Selecting a model partner for your clients’ investment needs

The use of model investment strategies continues to increase among financial advisors. A recent article¹ indicated that assets in model portfolios passed $4 trillion in 2020, up from $3.5 trillion at the end of 2019. This trend is likely to continue as advisors face the double whammy of challenging capital market environments and greater client servicing demands. Model strategies grant advisors the advantage of providing professionally-managed investment solutions while refocusing the time and resources necessary to nurture and grow client relationships, the lifeblood of any practice. Growing advisors are likely to make models an integral part of their business.

The investment management industry has acknowledged this trend as well. The universe of available investment models will likely keep growing. For advisors looking to partner with a model provider(s) to help improve client investment outcomes, how do they decide which firm(s) to go with? What is the best fit for clients and the practice? Is there guidance available for making these selections as the options continue to increase?

Russell Investments was one of the earliest participants in the model marketplace. Our Core Model Strategies launched in 1985 and own a 35-plus-year uninterrupted track record of providing growth-oriented investment solutions for advisors and their clients. This experience has given us insight into what it takes to successfully build and manage investment models to help individuals meet their financial goals.

We believe advisors should consider these 5 factors when evaluating a model provider for a role within their practice.

1. Does the model provider have demonstrated experience in making both asset allocation decisions and structuring individual asset class portfolios?

At the risk of stating the obvious, building multi-asset investment models requires skills in asset allocation and in managing individual asset classes. Many mutual fund providers specialize in managing individual asset class exposures, but don’t have demonstrated experience building multi-asset portfolios. The skill set needed to identify the best large cap stocks does not necessarily translate to constructing a diversified equity portfolio for an individual. Probably more importantly, it doesn’t translate into combining the right mix of stocks, bonds and real assets necessary to deliver on long-term financial objectives.

Viewed from the other direction, many firms specializing in asset allocation don’t necessarily have experience in managing, or successfully identifying another firm to manage, individual asset class exposures. Identifying the appropriate building blocks for constructing multi-asset class investment models is critical to long-term success. The last thing an advisor needs is identifying an appropriate asset allocation for a client, but seeing poor implementation impede expected results.

Therefore, in evaluating potential partners in the model space, advisors should identify demonstrated capabilities in both these critical dependencies of the investment process. Combining specialized portfolio construction with demonstrated asset allocation skills should greatly increase the likelihood of long-term financial success for investors.

2. Is the model provider including non-proprietary solutions within the model composition?

We are all familiar with the phrase no one is good at everything. That saying tends to hold true in all aspects of life and extends to the investment industry. One organization may have world-class large cap U.S. equity growth abilities but little to no ability in investment-grade bonds. There is nothing wrong with that profile: Investment firms are typically formed with specialized expertise. However, one shouldn’t hire that firm to manage the entire client portfolio. Hence, it is critical to incorporate non-proprietary investment solutions within the models, because no firm is the best of the best in every asset category.

Advisors should look for models that are managed under an open architecture approach—in other words, models that incorporate investment strategies from multiple investment firms to identify the best solution for each assignment in the portfolio. Why settle for one firm’s large cap U.S., small cap U.S. and international-developed equity solutions, when you realize it is very difficult to be the best in all three? Pursue model managers that look outside their own firm’s walls to identifying industry-leading strategies across all asset exposures.

3. Should investment models emphasize strategic or tactical investment approaches?

It is understandable to want a strategy that captures market rallies and avoids market declines, the calling of tactical strategies. Unfortunately, it is very difficult to perfectly time the two decisions required to be successful: when to get out and when to get back in. The impact of getting one of those wrong can be a significant setback to building long-term wealth. The dramatic market swings in 2020 reminded investors: Market timing (tactical moves) is difficult.

Most investors are better served with strategic positioning being the primary driver of investment results. Over the long-term, equities tend to be the best-performing asset class and should be the primary growth component of most models, living with the occasional bouts of volatility. Bonds have lower return expectations but play the important role of risk management. During normal times, bonds provide some level of income greater than equity. Identifying and managing toward the appropriate strategic mix of stocks and bonds for a given investor is likely the more dependable starting point for many investors.

This is not to say there is no room for tactical investing within model strategies. Tactical should probably simply play a more complementary—rather than a leading—role in the portfolio’s growth expectations.

4. Does the organization offer support and collateral, not only for the models, but also for the business of being a financial advisor?

A significant motivation for advisors to consider partnering with a model provider is the ability to create greater efficiencies within the practice. Integrating the models into the practice should not be difficult. In fact, the model providers should be doing everything they can to make the models flow seamlessly into the practice. At a minimum, the provider should equip advisors with client education resources, regular supporting collateral and ongoing updates pertaining to the investment process as well as the resulting model allocations.

In addition to supporting the investment solutions, supplementary tools, resources and coaching that help advisors build successful businesses can be invaluable to help integrate the overall solution. Investment organizations that understand advisors’ business realities and opportunities are more likely to offer investment solutions that fit their needs.

5. Does the organization demonstrate an ongoing commitment to managing model strategies as a vital component of the overall business?

There is nothing more frustrating than committing to a partnership and then having it dissolve as your partner moves away from the commitment. While advisors aren’t mating for life with their model providers, it is beneficial to know that a provider will be around for a while. To ensure this, advisors need to make sure that the provider is committed to its model business. Ensure that the models comprise a significant portion of the firm’s overall business and that the offering is robust: a suite of models each designed to help investors reach a variety of financial objectives. While growth is the objective of most model portfolios, there are taxable and tax-exempt solutions to be considered. In addition, for an aging client base, income models become a great component of today’s advisor practices. 

Breadth and a meaningful track record can demonstrate dedication to this field.

The bottom line

Once an advisor has made the decision to partner with a model provider, there is still the work of identifying the one, or multiple, partner(s) to work with. While there isn’t a single blueprint to identify the best fit for all situations, there are some simple guidelines, as outlined above, that can help with that decision.

1, “Model Portfolios Surging as Advisers Seek Quick Ways to Invest Client Money”, Dawn Lim, December 4, 2020 (subscription required):