A booming $4.9 trillion branch of the U.S. asset management industry is funneling investor cash into funds that are pricier and worse-performing than alternatives, new research claims.
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A trio of academics argues that model portfolios off-the shelf investment strategies, often consisting of bundles of ETFs, are ridden with conflicts of interest that undermine one of the hottest and most opaque businesses on Wall Street.
These allocation blueprints, usually created by asset managers and deployed by financial advisers, have exploded in popularity as easy one-stop solutions for investors of all stripes.
Jonathan Brogaard, Nataliya Gerasimova and Ying Liu wrote that the firms designing them tend to favor their own exchange-traded funds. The advisers are steering client money with little regard to what that means for performance.
The team said that these affiliated ETFs, on average, have lower past returns and higher fees than unaffiliated funds. We do not find evidence that the affiliated ETFs provide superior performance after they are recommended. These are big claims against a business with ever-growing clout over the billions that are gushing in and out of ETFs every day. Over the last five years, model portfolio assets have doubled over the last five years and Broadridge Financial Solutions believes that they can double again to $10 trillion by the year 2025.
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Many models are asset managers who can benefit from new cash flowing to their funds. Financial advisers have accepted them as a way to outsource allocation decisions, so more time can be spent on attracting and serving clients.
The investors are hardly innocent victims. The paper said that many people seem to be blindly following model recommendations and taking little notice of fees and performance.
The study found that investors who follow the recommendations also behave differently, as they pay less attention to the price and performance of theETFs.
Brogaard at the University of Utah, Gerasimova at the Norwegian School of Economics and Liu at the Shanghai University of Finance and Economics tracked the effects of model changes in Morningstar data between 2010 and 2020.
According to the findings, an ETF receives 1.1 percentage point more flows per month after a recommendation or inclusion in a model. Demand for the featured products becomes less sensitive to fees and past performance.
Despite fees that are on average six basis points higher and year-to-date returns 67 basis points lower than unaffiliated funds, the ETFs owned by the same parent company are a little more than three-times more likely to be added to a model.
The findings are the latest iteration of longstanding worries that Wall Street firms tend to use one business line to boost another, regardless of cost to the end-investor. Previous studies have found that investing platforms and retirement-plan providers favor funds of the same brand.
Anecdotal evidence has been growing for a long time about the impact of model portfolios. A number of outsize ETF flows have been linked to adjustments in large models in recent years.
A tweak to a strategy by BlackRock Inc. in July resulted in a record daily inflow to its ETF of inflation-hedged bonds. The world's largest asset manager has added its main ESG fund to its model portfolios, which has helped fuel $18 billion of inflows in the past two years.
BlackRock provides model portfolios for advisors designed to meet client's investment objectives while controlling risk in an efficient, cost-effective manner, a spokesman said by email. Our platform allows advisors to choose from a wide range of portfolio options, including iShares ETFs, BlackRock mutual funds and ETFs, and funds from third party managers. A new paper, titled Advising the Advisors: Evidence from ETFs, is among the first to document the sway of these portfolios.
The academics wrote that little is known about how they affect the investment choices of financial advisors despite the increasing number of model recommendations. We want to add to the industry debate about the opacity of the model portfolios. None of the work from home is a permanent part of how jobs are done.
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