and smaller investors can quickly add esoteric asset classes like commodities, real estate, or even Collateralized Loan Obligations (CLOs) to a portfolio.
And add them they have! It turns out ETFs are quickly becoming the investment vehicle of choice for advisors, investors, and model providers. Investment researcher Cerulli Associates now has the data behind ETF model adoption.
According to a report released over the summer, asset managers and third-party strategists have now allocated more than 54% of their assets in models to ETFs. Back in April of this year, ETFs moved into the top spot and have continued to take market share from other investment vehicles. ETFs in these instances have replaced separately managed accounts (SMAs), mutual funds, unit investment trusts (UITs)—which does not include several older ETFs like the SPDR S&P 500 ETF Trust (SPY) that are structured as UITs—and fund-of-funds as investment vehicles. So, model portfolio creators have quickly adopted ETFs to their arsenal. 1
And financial advisors have quickly adopted models.
Cerulli found that 77% of advisors either use model portfolios provided by third parties or create models within their practice. Moreover, 12% of advisor assets are held within practices that primarily use model portfolios for their clients as the construction method. Cerulli estimates there are 24% of assets within practices that are considered model portfolio targets.
The result is the growth of model portfolios and ETFs have gone hand in hand. More firms are using them to build their models. More and more advisors are starting to use them for their portfolios. According to Cerulli, this has cemented ETFs as powerful portfolio building blocks and models as the vehicle to use them.
A Win for Everyone
The continued adoption of ETFs within a model portfolio framework can only be considered a win on all fronts.
For investors, it allows them to stay invested in their target allocations in low-cost funds. They can quickly rebalance, add new asset classes, and meet their needs. Additionally, there could be tax savings from the ETFs themselves or tax-loss harvesting scenarios.
For advisors, there are benefits as well. By outsourcing the management of model portfolios, advisors can save significant time—up to 35%. This allows them to focus on client relationships and business development. At the same time, they can spend more time customizing and adding to a model rather than constructing them from the ground up.
It’s no wonder model portfolio adoption is set to grow at a 15% rate for the foreseeable future. And that means ETFs will grow further as well.
In the end, model portfolios are wonderful resources for portfolio construction. And ETFs have enabled them to grow and be all they can be. Together, models and ETFs offer plenty of benefits for investors and advisors alike.
Bottom Line
Model portfolios have continued to support growth in ETFs. As more investors look toward models for their portfolios, more and more model designers are looking toward ETFs as their building blocks. And it’s easy to see why. Together, they only enhance their benefits for both advisors and investors big and small.
1 Cerulli (June 2024). Retail Financial Advisors—and Their Model Portfolios—Propel ETF Assets
