5 Trends in How Advisors Construct Portfolios

Advisors’ approaches to portfolio construction are evolving, according to a new report by Practical Perspectives.

In the report, Practical Perspectives, an independent consulting, intelligence and research firm working with wealth management providers and distributors, explores important trends in how financial advisors build portfolios and how those trends may be changing in the future.

“We anticipate that accelerated change in how advisors build portfolios is now the norm,” writes Howard Schneider, president of Practical Perspectives and author of the report. “Knowing the next big thing in portfolio construction is anyone’s guess. History has shown there will always be another new ‘big thing’ and that firms willing to adapt to this change and respond with creativity and thoughtfulness will be most likely to earn advisors trust and allegiance and ultimately succeed over time.”

The report – titled “Trends in How Advisors Construct Portfolios – Insights and Opportunities 2017” – is based on more than 625 online surveys completed in December 2016 from a broad cross-section of advisors across key channels including Full Service (wirehouse, regional and national broker-dealers), independent broker-dealers, and registered investment advisors (RIAs).

Here are the five trends that Practical Perspectives identifies in its report.

1. The rise of fee-based approaches is inevitable.

While it is little surprise that RIAs are fully committed to fee-based approaches, advisors in the independent and full-service broker-dealer channels also are heavily oriented to these approaches, according to the report.

More than half of broker-dealer advisors report at least 50% of the assets they manage are in fee-based accounts, typically mutual fund and ETF wrap programs.

“We expect the growth of fee-based business will continue, potentially accelerated by the implementation of DOL rules or changes at broker-dealers in response to a greater alignment with fiduciary responsibilities,” the report states.

Overall, a large majority of advisors make significant use of fee-based platforms in constructing portfolios. Roughly 8 in 10 advisors (80%) make significant use of fee-based platforms in managing client assets and fewer than 1 in 10 advisors make minor use or do not use advisory solutions.

In contrast, less than 1 in 5 advisors (18%) make significant use of traditional commission or brokerage platforms and more than 6 in 10 advisors (62%) make minor use or do not typically use these capabilities in managing client assets.

2. The impending DOL fiduciary rule could affect key aspects of portfolio construction.

If the impending Department of Labor rules are implemented, which will happen on April 10 if the new administration and Congress don’t stop it, most advisors expect to shift more toward fee-based solutions and to lessen their use of brokerage platforms and higher-cost alternative investments, according to Practical Perspectives.

The report finds that nearly 2 in 3 advisors, or 64%, expect the DOL’s fiduciary rule will cause a significant or moderate increase in use of fee-based accounts, including 1 in 3 advisors, or 36%, that expect the increase will be significant.

In turn, a similar percentage of advisors (65%) expect a significant to modest decrease in use of brokerage platforms as a result of the DOL fiduciary rule. Among full-service and indie advisors, that percentage is even higher with nearly 75% of both expecting to decrease their use of brokerage platforms, the report finds.

Advisors also anticipate a move toward passively managed solutions if the DOL fiduciary rule is implemented.

According to the report, 42% of the advisors surveyed expect to increase use of passively managed solutions in response to the rule and 34% expect to decrease use of alternative investments as an outcome of building portfolios under the rule.

3. Advisors are increasingly embracing passive investing.

Practical Perspectives anticipates a continued gradual shift toward passive management driven by desire for lower cost solutions and tax efficiency.