2020 has been a year like no other instigated by a global pandemic, COVID-19, global markets experienced unprecedented levels of volatility. With the geo-political tensions between the United States (US) and China continuing, the re-opening and subsequently re-closing of economies, and a presidential election with a contested victory. 2020 can unequivocally be classified as a year of extreme disruption.
Despite all the uncertainty model portfolios implemented via managed accounts continue to gain popularity both locally and abroad. Why? The demand for constructed portfolios could of increased as a result of the uncertainty in 2020.
Many financial planners are reconsidering their value in the investment management of their clients’ assets. Even practices that run model portfolios in-house are open to partnering with investment experts to support their portfolio construction process. 92% of model users in the US believe outsourcing part or all of their portfolio construction improved their practice during the COVID-19 market volatility.2 Whether you decide to be responsible for the investment management of model portfolios or partner with professionals to outsource portfolio construction it’s important to consider what the future of model portfolios looks like.
Here are three trends for 2021 to consider, each trend provides the potential to meet challenges we have inherited from 2020.
ESG Model Portfolios
Environmental, social and governance (ESG) is topical across the globe and for 2020 assets have poured into sustainable funds, as at 30 June 2020 there was US$1.06 trillion globally in ESG investments. This figure has doubled over the most recent three year period.3 In an attempt to regulate this trend governments globally have intervened. In Europe regulatory changes have been largely supportive of this approach to investing, conversely the US has proposed restrictions that attempt to prevent ESG investment practices in private-sector retirement schemes.
Regardless of the governments approach to ESG investing, this trend is expected to continue as attitudes from investors and assets managers shift to recognise ESG factors and how they can be material to the long-term financial performance of companies. The pandemic has propelled this change, with a heightened focus on building sustainable and resilient business models based on multi-stakeholder considerations.
In response to an increasing number of investors targeting specific social or environmental outcomes, advisers will continue to seek better solutions that address the growing need for ESG investing. Therefore, we expect this this investment need to translate to ESG model portfolios solutions in 2021.
The ESG evolution has resulted in a mix of terminology across the industry, and advisers are being asked by their clients to provide guidance in defining ESG objectives and implementing the right solutions. Clients expect informative discussions and compelling materials to help them understand the concepts. Advisers are therefore encouraged to partner with industry experts to better understand ESG and ESG Model Portfolios.
Decline in Closed Architecture Models
Portfolio diversification is more than just asset class diversification. Your portfolio should include multiple investment styles and managers, allowing clients to benefit from the ideas and independent investment teams across the globe. With this comes a growing demand from advisers to partner with institutions to offer open architecture model portfolios.
Advisers are voicing their concerns when only proprietary products are included in the underlying asset allocation of model portfolios. The demand for this is reflective in the US market where there is an ongoing decline of adviser practices offering pure closed architecture models. One of the top developments for US advisers in 2020 was incorporating non-proprietary product into their model portfolio offering.4
2021 is the year we expected an increasing number of advisers to consider benefits of offering open architecture model portfolios to their clients.
As technology to implement model portfolios or managed accounts improves advisers are able to address the unique investment needs of their clients. These improvements are likely to result in an increase in customised model portfolio solutions for 2021.
The advisers level of customisation could be as straightforward as substituting or restricting one of the investment products within a model portfolio or as complex as adding an annuity or alternative, non-liquid investment.
It’s important to be cautious with the customisation approach as adding complexity doesn’t necessarily lead to better investment outcomes. Further, customised model portfolios seem counter intuitive to the goal of models; to create consistency in the approach to investing, while saving time for other activities. That’s not to say there won’t be clients that truly have unique needs requiring some element of customisation. It’s just as important that the adviser and their model portfolio partner are cautious of the level of customisation to ensure the customisation does not undo what models seek to achieve in the first place.
This is what we think is on the horizon for 2021. Speak with the State Street SPDR ETFs Team to further discuss how the model portfolio trends for 2021 could benefit your business.
1 AP Milliman Managed Account FUM Census as at 30 June 2020
2 Citywire: Model Portfolios 2020
3 Passive Sustainable Funds: The Global Landscape 2020
4 U.S. Asset Allocation Model Portfolios 2020
State Street Global Advisors defines a model portfolio as a collection of assets owned by the underlying investor and continually managed by professional investment managers. Model portfolios employ a diversified investment approach to target a particular balance of return and risk or portfolio objective.