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Portfolio > Portfolio Construction

Here’s How Advisors Structure Their Model Portfolios

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Advisors are paying lower fees on their model portfolios, increasing their use of ETFs but improperly using factor products, according to BlackRock.

Their average model portfolio fees fell below 50 basis points in 2019 from 54 basis points in 2018 while average ETF usage rose to 38% of portfolios from 36.1%, according to BlackRock’s Advisor Insights Guide, which is based on thousands of advisor investment models collected from the firm’s Aladdin risk management platform over the 12 months ended Sept. 30, 2019. 

Despite the increasing use of ETFs, an average 54.4% of portfolio models used mutual funds. A plurality of portfolios — 35% — used a blend of passive, active and factor products rather than just a single approach, while 13% used only active mutual funds, 8% only core index products and 3% only factor products. “The old debate of ‘active versus passive’ should evolve to a framework of blending index, alphas and factors,” according to the BlackRock report.

Within equity allocations, 41% didn’t include any factor products and among those that did, the allocation was too small — just over 21% — to have any meaningful impact on a portfolio’s tilt, according to BlackRock. Either the weights of most factor products were too light or other investments diluted the effect of factor tilts. Only portfolios using the small size factor showed any meaningful difference in tilt. 

The guide looked at five factors in portfolios: value, smaller size, momentum, quality and minimum volatility. The first two tend to perform best during the recovery portion of an economic cycle; momentum, during the expansion phase; and quality and minimum volatility during the slowdown and contraction phases, according to BlackRock. We are currently in the slowdown phase. 

In light of these findings, BlackRock’s Portfolio Solutions team, headed by Brett Mossman, developed a four-step investing approach that it says has been effective for many advisors. It helps advisors “establish an efficient strategic asset allocation” using tilts to enhance investments.

1. Benchmark. This the reference point for the risk and return of the market over time. In order to outperform a benchmark, a portfolio needs to adjust asset allocations or tilts within asset classes, such as value or growth, or include active management that picks the right stocks or times investment decisions correctly.

2. Budget. This is the budget for risk and cost. BlackRock suggests that advisors decide their market views, such as whether they’re bullish or bearish, which would set the overall direction for risk taking. In other words, should the portfolio have higher or lower volatility than its benchmark?

3. Invest. Once those investment views are crystallized, advisors can set and/or adjust asset allocations between and within asset classes, taking into account sectors, geographic locations and thematic weights. They can choose core index products to avoid making asset allocation calls but add factor products to generate tilts at a low cost. Or they can use only factor products, but those products can offset or dilute the impact of one another. If actively managed mutual funds are added to the mix, BlackRock recommends a “fairly short” list and heavy portfolio weights of only the “largest conviction” selections.

4. Monitor. Advisors should measure portfolio performance against a clients’ long-term goals and make adjustments to keep the portfolio on track. Successfully blending index, factors and alpha components involves measuring how much the portfolio is trying to track the market or beat it and not overpaying for any component.

BlackRock found that advisors allocated an average 45.5% of model portfolios to U.S. stocks, almost 11% to non-U.S. developed stocks and 4.7% to emerging market stocks. In 2019 they tended to overweight industrials, consumer cyclicals and basic materials and underweight technology, the latter hurting performance.

The remaining 39% of advisor model portfolios had an average 28% invested in U.S. bonds, 5.4% to non-U.S. bonds, 1.4% in cash and 4.3% invested in real assets, leverage and other assets. The average duration of the bond sleeve was 3.59, versus 4.14 a year ago. Ironically the average duration of the most aggressive portfolios was lower (and therefore less interest rate sensitive) than moderate portfolios and the credit risk of the most aggressive portfolios was less than the most conservative ones.


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