Model Behavior: Providers Focus on Taxes and Alts

To borrow from Indiana Jones and the Last Crusade, financial advisors must “choose, but choose wisely” what they suggest to clients. Thanks to model portfolios, however, they have fewer choices to make nowadays.

Assets in model portfolios totaled $943 billion as of March, more than triple 2021 levels, according to data Morningstar published last month. And providers are constantly honing their models. For many, taxes are top of mind. A new report from Cerulli found that more than 80% of model issuers say tax optimization services for taxable accounts are an important service and support effort, and 40% say that making models more tax-efficient is among their top-three product development initiatives. That’s music to an advisor’s ears. 

“Tax efficiency is a top priority for us because many of our clients are retirees drawing income from their portfolios,” said Sean Beznicki, director of investments at VLP Financial Advisors. “They need reliable cash flow, but how that cash is raised matters. Realized gains can increase taxable income and, for some clients, lead to higher Medicare premiums.” 

The Holy Grail: Tax Efficiency 

More tax-efficient model portfolios are super important to advisor Joon Um of Secure Tax & Accounting, too, as he works with higher-income clients. 

“I’d like to see model portfolios do more with tax-loss harvesting, asset location and managing capital gains,” Um said. “Clients may not always ask about ‘tax efficiency’ directly, but they definitely care about how much they actually keep.” 

Exposure to alternative assets is also a priority, with 57% of providers saying that incorporating semi-liquid and illiquid alts is a top-three product development initiative, per Cerulli:

• But not all advisors are convinced that it should be a focus. Beznicki said fundamentals — including tax-efficient ETFs, low-turnover funds and thoughtful allocation of assets between taxable and tax-advantaged accounts — should be the priority before more complex products are introduced. 
• “The goal should be better tax management and customization, not just adding more products,” Um said. 

Hunting for Diversification. Just this week, Raymond James announced that it’s expanding its model portfolio with enhancements for advisors who work with high-net-worth clients, and emphasized exposure to private markets as a means of diversification. “Alternatives can help with diversification,” Um said of adding more alts to model portfolios in general. “But I’d be cautious about fees, complexity and liquidity.”