Financial advisors are prioritizing the use of model portfolios over funds of funds (FoFs), according to the latest Cerulli Report – U.S. Product Development 2024.
The value and level of customization offered by model portfolios are more appealing to both financial advisors and asset managers, the report adds.
61% of advisors plan to prioritize model portfolios over FoFs. Additionally, 44% of financial advisors report using the FoF structure, but only 8% expect to increase their use of FoFs in the future.
Advised assets placed in FoFs are generally used for core client segments with lower investable assets. Advisors prefer to use actively managed strategic funds for these clients and remain divided on whether the fees charged by FoFs are proportional to the value they provide—a key reason why advisors are expected to deprioritize their use in the future, the report explains.
“The FoF structure is under pressure as it continues to conflict with part of financial advisors’ value proposition as portfolio managers, while other solutions, such as model portfolios, serve as a middle ground by offering outsourced, fully constructed portfolios that still allow customization by advisors,” says Matt Apkarian, Associate Director.
On the other hand, according to Cerulli, nearly two-thirds of asset managers believe FoFs encroach on the value proposition of portfolio construction by wealth managers, including model portfolios built by wealth management headquarters and advisors who prefer to create customized portfolios for clients. This creates a significant barrier for these products to get past gatekeepers and onto the shelves of key platforms.
Similarly, both gatekeepers and individual advisors face obstacles regarding fees, as FoF expense ratios and the underlying product expense ratios are subject to rigorous scrutiny, Cerulli adds.
“While the FoF structure will remain a staple in defined contribution retirement plan lineups, its use outside of 401(k) plans will be limited. Instead, more customizable solutions, such as model portfolios, are available to advisors for whom outsourced investment management aligns, and these will be preferred in the future,” Apkarian concludes.
