Gillian Kemmerer:

Welcome to Asset TV. Among the predominant forces impacting the product distribution universe is the increased adoption of model portfolios. In today's Masterclass, three firms that are pioneers in the model space will help us to understand why advisors are using models, how to optimize outcomes for clients and best practices for the evaluation of model managers. Joining me today in Studio are, Pete Hill, Managing Director and head of Model Portfolio Solutions at State Street Global Advisors. Joe Hosler, Managing Principal of Auour Investments. And Robert Michaud, Chief Investment Officer of New Frontier Advisors.

Gentlemen, thank you so much for joining us here today. We have a number of really important topics to talk about within the model space, but I think it would make sense to start with some introductions, because each of you really hold a market leading position in model portfolios. So Pete, perhaps you can begin with the story behind State Street and your place within this universe.

Peter Hill:

Thank you and thanks for having us here today. So as head of Model Portfolio Solutions, we've got a long history within ETFs and within models at State Street Global Advisors. Our history of ETF states back to 1993 when we launched the original SPDR, SPY, which has grown into the largest ETF in the US today at over 400 billion in assets and the most liquid security in the world. The broader franchise of SPDRs is north of a trillion with over 110 products today. Within model portfolios, we've been a leader within that space. We have about a 14-year track record of managing model portfolios today, and we manage nearly five billion in assets across our multi-asset class portfolios.

Gillian Kemmerer:

Wonderful. And Robert, what about New Frontier?

Robert Michaud:

Well, we were really one of the first ETF strategists that started as an ETF strategist. Before that we were a research and investment advisory firm. We did a lot of work in terms of institutional consulting, portfolio optimization, and just general research on how to do investments well. And so then when ETFs came along, it was a perfect fit for us to be able to take advantage of technology platforms, ETFs, and then deliver models with the same quality of institutional asset management that were now available to advisors on advisor based technology platforms. And this is what has allowed us to make available to advisors and their clients the same type of institutional quality investment portfolio that is used by the largest institutions.

Gillian Kemmerer:

And lastly, Joe, introduce us to Auour.

Joseph Hosler:

Sure. We are the smallest of the three, but we focused on something called regime based investing, and our idea was to leverage what we've seen in the success of model providers. And we started the firm in 2013 to be focused on something called regime based investing. The idea of understanding the different phases markets go through and tuning the portfolios accordingly. I think this all came about after the financial crisis of 2009 and eight, where everybody saw that a statically diversified portfolio did not actually provide protection during times of dramatic changes in the market. And so that's where we're focusing on our efforts. And we've grown to had very strong growth. We're about a half a billion now and focused with working with these guys as one component of a total solution.

Gillian Kemmerer:

It's perhaps no surprise that we are sitting here today because of the increased usage among advisors of model portfolios. So why don't we lay the groundwork. Robert, can you explain to us what models are and why they've increased in popularity?

Robert Michaud:

I think it's interesting to start from the beginning and think about how sophisticated investors have behaved over time and what their portfolios looked like. Now, going back a long time, 100 years or so ago, really all that was available was investing in individual stocks. And stocks were difficult to trade and you could only have a handful of them. And so a sophisticated portfolio looked like a maybe even price weighted set of just a few, a dozen or so different stocks. And then over time, of course, then we had portfolio managers. Now you had a professional who could pick stocks for you and even more importantly, really diversify across far more securities than any individual could in a portfolio that could start to be considered a well-diversified portfolio with maybe an investing theme over it. So then the job of an advisor or an investor was to think about, well, what's a good fund to invest in?

Now, as that evolved, it became why just invest in one fund? Almost like why just invest in one stock? Because notice that different portfolio managers had different style and were maybe going after different asset classes. And so then sophisticated portfolios became portfolios of a few different funds. And as that started to become more sophisticated, you could get slightly more complicated portfolios, but they were usually based on a lack of transparency into the underlying process and not really great diversification because a lot of the times portfolio managers did different things and canceled each other out. And so then ETFs came along and I think that's where things really changed and really got sophisticated. And that's where we are now. And where all of us are up here talking about you, which is with ETFs, you know exactly what you're going to get.

You get a very precise exposure to different asset classes and risk factors, and then you're able to build models that take advantage of that liquidity and transparency of the ETFs that you can trade quickly and you can trade precisely and you can build a portfolio strategy. And so depending on the different ETF strategists you have, you can have these different exposures, different types of investment objectives that model portfolios are built after. And now we're in a state where you can even think about knowing your client very well and then understanding deeply what is the different model portfolios objective and how does that serve your client? And maybe even how do you combine multiple model portfolios for the benefit of achieving your client's investment goals?

Peter Hill:

And when I think about model portfolios and ETFs, it's a very symbiotic relationship. The growth story of ETFs is really a growth story of models, and the growth story of models is really a growth story for ETFs. So you think about the ETF industry, it's growing at about a 10% compounded annual growth rate per year. You look at models, it's growing north of 20%, so nearly double the growth rate of ETFs is the growth rate of third party asset manager models, which is why all of us are in that space working with advisors, working with platforms. And when we think about ETF models, I think about the variety of models that are out there. There's home office CIO models, which according to Cirelli is about a trillion dollars in assets. There's third party asset manager models which we operate in, which is about 400 billion in assets, and again, growing at north of 20%.

And then there's advisor led models where the advisor is acting in a Rep as PM capacity, and that's nearly 20 trillion in assets within the US wealth industry according to Cirelli. There's a lot of different applications of models, and I think given the advent of ETFs and the growth of ETFs, there's a lot of choices to be made for advisors. There's well over 1,000 ETFs in the US marketplace today. There's a lot of choices there. And so working with a third party asset manager to distill that universe down, pick the right solutions for the portfolios that add tax efficiency, cost-effectiveness, transparency, and liquidity into the portfolios is a very important thing.

Joseph Hosler:

I think just to put a pin on it for both of these or accentuate, ETFs have added a new layer that allows us to get broad exposure to a certain class or category or factor that we want, then the portfolio manager or the model manager is able to take that and build around their philosophy, how best to approach a certain perspective in the market that they think needs to be protected or accentuated. And then as we're talking about it, now, we're at a point where we've added all these abstraction layers and technology's allowed us to blend all these different perspectives into one portfolio to provide a much more rigorous solution for the client.

Gillian Kemmerer:

So to Joe's point about technology, I want to stay there for a minute, and Pete, I'll come to you. It's clear that technology is the enabler in this space, but there must be demand from advisors for models, correct?

Peter Hill:

Yeah. So if we look at financial advisors to start at SSGA, we did a survey not too long ago where we surveyed hundreds of financial advisors in terms of how they're operating their practices, what they want to do more of or less of on a day-to-day basis. And at the end of this survey we learned two things. One is they obviously want to get deepen and stronger relationships with their existing clients, but also meet new ones and grow their book of business. But when we asked them how they spent their time, their top three activities on a day-to-day basis was portfolio management, administrative and investment research, a bit of a different outcome relative to the results that they wanted to deliver on a day-to-day basis.

So model portfolios and a rise of models is also a story around time management for these financial advisors. And they're realizing every single day that in order to grow more scalable, more efficient businesses, they needed to in some aspects of their day-to-day, outsource components of that to third parties to be more efficient.

Gillian Kemmerer:

Joe, I see you nodding.

Joseph Hosler:

Well, yeah, definitely. It's a division of labor that we're all trying to focus on and what's moved forward is the position of a advisor to a client. In the past it was to gain access to markets, which is, as Robert was talking about earlier, you needed somebody to buy a security for you. Now you don't need that. It's easy and cheap. So where does the advisor sit? What's their value proposition? And it's about being the financial confidant to their client base. So they have to be spending more time because other advisors are doing that, and so they have to be competitive. So they want to spend more time with their client focusing on the actual needs and the goals that they have and the complexities that they bring about.

They need, because of time they can't do everything else by themselves, so they need to outsource, we believe, I believe that they need to outsource and focus on providing a durable solution where they can rely on other participants, third party participants to do the research to find the selection of securities, the right securities to provide that durable solution, because they just don't have the time to do it anyway. We see it day in day.

Peter Hill:

I also think too, those holistic financial planning activities are really the activities that endear themselves to their end clients. Investment performance comes and goes, but having a strong relationship with your existing book of business, intergenerational wealth transfer, education savings, all the things that financial advisors do every single day are really the services and the value add that keeps their clients coming back to them.

Gillian Kemmerer:

Now, I want to stay on this word outsourcing because it keeps coming up in this conversation. And Pete, it could be said that this is described as the advisor completely outsourcing investment management. What would be your response to that and what is the roles of the advisor and managing client portfolios here?

Peter Hill:

Well, I would say it's not a one size fit all type of scenario. You have some advisors that are outsourcers, right? And we actually see that pool of advisors growing within the US. I think that's growing primarily because a lot of the home offices, broker dealers and platforms are really taking away that Rep as PM functionality and shifting advisors to advisory platforms, right? So they want advisors to become asset gatherers, not asset managers, and they want a consistent client experience at the end of the day, so therefore outsource, get that consistent client experience. But what we also see within our distribution efforts is a bit of a hybrid user of models where you have financial advisors that maybe use the models for small accounts or use the models for core positions within their portfolios and then still do some almost bespoke or customization within that model holistically.

And then you also have the in sourcers. Those are the advisors that are operating that Rep as PM capacity, but as we just learned, their time is very valuable to them. So how much time could they spend researching the merits of investment A versus investment B every single day within their business? They're tending to do more and more outsourcing to third parties within this marketplace.

Robert Michaud:

I don't see this as advisors reducing their involvement in the investment process and the investment outcomes of their clients. I actually see this as the other way around, that models give them a way to really leverage and think much deeper about investment goals and investment ideas and how they apply to their client by instead of spending time even thinking about individual stocks, which most of us know is really not a productive thing to do with your time and they're just too many of them and markets are too efficient to worry about that sort of thing. Really try to deeply understand what's the philosophy and the process behind each of these models that they're considering for their clients and really matching them to their investment goals.

Think about how does this client investment needs line up with a long-term model and a combination even of models that really bench better serves them. It's almost like using technology to do something that's far more leverageable than what they were doing before.

Peter Hill:

What the advent to models and more and more models being available in the marketplace, what we're seeing a lot of advisors do, and Robert hit on this briefly, is a model of models for lack of a better term, and blending models together that are available on a platform. So whether you're using a more strategic model provider as the core exposure and then using maybe an outcome oriented model around income or real assets as a sleeve within a broader asset allocation, we're seeing a lot more advisors pair these strategies together, one being more strategic, one being more tactical, one being more outcome oriented, one being a little bit more focused on innovation for example. There's a lot of different ways to blend these models together and we're seeing actually platforms recommend that type of interaction with models.

Joseph Hosler:

Actually what I would add to that is, Robert and I know this firsthand with one of our strategic partners, a large independent broker dealer where we were actually pulled in, they architected a unified management account program and they brought in a few different model providers each providing a different solution set or a different perspective. And based off of that, Robert's firm and my firm have been actually pulled together because we offer different perspectives, but we're still focused on trying to produce the right outcome for the client. It's a synergistic focus where the IBDs, the independent broker dealers want more consistency of returns, want a better solution set for their client base, and they've been pulling us into it.

And it's worked for both of us because as Robert started off with, the institutionally minded investment manager knows that we are focused on a certain perspective of the market and that's what we're focused on. It becomes the responsibility of the model of models to bring those different perspectives and to provide an institutional quality return to the client base.

Robert Michaud:

What we've just talked about really does allow an advisor to elevate their perspective on investments to be much more in line with what the investors at the largest institutions large endowments are thinking about how to invest in terms of thinking about what are their managers, what are their strategies and how to put those together to meet the unique needs of their clients.

Gillian Kemmerer:

Joe, coming back to you, are there regulatory reasons to move to model management?

Joseph Hosler:

Yes. What we've seen, and I'm the chief compliance officer for my firm as well as working with other CCOs at other RIAs, the amount of due diligence that the SEC expects you to do on investment management is increasing. They want more due diligence work to be done, not only on the product, but on the solution that you're providing, the philosophy that you're working with. And one of the things, as Pete said earlier was that consistency of return. They don't want to see you favoring some clients or actively trading some clients over other clients. A model portfolio allows you to have that better level of due diligence and consistency of return that we're all looking for.

Gillian Kemmerer:

Robert, anything to add there about the level of research that goes into a model manager's decisions?

Robert Michaud:

I think it adds a lot of credibility both with the clients as well as even the SEC if an advisor can point to a model manager with a deep investment process that has a serious due diligence of their own in terms of exactly why are they choosing every allocation, every ETF within the portfolio, what research went into it, if they're making a tax sensitive portfolio, how are they thinking about managing the taxes and even measuring the taxes that occur in each of the ETFs and thinking about if they have maybe an income objective. There's dozens of just US large cap dividend paying, dividend tilted ETFs out there and to try to understand them and to have a strong reason for selecting one over the other and putting a precise allocation of that into a portfolio I think should be a great comfort from a regulatory perspective for any advisor.

Gillian Kemmerer:

Now, Joe, I'm sure a question that you get asked is whether or not an advisor gives up anything when they move to models. For example, is customization for clients an issue moving forward?

Joseph Hosler:

I actually think they get better outcomes from customization using models than risking losing it. Every client is unique. We know that they're unique, but they all have certain issues that they share in common. We all want to reach retirement, we all need income while we're in retirement. We need to put our kids through school, we want to buy a house. These are all things that every client has. The customization comes from how do you blend those different goals to fit the needs of that client in a financial plan? And what I think using model managers can provide is you can outsource the vast majority of that that isn't unique and you can focus more on those aspects, the smaller aspects that are unique to that client and focus on the attention on that.

So as Pete was saying, a lot of the assets are still in Rep as PM territory channel. And that will always be there, but the amount of it doesn't have to be as big as it is. You need to be more precise with the customization you want. But if you bring in, if you establish good partnerships with model managers, you can convey the needs of individual clients to them and they can actually, or we can actually help guide you the advisor to what solutions we provide that could fit that need or as we do regularly saying, well, our models don't fit that, but you should talk to X, Y, Z model manager.

Gillian Kemmerer:

Anything you'd like to add, Pete?

Peter Hill:

I think within our business customization's vitally important. According to Cirelli, there's nearly eight trillion in assets available and customized model portfolios today. So it's a huge opportunity for all of us as asset managers to work with advisors and work with platforms every day to try to develop new and unique models. One area where we've had a lot of focus within our model portfolio business has been the integration of more third party product. So to have more open architecture solutions into our models in addition to just spot ETFs. We have a team that focuses on that, does due diligence on those products to make sure we have the right ones within our models.

And then as these folks had mentioned, we're getting a lot of requests from platforms to try to blend our solutions that tend to be more strategic in nature with more fast moving, more tactical solutions on platforms to provide a unified solution for advisors.

Gillian Kemmerer:

Robert.

Robert Michaud:

So customization can mean a lot of different things and sometimes people are too focused on what I would think of as cosmetic customization. So something that just makes you feel good, makes you feel like you've had a choice in your portfolio, but doesn't actually affect any of the investment outcomes that are going to matter to an advisor or their clients in terms of meeting any of their long-term goals. And so instead of focusing on cosmetic customization, I think what we're talking about here with models is much more meaningful customization, the ability to distinguish and invest in even for middle risk type of clients, there's a lot of different ways that you can build something that has the general risk of a 60/40 portfolio. Of course by combining different strategies, but even within one strategy, just think about inside a 60/40 portfolio, all the different opportunities and possibilities that there are.

And to be candid, the 60/40 portfolio is one of my favorites because it's the most fund to optimize, especially a tax sensitive 60/40 portfolio. But what you can do with it is instead of having a really aggressive portfolio, right? In a really aggressive portfolio, you're pushed in a certain direction to go after the high return opportunities. Conversely in a very conservative portfolio, you're again, you're really constrained in terms of how much risk can you take in any one asset class or risk factor. Whereas in a 60/40 portfolio, it's called a balanced portfolio for a reason because you have a good opportunity to really balance off the risk and the return trade-offs of virtually every different asset class that's available.

And to think about how you can, in our case, carefully optimize the risk and retrain trade-off and in other cases think about the different types of return sources they're going for, can lead to wildly different portfolios, even something that seems like it should be as consistent as a 60/40 portfolio.

Gillian Kemmerer:

Joe, how can an advisor educate and engage their clients on the value proposition of utilizing models?

Joseph Hosler:

I almost want to use an analogy for this, which is a car. You can get about any feature you want on a car, but you're not expecting that car maker to make each individual feature for that car. They outsource parts of that. And so when you're educating a client about this, you're trying to tell them that you are focused on getting the best outcomes of each feature that is going to be embedded within their portfolio, and based off of that, they have chosen to leverage the skill sets of outside professional managers to get to that.

Robert Michaud:

I think education on model portfolios can give an advisor an opportunity to move beyond the traditional way of saying, well, what's the performance of this portfolio or this component of your portfolio? Because we all know that's of limited information about the future. Also even trying to go deeper and talk about specific investments that the client is holding. Now, there might be a reason why they're holding that right now, but that might change over time. And so again, to go deeper in terms of client education and say, here's how sophisticated investors think, here's how they're building a portfolio, here's their investment philosophy and really familiarize your clients with an investment philosophy that's not just we pick stocks however we feel like, and then we're always just trying to beat the markets, but an investment philosophy that acknowledges that markets work a certain way and there are certain relationships between risk and return and there are certain reasons why investors invest the way they do.

And so to go deeper into an investment philosophy and then even the investment process in terms of what are all the steps of the investment process and how is this asset manager adding value and where are the risk exposures they're taking? And that gives advisors a better, deeper way to have a conversation with their clients about what their investments are doing.

Joseph Hosler:

I would say, I'll just add to put a point on that one, when you become a partner to a model manager, you have their access not just to the outcome of the solution that they're providing, but to their thought processes Robert was just talking about, the philosophy and such, as well as all the material that we produce so that when it comes to educating your client, you have this backup of information that's institutionally built that allows you to better convey the complexity of investing and how managers can actually help to minimize that complexity and bring it down to a conversation that you're able to have with your client. It comes down to the trust. When the markets become volatile, clients start to lose confidence or trust in the plan that was put in place for them. The more that you can educate them and provide them reasons for why they're invested a certain way, the better you are to get them to trust you and to stick with the plan.

I go back to, I think you guys all remember Peter Lynch who ran the Fidelity Magellan fund. I think he had an annualized return over his lifetime managing it, doubled the S&P 500. But the average client return of the Magellan was like half of the S&P 500. That large gap between what he produced and what people actually saw in their portfolio was based off of people making bad decisions at the worst time. When you start to bring in model managers that have a philosophy and we know what we do and we have reason for why we do it, you can better convey that down to the client. You can keep them in the portfolio as you defined and plan for.

Peter Hill:

And I think one thing I would add to that is, when we look across the hundreds if not thousands of advisors that use model portfolios of our firms or even these folks, many of those advisors as Joe mentioned, are leveraging a lot of what the firm can offer, whether it's access to PMs, conference calls, videos, blogs, written word, everything is being consumed by those advisors so they can tell a story, so they can articulate the story of the investment story that they're trying to convey to their clients. We do this in our business, I know these folks do it as well, but every single one of the pieces that we produce is for public use.

So that advisor can use that marketing piece in the meeting with the end client reference return streams, reference a trade rationale, reference the decision-making behind a portfolio management adjustment with the client so the client understands everything. It's almost like a sales aid for that advisor to articulate the merits and the current events within their portfolios using these pieces on a day-to-day basis.

Gillian Kemmerer:

Now, Joe, imagine we're at the point that an advisor would like to incorporate model managers into their practice. What are some of the prerequisites for doing so and how would that ultimately impact their business?

Joseph Hosler:

Those that we've seen that have done it and succeeded at it, meaning not just succeeded at implementing them, but actually growing their business and leveraging the skill sets. Technology is one of the things you have to have. That's an ante to it. You have to be able to blend different managers into it, and that's becoming easier and easier to get every day and cheaper. The other side is how do you figure out what managers you want to have within your portfolio and how do they help you leverage the discussion you're going to have with your client? The advisor has to take the approach that they are the financial confidant, that they're there to build the financial plan and to act as essentially to sit on the same side of the table as their client, to build out that plan and to interview managers.

Once you have that success, that technology and the ability to be sitting on that side of the table, then I think it comes down to how do you select those different managers? And where Pete and Robert have said, that institutional mindset that we bring to it, the model managers typically bring to it, because if you're going to start blending different managers into a portfolio, you have to make sure that they stick within their lane. You don't want them to be, as Robert said, just trying to beat the market and buying certain stock one day and another set of socks the next day. You need to know their philosophy. You need to understand what value they offer to the solution and depend on them to actually provide that consistency of return.

Gillian Kemmerer:

Joe, I think the comments that you were making are getting at this point of due diligence. So Robert, how do you select and evaluate model managers for clients and what are some of the key considerations?

Robert Michaud:

I like to go back to thinking about, again, how do the most sophisticated investors solve this type of problem? And one common way is to think about a core satellite approach. And so to start with deep understanding of your client's needs, your client's goals and their unique things that they need, and also the risk that they can tolerate from their investment portfolios. And then to go to maybe start with a reliable core which has very transparent risk objective that very carefully matches with the type of risks your client is looking to get exposed to for meeting their long-term goals. And then within these types of core strategies that have the right risk target, make sure that this strategy is something that you're comfortable with in terms of how is it managing risk, what types of exposures is it taking to get extra return beyond the market or not?

So some core portfolios will very deliberately take large exposures to certain risk factors. Some core strategies will do a little bit of market timing to dampen volatility. What we think is most appropriate for a core strategy is to not engage in those things, is to not speculate about the future or not try to time the markets, to provide a very consistent, very well diversified exposure to markets and also be consistent over time and well diversified over time as well as being well diversified across all of the investments that you're holding at a point in time. And so what a more consistent, a less volatile in terms of how it changes type of portfolio can do for someone, is it can make it a better core to match with other strategies.

So you can make sure that the other satellite strategies are where all of this extra customization is happening, where all these extra risk exposures or dampening of market volatility or going after the extra return is happening, but that's not happening in your core. Just want to add one thing, that doesn't mean that a core should be static. One thing that Harry Markowitz did in his research, and he was the father of modern portfolio theory and was thinking about optimization all the time. He had a particularly deep thought about how does individual investor behavior lead to aggregate investor behavior, right? The market portfolio might seem like the average of the right portfolios for everyone, but it is actually the wrong portfolio for everyone. It is no one specific optimal portfolio.

And part of what I learned from that as well as just the clearly changing risk characteristics, changing interest rate environments and the desirability or lack of desirability of cash at certain times and period, is that to have a good reliable core doesn't mean that you have to have the same portfolio quarter after quarter after quarter. It means that you have to have a consistent, agnostic, unbiased, but also sophisticated, optimized exposure to all of the risk and return opportunities. Now that's going in a consistent way after a risk target.

Peter Hill:

Some of the things that we've seen from advisors and platforms that perform due diligence on our strategies and ask questions around, is one is the track record. How long have you been managing model portfolios? What's the track record been? A big thing that comes up a lot with advisors and their platforms is the rebalance frequency. How often are the PMs going in there and rebalancing the positions? Strategic portfolios tend not to rebalance enough, so there's not enough going on within the portfolio. So the end client might think that the advisor is not doing enough or the model manager is not doing enough or fully tactical solutions that are all over the map. Maybe that's too much, maybe there's too much turnover and it leads to some of the tax efficiency.

The overall expenses of the portfolio comes up all the time as well as what outcome are you looking to deliver? Is it an income oriented model? Is it an aggressive growth model? What flavors of that model do you have across the risk spectrum to be able to meet the objectives of the end client?

Joseph Hosler:

I think what I would add to both is when you're looking at the model managers, it's not going to be the exact same statistics that you're going to be thinking for all of them, meaning a core manager, you need to look at certain aspects of it versus a tactical manager or other satellites. I'll go back to my car analogy and hopefully it'll make more sense. When you buy a car, you want the GPS system to work, you want it to route you to the outcome that you want most efficiently. Well, you're not going to look at the crash protection system with that same lens. You're going to look at the crash protection system, does it actually turn on when you need it right before you crash a car?

So the way that we've gone out to advisors who described it is you have that core side that is focused on optimal outcome or how to get to your optimal position that you want to or destination, but along the way, there are these uncertainties that come about and that you have to be guarded against. And that's where Auour sits, is mostly looking at all the different 1% risks that are out there and looking and identifying when they might turn into a much more material risk to a client base that could cause them to go off their schedule. But we're not looking for every other manager to actually be focused on that crash protection, we want and need to be put together with others that are more focused on just getting to the optimal outcome based off of history.

And so you have to look at analyzing each of these model portfolio providers by what they're focused on delivering and making sure that they're staying within their guardrails and focused on delivering it and can produce the outcome that you want.

Gillian Kemmerer:

Pete, how do advisors measure and demonstrate the value add of model managers to their clients and their business?

Peter Hill:

I think in the case of the three firms that are here today, it's really that access to institutional caliber asset allocation, personnel, research that all of our firms provide them, right? It's that institutional pedigree, that institutional access is very, very important. I also think that all of the firms here today do a really good job at providing advisor level and client use retail marketing materials to be able to talk through some of the changes that are made in the portfolio, demonstrate the value of overweight or underweighting certain asset classes and providing a story behind that as well. I think it's twofold. One is the access, and two is the story that we help them tell about the return stream that we're delivering.

Robert Michaud:

To elaborate what Pete was talking about and to make it specific to what we do, let me just go quickly through our investment process. We start with an investment goal, just like the institutional model does, and to make a specific portfolio good outcomes for an individual investment goal, you have to think about what are the right asset classes? And that's where we as an independent ETF strategists pick the best ETFs that best represent certain types of risk factors, diversification or exposure to asset class that we think are going to be most appropriate for meeting that investment goal for a portfolio. Then we want to understand the risk and return trade off. We again, don't want to think about how right now and going forward without speculating, but just what the market is telling us what the risk and return trade trade-off is. And then we want to use that information across all asset classes to thoughtfully optimize a portfolio.

And so to think about our value, we're never trying to speculate. We're trying to do solid portfolio construction, so you should be judging us based on is this portfolio behaving the right way and the right regimes, responding to risk the way it's supposed to? And to do optimization, we actually pioneered a statistical procedure that looks at thousands of ways that the future could unfold to build a much more diversified portfolio that's not specific to any one regime. And then finally, I think an important part of our job is not that we build a portfolio and then take a vacation for the next 364 days of the year, but that we actually monitor the portfolio every single day to say, well, what combination of changes to the portfolio that you're holding from price changes in the markets as well as what changes in terms of the risk and return environment available, or maybe there's even a new ETF that's more suitable for your investment needs.

What combination of these two things means that is your portfolio still on track? Is your portfolio still the best portfolio that the client could be holding in their accounts to meeting their investment goals? And really monitoring that every day and trading when it actually benefits the investor. And so to get this type of confirmation at various levels from your core manager, is something that I think advisors should be looking for to show their clients that there is the value there, that there is somebody looking out for them on a daily basis and that they're a very capable, thoughtful asset manager doing it.

Gillian Kemmerer:

Joe, all of this sounds great in theory, but let's talk about it in practice. Can you offer any real world success stories or case studies for us?

Joseph Hosler:

Yes. I think I go quickly to what New Frontier and Auour have done within a certain investment, a large independent broker dealer. It was something where the advisors wanted to be, they wanted something. It was mostly one of their groups that was focused on financial planning first. It was a younger group of advisors and they wanted defined asset allocations by managers for different types of client characterizations or categorizations, and we built that for them. And what we've seen is significant success in building out our assets with them, but also just the response from the advisors on how comfortable their clients are from this.

We've gone through over the last five years, a significant amount of disruption to the markets, with pandemics, oil crisis, fears of recession, zero rates going up to something like 5% rates. All of this stuff causes a lot of fear within the client base. And the more that you can produce and show the level of interaction between managers to focus on those different perspectives, and I think that gets to one of the points I wanted to make was that Robert, New Frontier and Auour look at the world slightly differently. We have different perspectives on what we want to do. It doesn't mean the other one's wrong, it just means that we're focused on it. The future is very uncertain.

So this ability to provide different perspectives to get to one optimal solution, we've actually seen advisors growing their business because they don't have to spend time worrying about what mutual fund to buy or what asset class to avoid. They're focused on understanding what we do, partnering with us and leveraging that communication channel and investment skills that we bring, and they've been able to grow their business. So we've seen great success within this one large broker dealer that is loving what we're doing and wanting more of it.

Robert Michaud:

Going on the other end of the spectrum, I've seen success in terms of countless little anecdotes of over the last almost 20 years of building models for advisors, saying, you guys have never let me down, you guys have provided a reliable portfolio that did what you said. And to me, that's a real success story.

Peter Hill:

And if I think about our business here at State Street, there's three key areas where we've seen real life application of models. I think one would be partnering with firms like them. We have a distribution team, they have a distribution team. We're going out and seeing advisors together, collaborating in the field, trying to figure out ways that we can mutually help each other and help our businesses grow, whether that's through engagements in the field or blending model portfolios for the advisors. We've worked with another large broker dealer and we actually partnered with our home office research team where that team was very small. It is a team of two people, but they have thousands of financial advisors all across the country, and they were looking for asset allocation model portfolios.

So we're able to open up the doors to our multi-asset class team, our investment solutions group at SSGA, and essentially allow this broker dealer to adopt their asset allocation, but implement it with a combination of both ETFs and mutual funds from a variety of providers, ourselves included. That's a great way to get them into the four walls of the insights of SSGA as the 4th largest asset manager in the world and be able to leverage some of our expertise. Another RIA that we worked with, very large RIA out of the Midwest, wanted a model portfolio but didn't want to buy the model that's off the shelf, really wanted to make some customizations to it. And it was along that theme of open architecture. They didn't really want to buy a model that had 90 to 100% SPDR ETFs within it.

So we empowered them to go out there and do research, understand what ETFs they wanted to put in that model. And the end result is we had a model portfolio that was built much less of SPDRs, but has been gathering a significant amount of assets on their platform. And it was more open architecture and nature that met their needs, but also met our needs in terms of asset gathering.

Gillian Kemmerer:

Pete, I'm conscious that we're coming toward the end of our discussion. Do you have any high level takeaways that you'd like to offer to advisors considering models?

Peter Hill:

Well, I think that the key takeaway here is models is here to stay, whether they take a variety of shapes or forms, whether it's home office models, advisor led models, or third party asset manager models, which we've talked a lot about here today. Models portfolios they really enable an advisor to be more efficient on a day-to-day basis, spend more time growing their practice, spend more time working with their end clients, and in fact, model portfolios and running a model-based practice enables their practice to be more marketable, most sellable, right? The average age of the financial advisor is north of 50 years old today. That advisor at some point has a decision to make about their practice and what they're going to do.

And if every single portfolio is customized and bespoke, is not really marketable and sellable. So if they look at the next generation of how to pass that practice onto the next advisor or to the next firm, there's a lot of MNA in this industry, and having a models based practice makes your practice more marketable and sellable.

Gillian Kemmerer:

I'd like to hear from each of you, your opinion on the future of this business. Where are models going? So maybe Robert, we can start with you.

Robert Michaud:

Well, I think one thing that we all agree on is that customization has become more possible, more sophisticated and just more broadly applicable. And some of those reasons are just things that we understand. There's the technology, the technology of the industry, of trading systems. There's the custodians and trading costs, which have gone to almost nothing, especially if you're trading in ETFs where they're just so liquid that you can trade them all the time and it hardly has an effect on your portfolio. And then just the raw power of optimization to put this all together in an effective way that represents your investment objectives. But my concern is that we're focused on some of the flashy technologies, the tax loss harvesting, the allure of never having to pay taxes again and missing the real goal of investing.

The real goal of investing is taking advantage of returns on markets over time to provide a return to investors. And so just focusing on losing money on individual securities is the wrong way to think about that. I actually really like ETFs as actually for tax loss harvesting instruments, because to keep the portfolio focused on the right goals is incredibly important. To let it drift because of tax decisions away from your goals is missing sight of the real objective here. But with ETFs, you can actually have a really solid substitute where there are great opportunities to take tax losses. And just to give a simple example, right? There's a lot of great large cap growth ETFs out there. There's only one Apple or Tesla or whatever. So when you're doing tax loss harvesting with ETFs, you can keep perfectly on track with your investment goals.

And I think that this is really going to be the next generation of custom models where the customization is about what's really meaningfully important to the investors from an investment perspective. What are their individual circumstances? And I know I'm being a little repetitive, but this is to make the regular advisor and individual world look a lot more like the institutional world where it has the original customization there. Every institutional portfolio is a custom portfolio because every institution is different, but every individual is also different. And so with technology to help understand what's different about them in a meaningful investment way, we can build the next generation of customized models.

Gillian Kemmerer:

Pete, what would you add there?

Peter Hill:

When I think about the future of models, I think about the asset management industry and the wealth management industry more broadly, right? We've spent the last 30, 40 years packaging everything up and we're going to spend the next few years unbundling everything. So personalization, customization, it's going to take a variety of forms. I think what we're starting to see a lot of within our model portfolio business is more open architecture. So no longer just having a model that's entirely populated with your own proprietary product. We've got to use more third party products, not just in ETFs, but also in funds. We're seeing the advent of liquid alternatives and the injection of those in the models. We could debate the merits of that, but we're seeing more and more of that over time.

We're also seeing multiple vehicle types, whether it's ETFs, mutual funds, and SMAs within a model, or even the possibility of integrating direct indexing retail SMA into the core of a portfolio. The end investor gets their personalized version of the S&P 500. And mind you, all of this would be taxed managed in some way, shape or form through the advent of technology and the partnership with the custodians, right? There's a lot going on in this space and I think it's going to get more customized, more personalized because of the role the technology can play and because of the demands from advisors and platforms for their end clients.

Gillian Kemmerer:

And Joe, any thoughts about the future?

Joseph Hosler:

Definitely. Well, I think we have to be cognizant. We're still just starting the future of model portfolios. I think Pete started off, it's 400 billion ish or so in a multi-trillion dollar environment. We're still very early on the models. Where I see the future is more on, and I'm with Robert on this, about ETF development. We're seeing a lot of new ETFs come out of the market that are pinpointing certain asset classes or parts of the market that have not been attainable before. CLOs are one where it was hard to get into the CLO, now there's three or four, and I'm waiting for State Street to bring out the next.

But you have these different asset classes that have always been focused much more on the institutional space that are making it into the ETF space and allowing us to then deliver those or use those to accentuate our toolbox to provide the right solution to the client. I think we're still early on in the models, but it's the underlying tools that are available to us keep on expanding.

Gillian Kemmerer:

From implementation to the evolution of models, due diligence, to best in class examples, we have covered a lot of ground today. Thank you so much each one of you for taking the time to educate our audience.

Joseph Hosler:

Thank you.

Robert Michaud:

Thank you.

Peter Hill:

Thank you.

Gillian Kemmerer:

From our studios in New York, I'm Gillian Kemmerer for Asset TV, and you just watched Masterclass.