Model portfolios gain fans

The separately managed accounts industry is evolving, as model portfolios, which may make life easier — but less lucrative — for participating money managers, grow in popularity.

For financial advisers and their clients, the model-portfolio format is expected to increase the use of customization and tax-efficiency features. There is even some speculation that the increased use of model portfolios could eventually lead to lower management fees for investors while better addressing client expectations.

“I think the model portfolio is a move that is much more conducive to what a client really needs,” said Roger Paradiso, president and chief investment officer at Legg Mason Private Client Group in Stamford, Conn.

Unlike the traditional system of linking a client’s portfolio to the money manager, often through a separate account sponsor platform, the model portfolio shifts virtually all the trading and administrative responsibilities from the money manager to the program sponsor.

In the most basic sense, a model portfolio is presented daily or weekly by the money management firm as a list of the latest holdings in a particular strategy. The sponsor or adviser is responsible for making adjustments to client portfolios based on whatever changes have been made to the manager’s model portfolio.

“People are finding that the model portfolio allows sponsors to exert more control over the entire investment process, and it provides advisers more flexibility to package separate accounts along with other investments,” said Jean Sullivan, managing principal of Dover Financial Research in Boston.

The use of model portfolios is expected to sweep across the industry at a pace that could make it the dominant means of separate account asset management within five years, according to the new study by the Money Management Institute in Washington and Westwood, Mass.-based Dover Financial Research.

It is estimated that of the 900 money managers offering separately managed accounts, more than 200 are using model portfolios, which reflects a 138% increase over the past four years, according to the study.

Ms. Sullivan, who spearheaded the research project, first presented to MMI members two weeks ago, said that about 10% of the nearly $800 billion in separate account assets is managed in model portfolios.

Within five years, she predicted, model portfolios could represent more than half of all separate account assets. The driving force behind the growing popularity of model portfolios is demand from wirehouse firms and various platforms designed to bring together a range of investment vehicles and strategies, Ms. Sullivan explained.

Many of the platforms have already developed unified managed accounts that allow the adviser to fold into a client’s overall portfolio a separate account portfolio that could include individual stocks, mutual funds and a range of alternative products. By shifting the customization features down to the adviser or sponsor level through the use of model portfolios, the separate account is more easily adapted for the UMA, Ms. Sullivan said.

“Most of the major sponsor firms are already using model portfolios,” she said. “This is where it’s all headed, and the entire industry will change.”

For money managers, the shift toward model portfolios will mean a cut in the fees they earn for participating on the various sponsor platforms. But it will also mean easier and less expensive access to a larger number of platforms.

“The model portfolio enables a lot of money managers who normally would not want to absorb the upfront cost of linking into a sponsor platform to participate in the separately managed accounts industry,” said Christopher Davis, executive director of the MMI.

According to industry estimates, money management fees for model portfolios generally range from 0.25 to 0.4 percentage points, compared with a range of 0.32 to 0.5 percentage points for the traditional method of managing the assets in separate accounts.

“This industry has been on an income-growth and expense-cutting mode for a decade, and the model portfolio continues that trend,” Mr. Davis said. “Hopefully, some of the fee savings will be passed along to the investors.”

Mr. Paradiso, whose firm is responsible for $60 billion in separate account assets, said the model portfolio trend would pave the way for more managers to enter the business, which will ultimately produce more choices and opportunities for investors.

“It does change the profit margins for the money managers, but the reality is that this is the way the whole market is going,” he said. “I think this is a three- to five- to eight-year process, and there will eventually be less space for those money managers in the non-model-portfolio group.”

While lower management fees could cause some money managers to resist model portfolios, their popularity will be boosted by the increased ease of use, according to Charles Widger, president and chief executive of Brinker Capital Inc. in Berwyn, Pa.

Brinker is both a sponsor platform and an investment manager, with $9.5 billion under management.

“The model portfolios make sense for all the participants, but most of all for the investors because they can get better customization and tax management,” Mr. Widger said. “For the money managers, it’s not as administratively intense, and it’s more efficient.”

Jeff Benjamin can be reached at jbenjamin @crain.com.