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Portfolio Models Could See Headwinds Ahead, Especially Among RIAs

Portfolio Models Could See Headwinds Ahead, Especially Among RIAs

Despite the fact that broker/dealers expect increased flows into their portfolio models over the next year, advisors’ usage of these models has declined in the last 12 months, especially among RIAs. The current market volatility will be a major test of these models, as advisors look closely at how they come out of this environment and possibly rethink their appeal, said Hari Krishnaswami, product manager for FA Vision, a joint service of kasina and Horsesmouth.

According to a recent survey of 2,922 advisors by kasina and Horsesmouth, 61.6 percent of advisors are using home-office models as of the second quarter, down from 67.7 percent a year ago. RIAs had the greatest decline in usage, from 55.9 percent in the second quarter of 2010 to 42.4 percent this year. Rep. ThinkTank research from 2010 found even fewer advisors using home-office models—38 percent—while less than 30 percent of RIAs were using the models.

“The key roadblock to the growth of model portfolios has been advisor pushback,” says Krishnaswami. “Some advisors are reluctant to place greater assets in models because of distrust in the asset allocation or investment decisions made by home-office research. An additional fear among advisors is that turnkey solutions like model portfolios diminish their value-proposition and inhibit the portfolio’s portability.”

Krishnaswami says the fact that RIAs are more cautious is reflective of the channel and their fee-based model; they want to show their clients they can offer additional value.

The Rep. ThinkTank research also found that only a small number of advisors rely exclusively on home-office models.

“The majority indicated that they use them as a foundation for their asset allocations, but make adjustments to suit their clients’ needs,” the 2010 report says.

The Need to be Nimble
Linda Stirling, a rep with RBC Wealth Management in La Jolla, Calif., says she does not rely on model portfolios because you need to be able to transition out of the markets and put client assets into more defensive stocks in a time like this. Models, she says, do not take into account the different stages of bull and bear markets. Right now, Stirling has moved clients from a more aggressive mid-cap growth portfolio into a more defensive large-cap dividend growth portfolio.

The models are less flexible, less dependent on the current environment, and don’t allow advisors to use their investment expertise, Stirling adds. They are probably coming into question because of the models’ underperformance over the last decade, she says. In 2009, advisors had to step back from the models to achieve alpha and make up for the losses incurred during the time. “Our short-term memories are very good,” Stirling says. “Everyone’s standing back and saying, ‘What’s the best approach?’”

G. Andrew Ahrens, founder and CEO of Ahrens Investment Partners in Lafayette, La., also doesn’t use home-office models. While the models diversify among different asset classes, they tend to stay long only, bringing all of the asset classes down at the same time, he says. He prefers to stay tactical, and he doesn’t like that the models rebalance on a set schedule, not on an as-needed basis. “They [the models] let a lot of water in the boat before deciding to plug the hole.”

Advisors especially need to be more nimble with clients’ portfolios during the summer, when the stock market tends to underperform, Ahrens says. “Very seldom do you get a rally in the summertime that has any legs to it.”

Ahrens has managed to weather the recent volatility by getting his clients out of more aggressive stocks and reallocating to gold, silver, higher-paying dividend stocks, cash and bonds.

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The Benefits
But the survey by kasina and Horsesmouth found that distributors actually expect 31.1 percent of asset flows to come from model portfolios in the next year. With regulations increasing, many advisors likely don’t want to deal with the potential for litigation, and these models put that responsibility on the broker/dealer, Krishnaswami says.

John Knowlton, an advisor with Portage, Mich.-based Oak Point Financial Group, says he uses LPL Financial’s dynamic model for smaller client accounts, and he’s been happy with its performance. The dynamic model, however, trades frequently, so clients are able to take advantage of different market environments, Knowlton says. It also allows his clients to get good investment advice regardless of their account size. Less than 5 percent of Oak Point’s assets are in the models, but they’re adding to that.

That said, home offices still have a long way to go in building trust with their advisors, Krishnaswami says. According to the FA Vision study, only 26.1 percent of reps have “strong trust” in the home office, compared to 63.9 percent having low to moderate trust.

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