The Evolution of Wealth Democratisation – From ETFs to Model Portfolios

  • Model portfolios allow financial advisers to quickly offer well-constructed vehicles that fit their clients’ specific investment needs
  • This immediate appeal makes them one of the market’s fastest-growing product choices, worth over US$4 trillion in the US alone1
  • Constructing model portfolios using ETFs is a logical choice given the natural synergy between both structures

Twenty years ago, exchange-traded funds (ETF) were introduced to Australia. Since then, they have helped democratise the investing ecosystem, enabling the ordinary investor to obtain straightforward, low-cost, and diversified exposure to various asset classes. $113.5 billion worth of assets were invested in over 223 listed ETFs as of 30 June 20212.

To be truly diversified, investors must hold investments across asset classes. An efficient and cost-effective way to do this is to construct a portfolio of ETFs that spans a variety of holdings. Determining this mix is often the purview of the financial adviser. Yet, even with professional assistance, this can still be a time-consuming task.

Fortunately, advisers now have access to a range of institutional grade “done for you” diversified model portfolios that can be immediately implemented with managed accounts.

Model Portfolios 101
Model portfolios are pre-packaged portfolios consisting of a variety of underlying funds. Each portfolio can have a distinct goal – for instance, high growth or a steady income. These objectives determine the broader asset allocation structure and the type of funds used to achieve this. All this is set by an investment manager, who is also responsible for the ongoing management, including rebalancing the portfolio.

However, unlike ETFs and managed funds, model portfolios are often not directly available to retail investors. In Australia, managed accounts – a product or service where the underlying investments are transparent to the investor but managed by an adviser – are the predominant vehicle for implementing model portfolios.

Why are model portfolios so attractive from an adviser perspective? They offer a few key benefits, namely:

  • More time for the adviser to focus on their core value proposition: Model portfolios allow advisers to leverage the expertise of investment managers to offer well-constructed vehicles that suit their clients’ financial needs. This frees up time to focus on holistic financial planning and advice – their core value proposition.
  • Improved client retention: With more time to focus on their core value proposition, financial advisers may be able to retain clients for longer. The COVID-19 pandemic and ensuing market selloff further reinforced the importance of using model portfolios. 
  • Outcome-oriented: Model portfolios are often categorised by desired outcomes and risk profiles, making it easy for advisers to match their clients’ goals to specific vehicles. 
  • Tax-efficient and transparent structure: Managed accounts allow the adviser and client to see how their money is invested. Further, they are generally more tax-efficient than managed funds, as investors directly own the assets in the account. 
  • Access to institutional investment management: Clients get access to institutional investment teams with deep asset allocation capabilities and research expertise. 

A Fast-Growing Landscape
In the US alone, there is an estimated US$4.1 trillion worth of assets invested in these model portfolios – a figure expected to hit US$10 trillion by 20253. In Australia, managed accounts held AU$95 billion of assets as of the end of 20204 and are on track to be the dominant investment structure within financial planning practices over the next decade.

Research shows that 70% of Australian financial planners already use or intend to use managed accounts – a 25% increase over the past five years. Furthermore, planners expect almost a quarter of new client inflows to go to managed accounts by 20245.

However, not all model portfolios are created equal.

ETFs in Model Portfolios – A Natural Synergy
Model portfolios can be constructed with managed funds or ETFs. Currently, out of 1,003 unique model portfolios available in Australia, about 12% use ETFs as their building blocks6. We expect this figure to grow to at least 30% within the next five years.

  • ETFs lower the cost of the model portfolio. Investors in model portfolios must bear the costs of the underlying funds. As such, ETF model portfolios should have lower fees compared to their managed fund counterparts – which can influence future returns.
  • ETFs improve the liquidity of the model portfolio. As publicly listed securities, ETFs are generally more liquid than managed funds. By extension, the ETF model portfolio also has higher liquidity.
  • ETFs give the model portfolio greater flexibility. The higher liquidity of ETF model portfolios makes them easier to rebalance and optimise – giving them greater flexibility.
  • ETFs ensure the model portfolio has maximum transparency. Unlike managed funds, investors will always know which securities their ETF holds. Combined with managed accounts, this means the ETF model portfolio has the highest degree of transparency.

The Growth Engine of Model Portfolios
The alignment between the structure of ETFs and model portfolios makes them a logical fit. Therefore, we believe ETFs will be responsible for most of the growth of model portfolios moving forward.

After all, ETFs themselves have seen the highest growth in the past five years as investors have become increasingly aware of the impact of fees on returns. There are now over a million ETF investors in Australia . This trend is likely to be reflected in model portfolios – which is excellent news for Australian investors who can enjoy fully diversified and low-cost investment portfolios.