Financial advisors are facing serious demands on their time. They need to provide a broader set of services to a diverse clientele, build new client relationships to grow their business, and handle complex operational and practice-management issues on a moment’s notice. On top of these challenges, advisors must grapple with portfolio construction amid volatile late-cycle markets, full valuations across many major asset classes, and historically low interest rates.

Many advisors have turned to model portfolios for help. In fact, Cerulli estimates that nearly half of all advisors now utilize professionally managed models in some capacity, and up to 90% may incorporate models in the coming years.

Going forward, learning when it makes sense to outsource portfolio construction will be critical for financial advisors to deliver the best potential solutions for investors and free up resources so that they can provide even more value to their clients.

The benefits of model portfolios

Professionally managed models have been around for decades, but adoption has grown significantly in recent years. According to Cerulli, models now play a role in the management of $6.5 trillion in wealth management assets and have the potential to ultimately influence up to $11 trillion as advisors weigh the costs of managing portfolio construction themselves against the potential benefits of utilizing home office and third-party models. At PIMCO, we understand that this approach represents a change to many advisors’ business models, but ultimately we think it can offer three substantial benefits:

Time savings. Many financial advisors spend considerable time on portfolio construction: On average, investment management responsibilities comprise 15% of the average advisor’s time (see Figure 1), which translates to 300−400 hours over the course of a full calendar year. With time becoming an increasingly scarce commodity for advisors, models offer a compelling solution that frees up valuable capacity to deepen existing client relationships, source new clients, and build additional value-added capabilities to offer clients.

Figure 1 shows a pie chart of where advisors allocate their time. The bulk of it, about 58%, is taken up by client-facing activities. Administrative tasks come next, at 22%, followed by investment management, at 15%, and professional development, at 5%.

  • More predictable outcomes. One of the greatest risks to a financial advisor’s practice is unexpected portfolio outcomes. Utilizing model portfolios can potentially increase the predictability of outcomes. Figure 2 compares portfolio returns of advisor-managed accounts to those of model-based accounts: With considerably more data points closer to the central line, the model-based accounts demonstrated roughly half the return dispersion of the advisor-managed accounts.

Figure 2 shows two scatter plots comparing portfolio returns of a large number of advisor-managed accounts to those of similar amount of fund-strategist-managed accounts. With considerably more data points closer to a horizontal central line, the fund-strategist-managed accounts demonstrate roughly half the dispersion of the advisor-managed accounts.

Importantly, the data does not imply superior performance from model-based accounts, but rather suggests that using models can help increase the likelihood of predictable outcomes, mitigate the risk of unpleasant surprises, and potentially lead to a smoother ride for the advisor and the client.

  • Protection against cognitive biases – Virtually all investors bring a myriad of cognitive and emotional biases to their investment decisions. These embedded biases can be difficult to self-diagnose, and even more challenging to account for before an irreversible suboptimal investing decision is made.

Figure 3, which examines monthly asset flows into intermediate-term bond funds relative to the 10-year U.S. Treasury yield in 2018, provides a useful recent example of these biases in action and their potential impact. Through the first nine months of 2018, flows into the high quality (core) bond category were positive as Treasury yields largely remained range-bound. However, investor sentiment changed rapidly when Treasury yields increased in October and many market participants suddenly worried that the Fed was falling behind the curve on inflation. Whether the sentiment stemmed from confirmation bias (as investors thought that recent upticks in yields were a signal of the rising rate environment they’d long been waiting for) or the bandwagon effect (as investors saw their peers running for the hills), the result was clear: Investors fled from high quality bonds in the fourth quarter last year − as stock market volatility increased and bond prices rose. That left many without sufficient diversification away from the equity market.

Figure 3 is a bar and line graph showing core bond flows superimposed with Treasury yields for the 12 months of 2018. Through the first nine months of 2018, flows into the intermediate-term bond category were positive, as Treasury yields largely remained range-bound, roughly between 2.70% and 2.95%. When rates broke out of the range to the upside in October, increasing outflows were registered for the last three months. Yet in December, rates had fallen back again to below 2.70%, even as outflows were at their highest for the year, at about $17 billion.

Models offer a way to potentially reduce the impact of biases. By entrusting portfolio construction or guidance to a professional asset manager, advisors can help clients keep emotions in check, separate signals from noise, and maintain a disciplined, long-term approach to managing for specific outcomes and maximizing future return potential.

Where do models fit in?

For many years, model portfolios were essentially an all-or-nothing proposition: Advisors either outsourced investment selection altogether or built their own portfolios using individual securities, mutual funds, and exchange-traded funds (ETFs). Now, advisors have more flexibility to reap the potential benefits of models while still retaining the level of discretion that’s most appropriate for their individual practice.

  • Option 1: Full outsourcing – For advisors who want to focus on providing holistic financial planning services to existing clients and prospecting for new relationships, fully outsourcing to model providers is a valuable option that can potentially generate time savings upwards of 300 hours per year. That said, many advisors have long-standing client relationships that were built primarily on investment selection and asset allocation advice, so a full-scale immediate shift in operating model can be a big leap for both the advisor and the client.
  • Option 2: “Unbundle” the traditional model portfolio – For advisors looking to free up capacity but still retain some portfolio construction engagement, unified managed account (UMA) platforms and expanded product offerings now allow for a hybrid, building-block approach. Rather than choosing one portfolio model provider, advisors can now select a few asset management partners to oversee different sleeves of their client portfolios. At PIMCO, we see this hybrid, unbundling option as a great middle ground for advisors. It offers substantial time savings and allows for more flexible implementation of client preferences (level of active management, fees, etc.); but it is a less drastic change than Option 1 and keeps advisors more entrenched in clients’ holistic financial plans.
  • Option 3: In-source decision-making, leverage guidance Rather than simply listing all the potential ingredients, model portfolios now detail the asset manager’s suggested recipe. So even for advisors that retain full control over portfolio construction, asset manager models can offer value as an additional input in the decision-making process, providing guidance on the number of line items and position-sizing in certain strategies across client objectives.

At PIMCO, we recognize the challenges that advisors face, and we are excited to offer a range of actively managed model suites, including:

  • Fixed income models that are designed to address a variety of investor objectives, including capital preservation, equity diversification, and income generation
  • Multi-asset models across the risk spectrum, including income-focused strategies designed for clients nearing or in retirement

Click here to learn more about the PIMCO models platform or contact your PIMCO account manager for additional information.

The Author

Justin Blesy

Asset Allocation Strategist

Ryan McMahon

Global Wealth Management

Mark Thomas

Account Manager, Global Wealth Management

Related

Disclosures

The PIMCO Models described in this material are available exclusively through investment professionals.

PIMCO Models are based on what Pacific Investment Management Company LLC (together with its affiliates, “PIMCO” believes to be generally accepted investment theory. PIMCO models are for illustrative purposes only and may not be suitable for all investors. PIMCO Models are not based on any particularized financial situation, or need, and are not intended to be, and should not be construed as, a forecast, research, investment advice or a recommendation for any specific PIMCO or other strategy, product or service. Individuals should consult with their own financial advisors to determine the most appropriate allocations for their financial situation, including their investment objectives, time frame, risk tolerance, savings and other investments. Volatility is historical and is likely to change over time. PIMCO has not undertaken, and will not undertake, any analysis to determine any specific models’ suitability for specific investors.

The risks of a PIMCO Model allocation will be based on the risks of the PIMCO mutual funds (each, a “Fund”) included in the PIMCO Model allocation (“Underlying Fund”). The PIMCO Model allocation is subject to the risk that the Underlying Funds and the allocation and reallocation of the PIMCO Model among the various Funds may not produce the desired result. The PIMCO Models may not reflect the impact that material economic and market factors might have had on PIMCO’s decision making if PIMCO were actually managing a portfolio with assets pursuant to the PIMCO Model. The PIMCO Model allocations to Underlying Funds have changed over time and may change in the future. The selection and weighting process across Underlying Funds is informed based on return estimates driven by PIMCO’s forward looking view and risk estimates driven by PIMCO’s analytic infrastructure. Management risk is the risk that the investment techniques and risk analyses applied by PIMCO will not produce the desired results, and that certain policies or developments may affect the investment techniques available to PIMCO in connection with managing the strategy.

PIMCO Model allocations are licensed or otherwise made available to investment professionals. PIMCO Models’ allocations are updated on a defined production cycle. The Underlying Funds are available by prospectus only. Implementing investment professionals may or may not implement the PIMCO Model’s allocation as provided, and actual allocations to Underlying Funds may vary. There are expenses associated with the underlying Funds in addition to any fees charged by implementing investment professionals. Additionally, the implementing investment professional may include cash allocations, which are not reflected herein

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification does not ensure against loss.

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626.  ©2019, PIMCO.

For financial professionals: The implementation of, or reliance on, a model portfolio allocation is left to your discretion. PIMCO is not responsible for determining the securities to be purchased, held and sold for a client's account(s), nor is PIMCO responsible for determining the suitability or appropriateness of a model portfolio allocation or any securities included therein for any of your clients. PIMCO does not place trade orders for any of the your clients' account(s). Information and other marketing materials provided to you by PIMCO concerning a model portfolio allocation –including holdings, performance and other characteristics -may not be indicative of a client's actual experience from an account managed in accordance with the model portfolio allocation.

CMR2019-1031-422209

Monthly Municipal Market Update, September 2021
XDismiss Next Article