Many great financial advisors add considerable value to clients through their planning services: listening, weighing opportunities, creating a financial plan, and encouraging follow-through. The irony is that most advisors don’t assess fees related to this value creation. In an environment where 95% of financial advisors charge fees based on assets under management (AUM), a growing number are outsourcing the part of their business that most directly drives their fees, investment management.

The question: Who will manage my assets?

Financial advisors working with individuals originally adopted the same AUM fee structure used for decades by the investment management industry. For investment managers, this fee made sense because it reflected the day-to-day advice applied through their portfolio buying and selling decisions. Most fees ranged from 1% to 2%, and larger portfolios would get a fee break to reflect economies of scale. The financial advisory industry decided it made sense for them too due to the simplicity; it is easy to calculate, it didn’t require that the advisor put a value on the planning advice, and it encouraged a recurring revenue stream.

The problem for advisors is that investment management is hard work. It requires commitments of time, money, and infrastructure. Even then, it is not always the case that a good financial advisor is a good investment manager, too. Yet, despite the overwhelming choice to charge fees based on AUM, a growing number of advisors are downplaying the value they add through investment management, believing it to have become commoditized. We disagree.

Further, investment management diverts attention from other requirements of the business: educating clients, servicing clients, and marketing for more clients. In the case of broker-dealers, mandates often came from the home office wanting to exert more control over the investment process. This shift has the added effect of reining in brokers who take excessive risks and present compliance problems for the firm.

Therefore, the conclusion of a growing number of advisors is to outsource investment management altogether. And doing so by the use of model portfolios created and managed by third parties, or home offices, is surging. Data provider Broadridge Financial Solutions estimates that model portfolios held $4.1 trillion in September, up from $3.5 trillion at the end of 2019.

But no solution is perfect and drawbacks exist for investors whether they use models offered by their advisor or find one themselves. First, there is no universally agreed definition of a model portfolio. The universe of model portfolios is large and growing quickly, offering a dizzying array of choices, complicating any search for the right model. Second, investors in model portfolios give up the option of any customization that might be beneficial in their case. One analogy described investment models as like buying a store-bought pie rather than baking one from scratch.

Third, many models are still quite new and unproven. Some newer options are promoted using hypothetical back-tested track records, a foundation upon which investment decisions should never be made with money you cannot afford to lose.

Models have their place in the investment management marketplace as but one choice among many, but they are not for everyone. When you entrust your money to an advisor, be sure you know exactly who is going to manage it and are comfortable with the arrangement.


Disclosure: This is for informational purposes only and is not a recommendation for any particular service.