Vanguard, Envestnet Team Up to Curb Tax Risks on Model Portfolio Conversions

Envestnet and Vanguard are expanding their partnership to tackle one of the biggest obstacles to broader adoption of model portfolios: the tax bills that can come with moving longtime clients into them.

While model portfolios have become a staple of modern wealth management, allowing advisors to outsource investment management and spend more time on financial planning, many are reluctant to trigger capital gains levies by leveraging them, especially for clients with highly appreciated, legacy portfolios.

To bring more expertise to bear on the challenge, Envestnet announced last week that Vanguard will join its Fund Strategist Tax Management (FSTM) Advantage program, which helps advisors make such transitions in a tax-sensitive manner. The Vanguard Advisor’s Alpha service model is also now available through Envestnet’s platform. “We are long in the tooth on a bull market that makes the provision of tax services all the more important,” Dana D’Auria, Envestnet co-CIO, said in an emailed statement. “Advisors cannot control market returns, but they can control an important factor in after-tax return realization by managing tax consequences.”

Can’t Someone Else Do It?

Model portfolios, which seek to provide diversification while taking risk profiles and financial goals into account, have surged in popularity as advisors look to scale their practices:

• More than 80% of fee-based advisors use model portfolios to some degree.
• Third-party model portfolios, those designed and managed by firms like BlackRock, Vanguard and Morningstar, hold almost $1 trillion in assets.
• Across all model portfolio segments, Broadridge Financial expects asserts under management to reach $18.6 trillion by 2030.

I Got a Little Tax Problem. Taxes remain a major hurdle, particularly for older clients with concentrated positions or decades of embedded gains. Jeff Judge, a CFP with Chesapeake Financial Planners, recently worked with a client who held $2.8 million of a single stock purchased for just a few dollars a share in 1997. “The model made perfect sense from a diversification standpoint, but the tax bill didn’t,” he told Advisor Upside. “The easy move is to reset and take the tax hit all at once, but that’s rarely the right answer.” Instead, transitioning legacy clients often requires a multiyear migration strategy, gradually unwinding concentrated positions while running parallel bucket strategies, which Judge acknowledged creates significant amounts of administrative work for advisors.