One of the primary ways financial advisors have added value to their client relationships has always been through investment selection and asset allocation guidance. That’s still true, of course, but it’s probably fair to say the dynamic changed a bit after the 2008 financial crisis. Not only has the investment landscape changed dramatically, so too has the compliance and regulatory backdrop. Advisors today simply have less time, and less desire perhaps, to pick investments and asset classes. Not surprisingly, the result has been a growing movement toward the use of fund strategist portfolios.

Outsourcing the Process

By definition, fund strategist portfolios are asset-allocated investment solutions comprising some combination of mutual funds, exchange-traded funds (ETF) and individual securities. While a host of different types of shops have emerged to meet the growing demand, there are basically four forms of allocation strategies being employed:

  • Strategic: A long-term, fixed target asset allocation where a strategist attempts to achieve a risk/return profile that mimics a point along the efficient frontier.
  • Tactical: An approach in which the strategist can quickly change a portfolio’s risk profile and actively allocate to a range anywhere from 100% allocation to equities to 100% allocation to cash, depending on the strategist’s outlook. A tactical strategist may have the ability to actively move in and out of sectors, asset classes or countries based on their evaluations. These types of portfolios are typically used as complements to investors’ existing strategic asset allocation rather than replacements.
  • Dynamic: An approach in which the strategist utilizes a combination of tactical and strategic elements within a constrained range around a target allocation.
  • Asset Class Specific: A self-described approach that will utilize specific asset class segments like High Yield, TIPS, Global Equity, Emerging Markets, Alternatives, etc.

A Rapidly Growing Space

In just the last few years, the investment outsourcing marketplace has exploded from just a few, relatively inflexible funds-of-funds to a wide variety of products and providers. In fact, the investment and consulting industries have been creating products at a rapid pace in an effort to meet growing demand for more efficient and effective products. According to Cerulli Associates, Packaged Mutual Fund Advisory Assets have increased from $141 billion in 2006 to $332 billion as of end of the year 2011. 

But both investor education and research on these popular products remains a near-term hurdle. According to Morningstar, nearly two-thirds of these strategist solutions started in 2005 or later and roughly 30% of the strategies have a track record less than three years old. Utilizing the traditional elements of manager research and due diligence are critical, but only to a certain extent as a result of the limited performance track records for most strategist portfolios.

A Higher Level of Due Diligence

All of which means the selection of fund strategist offerings for clients warrants a higher level of research and due diligence. An advisor considering fund strategist portfolios needs to dig deep into what these models deliver and make sure that the asset allocation solution chosen is in sync with his or her business model and client objectives.

The primary driver of the selection process should be the investment capability of the outsourcing firm. A candidate must be able to demonstrate a successful track record and investment acumen. Particular attention should be centered on the investment team and firm. Specific elements to take note of would include:

  • Investment Type – strategic, tactical, dynamic, asset class specific
  • Track Record – real or hypothetical (back-tested)
  • Performance Evaluation – What is the proper benchmark for evaluation? Does the strategist even attempt to track a benchmark?
  • Portfolio Fit - We aren’t filling style boxes anymore. Depending on the investment type, how does the strategy fit into a client’s specific portfolio allocation? Is it a complementary solution or a stand-alone investment option?
  • Measuring Risk – Depending on how tactical the strategist is and their bands (limitations) around their allocations, risk profiles for strategies have the ability to drastically change. How can this potentially impact a client’s portfolio risk/return?
  • Underlying Investment Vehicles – Does the strategist use only ETFs, only mutual funds, or a combination of both? How does that affect the underlying cost? How does it affect their trading? How does it increase/decrease their ability to gain exposure to unique asset classes?
  • Trading – How tactical is the strategist manager? Some tactical strategists have more than 300% turnover.

Beyond that, factors such as administrative ease, investment flexibility, and potential conflicts of interest weigh in the decision. And somewhere along the line, advisors need to consider whether they’re willing to make relative sacrifices in potential investment return and flexibility when comparing products.

The Choice Is Yours

As many investment firms and advisors have come to know, combining funds to produce a desired stream of returns is much more difficult than back-testing might suggest. But challenges notwithstanding, it’s hard to argue these packaged products don’t allow advisors to act in the most consultative way possible.  Not to mention how they can help scale an advisor’s practice in an efficient manner.  The broad diversification goals behind most fund strategists represent a step forward for investors. They could be a big step forward for advisors willing to do their homework.   


Author’s disclaimer: Past performance is not indicative of future results. The opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. Information obtained from third party resources are believed to be reliable but not guaranteed. Any mention of a specific security is for illustrative purposes only and is not intended as a recommendation or advice regarding the specific security mentioned.