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.
“External events such as pending DOL rules (if implemented), growing prominence of RIAs and fee-based business, and lagging performance of many (although not all) active managers may accelerate the shift,” the report states.
The report finds that while 68% of advisors indicate no significant shift in their relative usage of active vs. passive solutions during the past year, those who have changed are overwhelmingly tilted toward increased use of passive management by about 2 to 1.
More than 7 in 10 advisors (71%) view use of passive management as a strategic long-term decision and are unlikely to shift these assets to active management in the foreseeable future, according to the report.
The report also finds that there’s a shrinking segment of advisors that do not use passive management in any form, and this shrinkage appears to be accelerating. 4. Smart beta use is on the rise – but still unfamiliar to many.
Smart beta products have emerged in concert with the growing orientation to passively managed solutions and the interest in creating a better “mousetrap” as far as risk and reward.
Familiarity with smart beta solutions continues to grow with 65% of the advisors surveyed now aware of these products, according to the report.
And, the report finds that smart beta solutions have been quickly adopted with 1 in 5 advisors now using them.
However, a significant segment of advisors – especially those in brokerage channels – are unfamiliar with these solutions. Overall, about one-third of advisors remain unfamiliar with smart beta. Nearly 45% of indie advisors and 38% of full-service advisors are not familiar with smart beta solutions.
According to the report, the use of smart beta has increased gradually in the past year, and most advisors do not expect a significant change in use during the coming 12 months. In fact, one-third of advisors indicate no likelihood of using smart beta in the coming year.
5. Liquid alternatives, while widely embraced, represent a small portion of advisors’ assets.
While most advisors employ liquid alternatives in constructing portfolios, use is generally modest as measured by share of total assets managed or usage across the advisors’ base of clients, according to Practical Perspectives.
The report finds that 78% of the advisors surveyed have assets in liquid alternatives; however, these holdings typically represent 10% or less of the overall assets managed for clients.
“It appears that most advisors are selective in their use of liquid alternatives, although to some extent the use of these solutions may be limited by compliance guidelines or internal firm policies,” the report states.
Only 9% of the advisors surveyed have committed more than 20% of the assets they manage to liquid alternatives, according to the report.
The strategies most widely used for liquid alternatives include real estate, strategic income, commodities or natural resources, and multistrategy approaches.
Regarding the performance of liquid alternatives, most advisors are only modestly satisfied, the report finds.
Roughly 45% of the advisors surveyed appear to have modest satisfaction with how liquid alternatives performed in the past 12 months. Only 12% of the advisors are very satisfied with liquid alternatives’ performance, while 43% are less satisfied or not satisfied.
“This suggests a significant portion of advisors do not perceive that liquid alternatives have met performance expectations and this dissatisfaction may impact future use of these vehicles,” the report states.
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