by P.E. KelleyMr. Kelley is managing editor for this magazine. Connect with him by e-mail: [email protected]
Broadridge, a leader in global financial data and analytics, recently noted the growing popularity of model portfolios among financial advisors. An October 2019 survey by the firm reported that the use of model portfolios has grown nearly 19% annually since 2016. Broadridge predicts that model portfolio assets will more than double by 2023. It also noted that model portfolios are the fastest growing vehicle among intermediary-sold products. More than 50% of advised assets are reported to be in these portfolios. At the same time, we know that many life insurance agents are looking to provide more comprehensive or holistic services by offering investment products, and have been turning to model portfolios to do so.
Northern Trust Asset Management, which has guided generations of investors, now offers its time-tested asset allocation and portfolio construction expertise through a number of model portfolios. We spoke with Melinda Mecca, director of investment solutions.
PEK: What is fueling the popularity of model portfolios — and how they might fit in an overall portfolio or financial plan?
MM: What’s driving interest can be summarized by our own FlexShares ETFs Race to Scalability survey of advisors, which was designed to gauge financial advisors’ attitudes regarding the use of third-party investment management solutions. The survey found that advisors who outsource cite benefits such as more time with their clients, a consistent investment process, and better investment results.
With regard to model portfolios, this is quite logical given that they are professionally managed and often diversified or multi-asset class, making them a one-stop solution for advisory or insurance firms that want to outsource the investment management part of their business.
We’ve observed an increase in the use of model portfolios by agents and advisors. We believe there are several reasons for this. First, there’s the rise of Turnkey Asset Management Platforms, known as TAMPS, which offer easy access to professional investment management. Second, there’s industry competition, which has blurred the lines between insurance and advisory practices, according to surveys such as the 2018 study by LIMRA and EY. The comprehensiveness and simplicity of model portfolios make them a perfect fit for agents looking to take on investment needs as part of their practice. In addition, for models such as Northern Trust Asset Management’s, they reflect fiduciary standards.
PEK: What are the most common funding or investment vehicles used by model portfolios?
MM: Exchange-traded funds and mutual funds are the most common vehicles found within model portfolios. This is due to potential benefits such as cost-efficiency, risk-efficiency and operational ease of use. For more than 40 years, Northern Trust Asset Management has been managing multi-asset class portfolios for sophisticated investors – from wealthy individuals to large institutions. We can use any combination of investment vehicles, and we have the ability to trade and custody these portfolios in-house, while also making them available through platforms such as TAMPS.
PEK: Tell us about the model portfolios that Northern Trust Asset Management offers.
MM: We offer a range of multi-asset strategies that target different risk return and time-horizon characteristics. Our Diversified Strategist Portfolios target a range of risk and return objectives and are designed to navigate changing market conditions. By this I mean we make tactical adjustments to the asset allocation mix, which is always driven by Northern Trust Asset Management’s overriding belief that investors should be compensated for the risks they take – in any market environment and in any investment strategy.
Our Goal Engineer Series target a particular goal date, similar to target date mutual funds. With these portfolios, asset allocation starts out more skewed to stocks than bonds and then begins to move to a more conservative position as investors approach their goal date. Goal Engineer is suited for retirement or college savings, or other investment goals with a timeframe.
We realize that agents and advisors have many choices when considering model portfolios. For those weighing the merits of our target-risk Diversified Strategist Portfolios and our target-date Goal Engineer Series, we believe it’s important to do so in the context of the experience. For more than 40 years, we’ve been helping investors navigate changing markets and honing our asset allocation process. Our strategies are built with a time-tested, global asset allocation discipline and enhanced by extensive risk management and portfolio construction expertise. The manifestation of this process is accessible in our model portfolios, as well as the 4-star Northern Global Tactical Asset Allocation mutual fund. (Overall Morningstar Mutual Fund Rating among 376 World Allocation funds derived from a weighted average of the fund’s 3- 5- and 10-year risk-adjusted returns as of 9/30/19.¹) My point is that we’ve been at this for many years, with much success, serving very savvy investors who are known for doing their due diligence.
PEK: With regard to the tactical adjustments made by Diversified Strategist Portfolios, what dictates them or how are they determined?
MM: Before answering that, let me first say that initial portfolio composition is determined by our firm-wide dynamic asset allocation process and implemented in real time. Annually, our Investment Policy Committee meets to determine a 5-year risk/return outlook for a wide range of asset classes, based on historical data and forward-looking economic themes. For example, in 2019, we lowered our expectations for global equity returns. Our view is that a shifting economic model, due to geopolitical and technological developments, will slow growth. These assumptions inform our strategic asset allocation weights across all of our models.
Now, with regard to your question about tactical adjustments in our Diversified Strategist Portfolios, every month, our Investment Policy Committee meets to determine if our strategic view still holds, and whether we need to make any tactical adjustments to our asset allocations. For example, in our outlook for the year ahead (issued in December 2019), we reinforced our base case views of continued slow growth and lower interest rates. We also noted that resilient economic data, especially in the U.S., has helped support financial markets and reduce investor concerns about a possible recession. However, we also acknowledged that trade/tariff risks and U.S. election uncertainty still have the potential to weigh on investor sentiment. On balance, this left us continuing to favor “less risky” risk assets, a position that is supported by our expectation that U.S. – China trade tensions, while not going away, will not worsen over the tactical horizon. Taken together, these views and conditions led us to reduce our natural resources recommended allocation by two percent and increase our high yield and global real estate allocations by one percent.
We strive to be very transparent, and all of our views and risk/return expectations are publicly available on our website. Our monthly views and any tactical adjustments are communicated to clients of Diversified Strategist Portfolios in our monthly asset allocation update.
PEK: How can advisors, agents or their firms, get access to Diversified Strategist Portfolios as well as other portfolios:
MM: The easiest way to access model portfolios is to go through an intermediary such as a TAMP. Envestnet is the largest TAMP in the U.S.
PEK: Your first retail clients came through Banker’s Life. What led to its relationship with Northern Trust Asset Management?
MM: In June 2016, CNO Financial Group, Inc., the holding company for Bankers Life and Casualty, announced the launch of Bankers Life Securities and Bankers Life Advisory Services to assist their customers with a broader range of services and to better meet their financial needs. They partnered with “leading institutional-level asset managers” such as Northern Trust Asset Management to manage their clients’ portfolios. Since then, other insurance providers who utilize TAMPS have partnered with us for similar reasons.
PEK: What do you believe will be the next significant development in the model portfolio space in regard to income strategies?
MM: We believe retirement income strategies will dominate the model portfolio industry in the near future. Consider this: Currently, 40.6% of U.S. households include individuals who are 34 to 65 years old. According to the Population Reference Bureau, the number of Americans aged 65 and older will more than double by 2060. And according to the 2019 Employee Benefit Research Institute (EBRI) Retirement Confidence Survey, what people want in retirement is income stability. The problem is that many of these individuals will run out of money in retirement, according to EBRI.
So we believe what Americans need are portfolios that can grow large enough to last not only to – but through – retirement, while producing income to maintain living expenses. It’s hard to meet both investment objectives, however, especially in our current slow growth, very low interest rate environment. Striving to meet this challenge is the next major development we see within model portfolios.
We’ve met this challenge head on. Last year we created the Growth with Enhanced Income option for our Diversified Strategist Portfolios. It follows the same proven tactical asset allocation process as Diversified Strategist Portfolios’ other options, but tilts toward yield-producing asset classes, such as high yield corporate bonds, and quality dividend stocks. This moderate-risk portfolio takes enough risk to potentially grow the portfolio, while generating income that targets a withdrawal rate of 4%, which is widely considered in investment circles to be a rate that will keep most retirees from outliving their savings.
¹Past performance is no guarantee of future results. Ratings reflect fee waivers in effect; in their absence, ratings may have been lower.
The information is provided for informational purposes only and is not intended to be, and should not be construed as an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice.
Forward-looking statements and assumptions are Northern Trust’s current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.
Capital Market Assumption (CMA) model expected returns do not show actual performance and are for illustrative purposes only. They do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact the future returns. Stated return expectations may differ from an investor’s actual result. The assumptions, views, techniques and forecasts noted are subject to change without notice.
© 2019 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the U.S. Products and services provided by subsidiaries of Northern Trust Corporation may vary in different markets and are offered in accordance with local regulation. For more information, read our legal and regulatory information about individual market offices at northerntrust.com/disclosures.
Northern Trust Asset Management is composed of Northern Trust Investments, Inc. Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K, NT Global Advisors Inc., 50 South Capital Advisors, LLC and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.