MASTERCLASS: Model Portfolios - August 2021

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  • 56 mins 01 secs
Financial advisors are feeling the time crunch as they balance the many needs of their clients. Two experts discuss ways that model portfolios can offer them more efficiency and resources. They share some of the areas where they are seeing the most accelerated growth, some of the features that are resonating the most, and other industry trends on the horizon.

  • Seth Buks, CIMA® - Client Portfolio Manager, Columbia Threadneedle Investments
  • Suzanne Daly- Vice President, Model Portfolio Business Development, Fidelity Investments

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MASTERCLASS

 

Jenna Dagenhart: Welcome to Asset TV's Model Portfolio Masterclass. Joining us now to talk about advisor adoption, some of the features that resonate most and more, we have Susie Daly, a vice-president, Model Portfolio Business Development at Fidelity Investments and Seth Buks, a Client Portfolio Manager at Columbia Threadneedle Investments. Susie, starting with you, could you help introduce our viewers to Fidelity, how, and when you brought model portfolios into the market, how they've done, who your clients are, et cetera.

Suzanne Daly:  Absolutely, Jenna. Thanks for the question and thank you very much for having us here today. We're really excited about the dialogue. I represent Fidelity Institutional. Fidelity Institutional is one of three legs of Fidelity Investments. Fidelity Institutional is focused on delivering intermediary solutions to the broker dealer, RIA, multi-family office and even self-clearing and wire house institutions across the industry. That's everything from our mutual funds, our ETFs, and most recently, our model portfolios and separately managed accounts. But before I get into the Fidelity Institution line of business, the other two legs of Fidelity Investments are our workplace investing solutions. That's where we deliver our 401k capabilities, and then our retail solutions, those are our investor centers in our branches across the nation.

Suzanne Daly:  Back to Fidelity Institution though, back in 2018 is when we introduced our model portfolios to the marketplace. Three years just passed this summer. It was a big summer for Fidelity Model Portfolios. I'm happy to report that on average, Fidelity Model Portfolios, our core model offering on average make 80% of our peers, the Morningstar's database. We were really thrilled about that. Thank you very much for the question, Jenna.

Jenna Dagenhart:  Congrats on near a three-year anniversary.

Suzanne Daly: Thank you.

Jenna Dagenhart: Seth, turning to you, what's your approach to model portfolios? Could you share a little bit more about Columbia's approach and history?

Seth Buks: Absolutely. Again, I'd echo Susie's comments. Thanks so much for having us here. I'm excited to be here for the conversation. Columbia's journey in models started back in 2006. Our oldest models have close to a 15 year track record now. We manage about $10 billion in model assets, which makes us a top 10 provider of asset allocation models in the industry today. We have 24 models in total, no paper models. All of our models are sub-advised with our partners on SMA or UMA platforms as discretionary models. They're managed by our asset allocation team. That's the team that I'm on. We're a 30-person team. We manage about $150 billion in assets across asset allocation, different types of products and vehicles for clients around the world. Even though models are a smaller percentage of that total, we are certainly very dedicated to this space.

Seth Buks: We recognize that almost three fourths of advisors are using models and models have a 19% compound annual growth rate over the past five years, really outpacing other platforms like fee-based and retail brokerage, et cetera. We know this is one of the fastest growing areas of our industry. Now estimated to be about a $4 trillion market, well over 10,000 models. This is really a core business and competency for Columbia that we're dedicated to and focused on as it becomes not only more ingrained in the industry, but also in how we partner with our clients as well.

Jenna Dagenhart: Certainly, such a fast growing area. Susie, could you define why you think there's a desire for model portfolios in the marketplace?

Suzanne Daly:  Absolutely. I really do think that there's a paradigm shift happening across the advisor landscape. Where advisors are being asked to extract and deliver value is really changing. By that, I mean advisors are being asked to do and carry a lot more as far as their responsibilities in the relationship. Fidelity actually has some material out in the marketplace called the Advice Value Stack that explains this phenomenon pretty well. I'll take you back to psychology 101, Maslow's hierarchy of needs essentially envisions a triangle of the base of your needs is food, oxygen, water. As you climb up the stack and evolve in your needs to understand safety and security, and then even overall fulfillment. At the top of this Maslow's hierarchy of needs is self-actualization and fulfillment. We've done a lot of work internally within Fidelity to understand and actually draw a parallel to Maslow's hierarchy of needs to the advice landscape.

Suzanne Daly: We truly believe that advisors are climbing up the Advice Value Stack and identifying new ways to deliver value. At the baseline of the Advice Value Stack at Fidelity, we talk about managing the money. Managing the money is core and essential to any advisor's book of business but it may not be the only way in which they extract value for their end clients. Specifically, we see advisors looking to have a more holistic relationship and approach with their clients. That is reached through financial planning, trying to gain a holistic share of wallet, understanding their true needs, whether it's succession planning, what's meaningful for them, social awareness, impact awareness, legacy. Having advisors really have the time to understand what fulfills their end client relationships. They need more time. To unlock more time for advisors, model portfolios is really one way to drive scale across an advisor's book of business. I think we'd all agree regardless of our profession and regardless of the industry, discretionary time is the number one resource we all want back in our day. I think you'll find that model portfolios is an incredibly successful tool to do just that.

Seth Buks: Susie, I'm so glad that you mentioned this idea of the paradigm shift. I'd love to just expand upon that for a second because we think about it at Columbia in a very, very similar way. There's recognition in the industry that the reasons that clients engage with advisors has changed as you mentioned. Sure, some clients still want stock picks and the like but most are now much more interested in creating that plan, getting help with sticking with that plan, having somebody to talk to about their goals, keeping them on track, understanding their family needs, as you mentioned. One could argue that the role of the advisor has moved closer to that of a financial or a behavioral coach. There've been studies to prove that this is really what clients want and in fact, what many clients actually think that they're paying for.

Seth Buks: If you think about it from that time allocation perspective that you mentioned for FAs, there've been studies and I'm sure you've seen them that current model users are estimated to spend about 8% of their time on investment management activities compared to 18% of time for FAs who create models within their practice and 23% of their time, for those who create custom portfolios on a client by client basis. All this time spent on investment research, due diligence, monitoring, trading, rebalancing that bottom level of that hierarchy of needs that you touched on, compare that to only 10% of time spent on financial planning. Only 9% of time spent on prospecting for new clients. Advisors, as you mentioned, are realizing that all of these daily investment activities have really limited value in the eyes of the client and maybe just aren't worth the time commitment from a business perspective. The profitability of that hour spent on these activities is significantly lower than actually going out and meeting with your clients and prospects. As those numbers show, that 8% versus 23% of time, as you mentioned, huge time savings to be gained.

Suzanne Daly: Absolutely Seth. Just to jump on that even more, I think helping advisors understand that at the top of this Advice Value Stack, in my example, there's a lot of earning potential and revenue potential. It's just a new way of wiring and communicating value for advisors to talk to their clients. They're not used to assigning a basis point relationship to some of these activities at the top of the Advice Value Stack, whether it's succession planning and overall impact investing. They're used to designing value and assigning a basis point structure to portfolio construction. We've done a significant amount of research in the space that you're talking about, Seth, that says there's a lot of opportunity for advisors to start to charge explicit value for some of these activities at the top of the stack where clients are expecting and hoping and wanting advisors to take them, completely agree.

Jenna Dagenhart: Still waiting on that 25, 26, 27 hour day but good thing is we have some ways to save time, as you highlighted. Given where markets currently are, stocks at all-time highs and elevated valuations together with interest rates still very low and spreads very tight, Seth, is that a better or worse environment for model implementation? Do you expect the market environment to impact interest?

Seth Buks: Yeah, we certainly do. It seems both Susie and I are going to quote a lot of studies here. There have been studies that prove that this is happening right now as we speak. Compared to the pre-COVID era, surveys have shown that advisors are 53% more likely to add to models now and only 4% are saying that they are going to detract from their model usage. We know that there has been a shift in advisor thinking since the pandemic and since the recession. I think a lot of it has to do with exactly what you just mentioned.

Seth Buks: We know that the markets have had a great run. They're now pretty expensive. We know that fixed income arguably has also had a great run and that interest rates are now pretty low and credit spreads are pretty tight. Given that environment, we think it's going to be even more important to be able to protect on the downside when markets are falling or protect when interest rates start to rise. At the same time, being more tactical is going to be even more important in an era where we're expecting lower returns across all asset classes, being able to make appropriate timing decisions, overweighting decisions, underweighting decisions becomes just that much more important than say when stocks were returning 15% per year, every year for the past decade

Suzanne Daly: Seth, it seems like as we step into a 20-year market bull run where we've had pretty reasonable returns that what's expected of advisors to deliver on consistent performance going forward is going to be even more exhausting and chasing alpha is going to be even more time consuming. To the point you and I are both making before, I think the opportunity to deliver that value through a third-party or an outsource investment management provider who wakes up all day everyday thinking about that as their sole task may make more sense.

Jenna Dagenhart: Susie, what are advisors asking for in model portfolios?

Suzanne Daly: It's a great question. When I think about advisors and how they engage with model portfolios, there's a lot of different avenues for advisors today but in terms of adoption, it all comes down to the experience for me. As an asset manager or a platform provider, regardless of the venue in which you're providing for these advisors, it comes down to a simplified user experience, having low friction and making it as easy as possible to educate advisors on what the value proposition is. Think about being an advisor and essentially being on the same side of the table as your client. Turning over to that side of the table and saying, "This is why as your advisor, I am outsourcing to a third-party in this space either because they have the discipline where I don't cover today, they have consistent returns. They have the maniacal focus in this area of the market where I don't have that sophistication today or where they just have a steadfast household brand name." Where you're looking for diversity in your overall offering for the client.

Suzanne Daly: When it comes down to the experience, there's an education. I think it's incumbent upon all of us to make sure that advisors have a real simple way to have access to our marketing collateral, our thought leadership, our value proposition, and how we help them position their value to their clients. To the points, that Seth and I were making earlier, really what we're all focused on is making sure we can help advisors deliver more for their clients. To the extent that we can make it easy for the advisor to say, "These asset managers are best of breed in their space and could deliver on value consistently, which gives me, your advisor, more time to do these other areas of opportunity to develop our relationship and develop our overall opportunity set together to make sure we hit your return on life goals." I think for me, it comes down to having the right marketing collateral, having the right and easy value proposition and making sure advisors are really clear on what it is you, as an asset manager, are providing through your turnkey model portfolio or your customer model portfolio that Seth was hitting on earlier.

Jenna Dagenhart:  When it comes to the attributes of model portfolios, Seth, what would you say are the features or benefits that resonate the most with advisors?

Seth Buks: I think Susie hit on a lot of them. I would just add a little more from our perspective. I really divide this into two areas. First, what I would call top down or broad attributes, and then some of the bottoms up or implementation factors. First from this macro perspective, we're hearing that advisors want their models to be global and multi-asset in nature, really broadly diversified. Giving them access to asset classes that they might not invest in themselves or don't have a firm process around when to get in or out or overweight or underweight, things like commodities, emerging market debt, REITs, et cetera. The second is to really be dynamic or incorporate both strategic and tactical repositioning. They want something that's going to be proactive in seeking to capture more upside when risk is on but also really seek to protect when risk is off.

Seth Buks: They want to know that there's a process behind those decisions. Then third is risk management, critically important, especially given where markets are as we touched on before. The advisors want a model to be able to provide consistent returns and consistent outcomes for clients, really help them smooth the ride through a volatile market. What we hear often from our clients is the moniker participate but protect. Then from an implementation or bonds up portfolio construction perspective, what we're hearing is that advisors really want a model that's thought through and built in a way that resembles, in essence, how an FA would build one, to really be emblematic of their portfolio construction process.

Seth Buks: We found that advisors appreciate a multi-manager approach. Not all proprietary funds in a model. I think we can all recognize that no one asset manager can be good at everything all the time. Being able to source from the industry's best in class managers or the most appropriate ETFs can make a lot of sense. Then lastly is to incorporate a blend of alpha seeking managers and passive beta exposures. That can really be achieved a number of different ways by mixing active and passive, strategic beta, direct indexing, funds or SMAs and ETFs. Incorporating that full pallet from a bottoms up perspective.

Jenna Dagenhart: Susie, I know you mentioned the importance of saving time earlier but what would you say are some of the top reasons that advisors outsource investment management?

Suzanne Daly: To the point about advisors being asked to do so much for their clients today, I think the bottom line comes down to driving productivity. Outsourcing investment management often at times, maybe not across their entire book, maybe for a niche piece or a segment of their book allows them to turbocharge their overall productivity, allows them to think about uniquely each of their relationships and what those relationships need, want, desire from them. One of the most common interactions we have with advisors is not every advisor looks to every client relationship the same. There are opportunities when an advisor looks at their overall book to segment to say, "This interaction may require something unique and different from me than these several interactions based on how I look at my overall book." When it comes down to the advisor interactions that we have, it's how can we help turbocharge their overall productivity in their book of business?

Suzanne Daly: Oftentimes it comes down to what we talked about earlier, which is we can save time in your overall day to the stats that Seth was mentioning earlier, whether it's model providers in this space on average are spending less than 10% of their time managing the money and investing the money versus maybe north of 20% for those that are taking that responsibility on themselves, not only because of the investment management and research, but some of the administrative tasks that comes with trading and rebalancing and the operations that come along with that.

Suzanne Daly: Going back to the earlier point on just productivity would be the number one reason we see an overall better allocation of time. Seth and I have talked consistently about this, our ability to share consistent performance, bring in unique experiences around active, passive blended mutual funds, ETFs, open architecture model designs, the ability for asset managers to partner together and bring in best of breed thinking across a diverse set of asset management thinking is something that we think is powerful that advisors may not be able to tap into in and of themselves unless provided in a custom model built by multiple asset managers together.

Seth Buks: we've touched a lot on time savings or time gained back, I'll give maybe an acute example here. I think a lot of it comes down to consistency in their practice, not only consistency from a client experience, which is clearly very important, but also consistency in their own daily routines. Take, for example something as simple as a client review, specifically one where an advisor might customize for every client portfolio. They're obviously doing a ton of prep beforehand. Studies have shown that this can take up to 25% of an advisor's day if they have a handful of meetings that day, perhaps not the best use of time. When using a model, even across different risk tolerances from the same provider, the messaging is the same. There's consistency there. Chances are that model provider has all kinds of materials, write-ups commentaries, et cetera, to make that job as easy as possible for the FA. They can spend more time in that review focused on planning, fostering that relationship, maybe asking for some referrals rather than focusing just on investment performance.

Suzanne Daly:  Absolutely. I'd add onto the space that what I think a lot of we asset managers that are model providers are really focusing on is making sure the advisor doesn't feel that they need to be experts in our space, that we give them the materials, the collateral they need to sell that story, to position that capability, to make their clients comfortable with their decision making process. That's really where a lot of our time is focused is making sure that the salient points of what we do and how we differentiate come through easily for the advisor. They don't have to spend a lot of time researching and becoming experts. That's our role.

Jenna Dagenhart: They have to focus on so many other things, 529 plans, all sorts of other different types of investments. You're the experts in Model Portfolios. Now, from a messaging perspective, Seth, what's resonating the most with advisors to help drive the use of models.

Seth Buks: It's funny that we're using the word model here so much. I actually swore off the use of the word a long time ago. You might be thinking, "Well, what's in a name?" Interestingly, we found some negative connotation in using the word model. To many advisors, this has become synonymous with outsourcing, essentially removing what many advisors still see as a large part of their value proposition of course, when we like to remind everyone is that models are effectively SMA's. Models can be used as a part of a portfolio construction no differently than any other packaged product.

Seth Buks: The advisor's value proposition doesn't change because ultimately they're still conducting due diligence on the model and implementing it within the overall broader client portfolio just like anything else they might invest in. At Columbia, we actually like to call them managed portfolios and to think about them just as another tool in the toolbox. The only difference between a managed portfolio and a true separately managed account or a traditional SMA is that that SMA tends to be a single asset class solution. Say, large cap value stocks or individual bonds as the drivers of alpha inside of that SMA versus a managed portfolio here is looking to invest across asset classes in underlying managers or ETFs to drive that bottoms up alpha.

Suzanne Daly: That's a great point. To build on that, I would argue that we refer to them as well here at Fidelity as Investment Building Blocks. I think with the advent and growth in the unified managed account space and really that being a program that allows advisors to pull in various investment building blocks, whether it's a model portfolio made up of mutual funds and ETFs, whether it's a separately managed account made up of underlying equities or whether it's a surrounding set of mutual funds, ETFs that are not in a packaged product. We are seeing an increased trend in unified managed accounts being the chassis of the program, for which a lot of investment building blocks or managed portfolios are being used in a core satellite approach to build their own custom approach to portfolio design,

Jenna Dagenhart: Susie, what are some of the top industry trends as they relate to model portfolios, building blocks, managed accounts, whatever you'd like to call them?

Suzanne Daly: Yeah. I hit on one of them just now, and that is the trend to continue the upward trend that we're seeing in unified managed accounts, just allowing advisors to be more free with their design and advisor-derived input for how to build a portfolio. We are seeing an increased demand for unified managed accounts. To the extent that we provide model portfolios or managed accounts or investment building blocks, we want to make sure they can be used as part of the UMA for an advisor. The benefits of a UMA is that advisors get to not only design the portfolio in and of themselves if they elect, but they also get all of these investment building blocks with one brokerage statement, one 1099, one consolidated performance report. From an end client's perspective, it's seamless, which is nice. We're seeing an increased demand for the unified managed account build.

Suzanne Daly: Additionally though, I think we started to hit on it earlier that no one asset manager can assume that they are the best of breed in every asset class. Where we're seeing a bit of coopetition in partnership across the asset management space. We're seeing a lot of asset managers come together to solve for common multi-asset class portfolios. We're seeing open architecture advisors are not as interested today in having a single asset manager solve their multi-asset class portfolio. They're excited to have diversity in their own portfolios to offer their clients. I think on this side of the table, we're all excited to learn from each other and build multi-asset class portfolios across the asset management industry. In addition to open architecture and also in addition to the UMA core satellite portfolio design that I hit on earlier, we're seeing a huge drive in custom model portfolios. Seth hit on this earlier.

Suzanne Daly: Sometimes one of the reasons we don't refer to them as model portfolios is it's interpreted as a turnkey lackluster opportunity where you take it off the shelf and you don't think much about it. One size fits all, which is not necessarily the case. These are thoughtful multi-asset class portfolios that have often stood the time in various market cycles. However, as we think about custom model portfolios, whether it's an RIA, a broker dealer, a single-family office, think about what's unique in their space, what is their differentiator, how can we help them either maybe co-build something with the broker dealer, with the RIA with the advisor, how do we help them back their thinking and bring their best thought leadership to the market through a multi-asset class portfolio or through a satellite portfolio or a completion portfolio? We really are seeing a huge trend. 50% of our flows are actually coming and going into custom model portfolio designs. RAs are really starting to think about custom model portfolios as a way to differentiate their business from some of the key model portfolios in the space today.

Suzanne Daly: Then lastly, I would say a few of the trends that we're seeing is tax transition and tax management. These are not new concepts but as we think about model portfolios, oftentimes after advisors get comfortable with the idea of outsourcing a piece of their business to a third-party, the first question is how do I execute? How do I actually make that first step and implement? Oftentimes, as we talked about earlier, we've benefited from a market run over the last several years and there's embedded gains.

Suzanne Daly: How do you make that move from portfolio A to a third-party managed portfolio B? We're really spending a lot of time on tax transition, partnering with other FinTech’s and tamps or our own proprietary capabilities around helping advisors make that model more implementable on day one. Then beyond the tax transition and management focus, I would say that the focus on thematic investing, impact investing, whether it's an overlay approach or whether it's the underlying building blocks, as well as alternatives in a model portfolio, liquid alternatives. These are some common trends that we're seeing today.

Jenna Dagenhart: Seth, any observations you'd like to share?

Seth Buks: Susie hit on a lot of trends. Maybe I'll just bring up one or two because she mentioned something specific around completion portfolios, which I think is very important and we can spend more time talking about this as well but we think this is a major growth engine within the models space. Some call them outcome oriented or goal oriented. Really, what we're seeing is that these can be a compliment to everything else an adviser is doing, acting as a satellite. They don't have to be a full core or the entirety of a client portfolio.

Seth Buks: Outcome-oriented or goal-oriented would be things like income-focused or downside protection or to manage volatility. Those can be very important diversifiers. Then to Susie's point about completion portfolios, these could be fixed income only portfolios. Maybe something like international equity where before an advisor might've bought an international value, international growth, emerging market fund. Here, they can implement one international equity model and have a team of experts deciding when to overweight geographically or by market cap or developed versus emerging markets.

Seth Buks: Completion portfolios are certainly a big industry trend. Then the last thing I would add is the use of traditional SMAs inside of models. Being able to really reach up into that higher net worth space and try to provide something that speaks to a high net worth investor that is not only tax efficient but also low cost.

Suzanne Daly: Question for you, Seth, if that's okay. Would you define an SMA being tucked inside of a model portfolio, a UMA, or would you think about that differently?

Seth Buks:  I would say it can. I think it depends on the distribution partner you're working with and how they might describe it on their own platform. For a wire house, it might be a little bit different than for an RIA. A lot of the big wire houses and broker dealers have these integrated platforms already built in from a technology perspective, whereas an RIA might not have access to that level of technology. In an ideal world, I would say absolutely yes. If we can combine inside of a model portfolio a number of underlying SMAs seamlessly, as you mentioned before, on one UMA platform, there, I think, we are getting something that really speaks to that higher net worth client.

Jenna Dagenhart: Good point. Susie, to quickly follow up on that, could you explain the different ways that advisors would encounter or engage with model portfolios?

Suzanne Daly:  Absolutely. We think about model portfolio distribution in three broad categories. One is through the managed account technology providers. Those are the big tamps in this space, Envestnet, [inaudible 00:27:29], SEI Asset Mark. The list goes on. It's becoming a crowded space. All of these players do an extremely powerful job providing productivity back to advisors, integrating workflows and allowing advisors to step through an almost Amazon-like process to pull down packaged, managed account portfolios and apply it to their clients. That's one key way that we think about distributing model portfolios and how advisors engage and consume model portfolios is through those managed account technology providers. Another way that we think about distributing and engaging with model portfolios is through paper models. I think Seth mentioned earlier that Columbia Threadneedle doesn't participate in this part of the marketplace.

Suzanne Daly: Fidelity does have a paper model business today. The way that we define that and curious Seth's perspective on this as well. We democratize out our tickers and weights for our north of 50 or so model portfolios today through an intermediary website and allows advisors on a quarterly basis as we reallocate our model portfolios, we distribute the newest current thinking of those tickers and weights and our commentary and our thinking as to why we've made those shifts across our model portfolios. Advisors are free to able to go down and download those tickers and weights and execute those model portfolios through their platform of choice. Fidelity has a brokerage platform called Wealthscape. They can integrate and plug those tickers and weights and trades through Wealthscape. They can integrate and essentially plug those, import those tickers and weights through any other platform of their choice.

Suzanne Daly:  However, we do refer to that as a paper model where we are not necessarily, as an asset manager, interacting with an advisor, providing any guidance to that advisor, delivering models directly to that advisor. We are sending those models to a platform where they are able to download tickers and weights. Fidelity will distribute those in a non-discretionary way. Advisors are free to interpret those, download and execute those to their liking. The way that fidelity thinks about that paper model business is again in a non-discretionary form. We're giving timely delivery of our best thinking on that model portfolio. Advisors can take that as is from an Excel spreadsheet or a PDF, or they can customize that and exclude tickers and make adjustments to those tickers. Those are the primary ways that we distribute our model portfolios today.

Seth Buks: Just to get back to what Susie was saying, we think about all the different monikers and nomenclature that we use in the model space. She touched on and we talked before about paper portfolios versus discretionary. For us, these words might be very easily digestible but for those that aren't as familiar in this space, it might be a little confusing. To Susie's point, we don't offer paper portfolios even though we recognize that they are a very important part of the industry for firms like Fidelity and many others that offer that type of guidance to the advisors that they serve. For us, at least at the time being, our discretionary partnership is where we would partner with a broker dealer or with an independence firm's home office as they onboard a model as we are making changes to underlying allocations making trades. The home office would implement those trades for the FA, for the client. The FA does not have to go in and review themselves and make sure that they are doing the trading.

Seth Buks: I would say that it's home office driven. While we're thinking about the home office and how advisors have relied on or interacted with home offices, I would say the percentage of advisors that are using some type of home office advice, be it models, recommended lists, et cetera, it's really continued to tick up every year. It differs by channel, of course. The broker dealer advisors tend to rely more on this type of guidance and RIAs. It's rising across the board. Of course, demographics also plays a role here.

Seth Buks:  In recent studies, over a third of advisors age 45 and younger have said that they rely on the home office in some form or fashion, but that's less than half of that third for advisors over the age of 60. Not only that, advisors under the age of 40 have invested two thirds of their fee-based assets in model portfolios. A quarter of the respondents to these surveys under 40 have said that they expect to have 100% of their fee-based assets in model portfolios within two years. The way that advisors interact with their home offices have changed and it's driven mainly, I would say, by the life cycle or the stage that that advisor is in in their career.

Jenna Dagenhart: It all comes down to how an advisor is able to discuss these topics with the end client. Seth, how important are supporting materials from asset managers, from model solutions, commentaries, and the like for advisors to be able to confidently discuss a model with the client.

Seth Buks: We hear it loud and clear that advisors find these supporting materials extremely important, particularly trade updates and rationale, both monthly and quarterly, client education and portfolio construction resources. If an advisor is going to recommend a third-party model, not only did they want to be fully clear on how it works but they also want to be able to explain it to a client. What we hear back is that with the right materials, support and messaging, most clients are actually extremely receptive to the idea of implementing a third-party model because after all, they trust their advisor.

Seth Buks: If their advisor can recommend it with conviction, the client will share in that conviction. Anecdotally, some advisors have actually commented to me that they love that we essentially write their client reviews for them. I'm sure that's a little bit tongue-in-cheek. Of course, they're still doing some prep but there's a lot less for them to review. They don't have to explain performance on a bunch of different funds. When it comes to partnering on discretionary models offered through broker dealers, the marketing is often done in partnership with that home office. FAs can offer materials in their branding, in their firms templates. It makes it look like the investment capability is a true partnership with the FA.

Jenna Dagenhart: It all goes back to our earlier points on time management. If you can write those resources for them, it also saves them time. Susie, what are your thoughts on shifting adviser and investor demographics? Does it have an impact on interest for model portfolios?

Suzanne Daly:  Absolutely. I think the crux of this for me and for Fidelity at large is standing out as an advisor with today's investor is critical. What it means to be successful in today's landscape is largely different than what it was over the past 20, 30, 40, 50 years. As you think about the generations that are in play today, there are over four or five different generations that are actively participating in the marketplace. You've got the Silent Generation, Baby Boomers, X, Y, and Z. As you look towards the trend, in 2027, more than half of the investible population will be millennials. Understanding millennials and Gen X and Gen Y and Z, and what their needs and wants and desires are from an advisor is critical to these advisors and how they're going to be successful. Some of the survey and research that Fidelity has done is going out to understand what these future investors are looking for from their advisors.

Suzanne Daly: What's really encouraging is that the Baby Boomers, if you have a conversation with them, oftentimes you'll hear that that generation was not overly interested in consolidating all of their assets with one advisor. They weren't overly interested in outsourcing a lot of their capabilities to third parties. What we are seeing is on average, Gen X, Y, and Z investors are looking for comprehensive services to one advisor. They want not just money management as we talked about before. They want financial planning. They want life coaching. They want succession planning. They want all of these services to be provided by their advisor. Additionally, these investors are looking for that one consolidated touch point. Think about friction in ease of interaction. Tomorrow's investor is not looking to diversify across a large percentage of advisors and increase the workflow for which they need to understand their own book.

Suzanne Daly:  As we look across the landscape, 45% of future investors are looking to consolidate their business with advisors versus just 15% of Baby Boomers were. I think a lot of this comes down me with, in order to be successful as an advisor today given the future investor, you need to understand what those investors are looking for. Another nomenclature and jargon and terminology that we use at Fidelity is this mention of emotional quotient. This definition of how emotionally intelligent you are as an individual. What we're seeing as successful relationships from advisors are those advisors that are flexing that EQ, that emotional quotient and moving away from otherwise really renowned IQ, intelligent quotient, which tends to hand more towards the analytical and deep dive skills.

Suzanne Daly: This shift from IQ to EQ to be positioned as a successful advisor for tomorrow's investors is really something that Fidelity is doubling down on to understand those behaviors. I think just to land the point here, I think model portfolios again, or just general outsourcing across your book of business, maybe it's not even just investment management as an advisor, maybe you look to other areas of your practice to outsource as well, allows you to then go invest in that emotional quotient and develop that need and flex that muscle to essentially build a stronger relationship with that client. That's what I'm seeing from an investor demographic shift.

Jenna Dagenhart: Seth, as we opened up the conversation, you mentioned how this is such a fast-growing space. Where specifically do you see the most acceleration of adoption in model portfolios?

Seth Buks: Absolutely. I would say it's coming mainly from advisors that are in their growth phase, those advisors that are aggressively trying to drive new business and client acquisition. They see models as an important part of their process. All the large wire houses have done studies to really confirm that model users see enormous benefits from a business building perspective, they add more households in non-model users, add more new clients, larger clients, they hit more of their target revenue hurdles. Really being able to, again, as we've touched on here, add time to your day, add efficiency and scale to focus on prospecting and business development is driving a lot of the adoption.

Seth Buks: Another big growth area for adoption is in the high net worth space, believe it or not. The original thinking was that models are good for FAs with smaller accounts, the old 80-20 rule, don't spend too much of your time on the bottom of your book. I would say that perception is fading very quickly. These are not just for orphaned IRAs and the like anymore. Many FAs are viewing models as an important part of their investment process for higher net worth clients, especially as they start to include things as you mentioned before, like SMAs inside their models, tax optimization, even tax loss harvesting is something that we started doing in our portfolios last year to really focus in on tax efficiency and lowering fees. We're seeing great adoption in that space.

Jenna Dagenhart: Those are great points. Susie, are you encountering different advisor personas? If so, how do they each leverage models? For instance, do you see a correlation between the desire for models and advisors that have more of a holistic planning approach?

Suzanne Daly: Absolutely. Categorically, we think about advisor personas in three primary buckets at Fidelity. As you vision a spectrum, on the left-hand side, we see the DIY engineer-minded advisor. Those are advisors who really continue to see the value that they deliver in a relationship is through investment alpha. They are constructing portfolios on their own, designing those portfolios. As you move and shift towards the outsource momentum, you'll see a customizer-minded persona, which is an individual who says, "Maybe I'm looking to outsource a percentage of my investment management to a part of my book of business. But for a key piece of it, I'm going to take some turnkey model portfolios and I'm going to tweak them. I'm going to customize them or I'll build something custom from scratch." Then on the way right-hand side of my invisible spectrum here is the true outsourcers.

Suzanne Daly: The true outsourcers are those that are looking to ground their practice outside of investment management and build it from planning up to say, "I am not the expert in this space. I deliver value in different ways along my earlier advice value spectrum." Looking to fully outsource to a third-party model or proprietary home office model, the likes. Across the spectrum, we range from engineer-minded customizers and full outsourcers. The other piece I'd mentioned is oftentimes we engage with RAs or broker dealers, advisors often have a blend of all three personas.

Suzanne Daly: It's not very often that we come into a practice where 100% of an advisor's book is outsourced. Sometimes, but not often. Nor do we come across an advisor 100% of their accounts are built from scratch. We do see a [inaudible 00:40:37] mattering of these personas. I think one of the important points for all of us to consider is how as asset managers or platform providers, can we provide the right set of solutions to align with the persona need? Maybe we provide outsourced thinking for a percentage of the book, we provide a custom model input to another percentage of the book or maybe we provide some thinking on how this advisor can think about portfolio construction to deliver his or her own value for their own engineer-minded portfolio.

Jenna Dagenhart:  Switching gears here, a lot of strides have been made but there also are some hurdles still out there. Seth, where do you see the most hesitancy and why?

Seth Buks: I think there's three main objections that tend to percolate up from advisors who haven't adopted models yet. First is that, as Susie actually just touched on a little bit, many advisors think of investment management as a core part of their value add. They're hesitant to offload it. They want to maintain that control of the investment decision because they believe that it's their investment expertise that their client chose to work with them in the first place. In many cases, I'm sure that that's true, obviously. But I would also echo what I mentioned before around how choosing a model should be seen as no different than choosing a fund or and SMA. It's just another tool in the toolkit and can be a very useful compliment to everything that they're already doing. It doesn't have to be a replacement for anything.

Seth Buks: Second is around the tax impact to transition models in taxable accounts. We know this is a barrier now since returns across really all asset classes have been so robust for the past decade plus and accounts are obviously sitting on huge gains. Now, one [inaudible 00:42:21] where taxes are most likely going up. Realizing some gains now to reinvest in a model where you're going to reset that cost basis and all those securities would be at a renewed higher cost basis might not necessarily be the worst move to make if you do think that taxes are going to be going up in the future. We do know that this is a challenge. As an industry, we're working hard to help solve for that tax piece. Third, finally is what I would call a misperception of poor performance, which really relates to how the markets have done over the past decade plus.

Seth Buks:  Models tend to be diversified across geographies, across market cap, some invest in alternatives, not only commodities but true alternatives like hedge funds or liquid alts. If you compare all that back to a 60, 40 S&P, Ag benchmark, most models will lag. It's been a great time to be in plain vanilla cap-weighted US stocks and high quality fixed income given the decline in interest rates we talked about before. I would also argue that we've been in a passive market. If you bought nothing but those two index funds or ETFs, S&P and Ag, and you have that buy and hold approach, congrats.

Seth Buks: You did fantastically well over the last decade but we're no longer in that environment. We've moved from a beta market to what I would call an alpha market where diversification really starts to pay off as it has this year. Being tactical will be more rewarded as it has this year. There will be greater separation between the winners and the losers. Now, I'm not calling for the death of the 60, 40 as some have but we believe that being invested in areas that haven't necessarily been the biggest winners over the past five years, like say, emerging markets will help you be a bigger winner over the next five years.

Jenna Dagenhart:  Susie, what are some of the hurdles related to adoption of models?

Suzanne Daly:  Seth really hit on a tremendous amount of them earlier on, but from our vantage point, it starts with education and coaching. I think oftentimes, advisors still need help telling the model portfolio story and helping them position, why they are choosing to outsource a piece or a component of their book to their client. To the points that Seth was making earlier around robust commentary and the value pillar language that we can help advisors with, acknowledging that, to his point earlier, is as simple as choosing a mutual fund or an ETF to solve for a specific use case in your client's overall portfolio is not different. Outsourcing to a professional in this space allows the advisor to position their strengths across the relationship more broadly. I think that's one area of opportunity for the model portfolio industry in general is to continue to increase robust collateral to help advisors position outsourcing investment management. Also, to hit on the points that Seth was referencing earlier, we still see the perception of implementation of models being a challenge.

Suzanne Daly: To the extent that whether it's technology providers in this space or we all come up with easier ways to implement from individual portfolios to a third-party model when there are embedded gains, that does come up from time to time. Coaching advisors on how to take that next step, is there a technology solution, whether it be continuous tax loss harvesting over a period of time to more gradually transition. These are things that we focused on to help with coach advisors to make that gradual transition into model portfolios. Then lastly, it's tied to the first point but it's helping to ensure that advisors do not lose control of the relationship or the investment management entirely when they choose to outsource a component to a third-party model. If we've done our job correctly, they are just as in tune with all of the decisions we are making, the value prop and why they've hired us to a specific discipline of their overall book.

Suzanne Daly:  It should still resonate with the advisor on having control to tell that story, feel close and comfortable with that story as they talk to their clients about it. Then I think Seth actually hit on this earlier on in our dialogue here, the misconception that models are really only applicable to the small account solution. I think as models continue to become more mature, there's an opportunity in the ultra-high net worth segment to solve for some of these sophisticated use cases. It's not the first natural instinct for an advisor oftentimes to think about that $3 million account or that $20 million account to go to a model portfolio. if you think about what Seth and I have been talking about, advisors that can think through a separately managed account tucked into multi-asset class portfolio that has tax efficiency with some alternatives, these are also just different ways of thinking about model portfolios and can solve really uniquely for a $30 million client. These model portfolios do not only need to be a solution for small accounts.

Jenna Dagenhart: Susie, you touched on this briefly earlier with your comment about the critique that sometimes models are one size fits all. I want to spend a little bit more time on that because I think a common objection is that models are too cookie cutter or they don't allow for the ability to meet unique client needs. Seth, how have asset managers evolved their offerings to address some of these concerns?

Seth Buks: We certainly understand where this perception might come from but I think it really comes down to where we are in the evolution of models and how they've transitioned really over the past five years. Some of the oldest model portfolios, including some of our own are those traditional asset allocation strategies that were designed as a single ticket solution for all or most of a client's portfolios. Chances are, they're only offered in a few risk tolerances, maybe five but that doesn't necessarily allow for the flexibility to solve for client's unique needs. The industry and us included, we've evolved through, I think a different approach. We touched on this before but away from that traditional asset allocation model towards this idea of goal oriented, which can really help express a particular goal within a portfolio. I use the examples before of managing volatility or generating income or protecting on the downside.

Seth Buks: I would argue that those are certainly not cookie cutter when they're viewed through the lens of portfolio construction because they can play an important role as a diversifier in that client's broader portfolio. Then of course, there's the models that can act as sleeves. We touched on this, the idea of a fixed income sleeve or international equity sleeve. If you are a true practitioner of models, you can put together a portfolio of models, these different sleeves, not only from one product provider but even across different product providers to get to that end space and have expertise in those different asset classes, making tactical shifts under the hood. Again, I would argue that that is certainly not a cookie cutter solution.

Jenna Dagenhart: As we wrap up this panel discussion, Susie, could you discuss the importance of technology and innovation as it relates to model portfolios?

Suzanne Daly: Oh, absolutely. This is a passionate topic for me as I used to lead the technology consulting part of the organization here at Fidelity. We would be charged with going into broker dealers and REAs and talking about optimizing their technology stacks and how to increase workflow and efficiency and again, back to advisor productivity. What I would say to this, Jenna, is to me, it's blending the best of a technology experience with investment product to yield investment experience. For those asset managers that are choosing to lead with technology, it's not a surprise to me that they're winning because advisors are walking through this investment experience with no friction, no complicated workflow, not looking for collateral. It is presented to them in a timely manner. To the extent that technology can present the repeatable process to support what the advisor is looking for when they were looking for it is going to be who wins the race in my personal opinion.

Suzanne Daly:  As we all think about building best of breed technology platforms and rendering investment solutions as part of those, we really want to think about who the advisor is, what the advisor workflow is and how we can help them solve what they're looking for and as least amount of time as possible. Give them the information upfront, assess their needs upfront, provide the research collateral upfront, give them the analytics, give them the performance and commentary through the portal. Technology is one way to think about solving for the initial hook into an advisor's experience as they consume models. Then as we hit on also here, as we think about the future of model portfolios and the importance of tax transition and tax management, a lot of that's going to be done through continuous tax loss harvesting and tax optimization engines that are powerful to do that.

Suzanne Daly:  Again, pointing to technology. That's something we haven't spent a lot of time talking about today is just this overall transition to mass personalization at scale. Whether some think about this through direct indexing or others is largely going to be a solve for technology on how portfolio solutions can look to an individual advisor's book or end client and say, who is this client? Understand everything about this client, their taxable income, their tax bracket, their reservations, their social imprints, their thumbprint on what they think is important. Optimize those capabilities and render various portfolio solutions that are specific to that household. Again, to me, that's all going to be done and delivered in scale through technology.

Jenna Dagenhart: Seth, you seem to be nodding your head over there. What kinds of innovation do you see on the horizon?

Seth Buks: I would, of course agree with everything that Susie mentioned and just add that really anything that makes implementation easier is critically important here. A lot of it is going to be driven by the technology that Susie just talked about. There's still a lot of hesitancy around the lack of transparency or the ability to conduct performance comparisons. Many advisors don't necessarily know where to go to find performance on models or conduct the same type of due diligence that they normally would on a mutual fund or an ETF, that running scenario analysis or combining models to see correlations between them is almost impossible for many advisors. I would argue that when there's more support in that regard, I think that will turbocharge adoption. Not only is it that ease of implementation that's a factor but on many platforms even just opening an account isn't always the easiest thing just yet.

Seth Buks: For now, it's still so much easier to just invest in a mutual fund or invest in an ETF. When that account opening process gets easier, I think that'll also be wind in the sails. Then just to echo Susie's comments quickly on technology, I would say that we are in the very early stages of model portfolio development. We might've gotten out to the 201 version but we are still far from where we might be. A lot of these exciting opportunities are happening in the not too distant future driven by that technology.

Seth Buks: Whether it's the mass customization that Susie referenced, this idea of an advisor being able to swap out building blocks, maybe create their own mix of active and passive or mutual funds and ETFs, being able to incorporate more SMAs at lower minimums with fractional shares, the tax optimization that she mentioned or even direct active tax loss harvesting with direct indexing inside of a model. All of that is happening in the near future as well as of course bringing values-driven ESG or responsible investment screens into models. I would say that with the technology, the future is very bright here.

Jenna Dagenhart: Susie, finally, what lies ahead for more broader adoption?

Suzanne Daly: It's a great point to end on because I think my vision of the model portfolios industry in the next couple years is reminiscent of all the conversation we've had over the last hour, which is seeing more coopetition and partnership among asset managers working together to meet advisers where they want to be, democratization of investments through personalization. Whether that be through ESG screens or democratization of swapping out tax loss harvesting and technology. Then lastly, it's just asset managers using technology as a differentiator. Open architecture, partnership of asset managers across the industry, personalization, then technology as a differentiator is really where I see the landscape for model portfolios in the not too distant horizon. I'm really excited about it and looking forward to all the contributions

Jenna Dagenhart: Seth, any final thoughts on your end?

Seth Buks:  No. I think we covered a lot here in the last hour and we really hope that this continues to drive the conversation not only for advisors that are already using models, maybe we opened up a few additional avenues for them, but then for those who might still be hesitant, we've given them some ideas to implement in their own books of business.

Jenna Dagenhart: Well, Susie, Seth, thank you both for joining us.

Suzanne Daly: Jenna, thank you so much for having us. It's been a really thoughtful dialogue.

Seth Buks: Absolutely. Thank you so much.

Jenna Dagenhart: Well, thanks for joining us and thank you for watching this Model Portfolio Masterclass. I was joined by Susie Daly, vice president, Model Portfolio Business development at Fidelity Investments and Seth Buks, a Client Portfolio Manager at Columbia Threadneedle Investments. I'm Jenna Dagenhart with Asset TV.