Model portfolios have been positioned as the tool advisers use to allocate assets and create investment scenarios for clients, but are they a reliable replacement for doing the underlying research and manager selection by hand?
According to Morningstar head of consulting Anthony Serhan, the fact that model portfolios are a form of implemented research, distilling the work of a research house is the advantage they offer to financial advisers.
“Even for the adviser who wants more control they are a big plus because they still have the flexibility to build around them and change some investments if they are not in the best interests of the client,” Serhan says.
According to Tim Farrelly, previously with Macquarie Bank and now heading his own group, Farrelly Consulting, model portfolios are beneficial because advisers cannot spend time doing research in the same way as the research houses are able.
He also says model portfolios generate more timely reviews as advisers will receive updates to model portfolios and can act on underlying manager changes if it adversely affects clients.
Serhan says despite the ease of use and advantages, advisers should still understand the rationale behind portfolio construction and that each model portfolio is still relative to the client’s appetite for risk, age and size of investments.
“Advisers should understand what works across the client base and we offer two types of model portfolios to our clients to implement based on that approach. It also means advisers can explain the portfolio to their clients and tailor it if needed,” Serhan says.
Even here Serhan is cautious about advisers becoming too hands-on with the portfolio construction or manager selection.
He says it is possible to decouple those elements, but they offer better value as a combined unit backed up by research house data and recommendations.
“Financial advisers are best placed to see the broad strategy position, but the fund manager selection is a function of extensive research, particularly when seeking diversification,” Serhan says.
Farrelly says picking managers is not an easy exercise and it can create excessive turnover in a portfolio with increased costs due to the buy-sell spread, being caught out by moving markets and realised capital gains tax.
However, this can also happen if advisers follow the recommendations of a model portfolio religiously and advisers should consider the implications of not moving, particularly if the portfolio change is consistent with the client’s risk profile and investment goals.
Serhan says without adviser input at the start, model portfolios don’t solve investment decisions or a client’s needs, even though a third party put the portfolio together.
“Even though the process was outsourced to an expert it may still never be right unless the adviser conducts a needs assessment.”
