Model Portfolios Decide Which ETFs Succeed. That Might Not Be a Good Thing

Advisors need to be unbiased, but what about the model portfolios they choose?

Not surprisingly, when issuers create a model portfolio, they’re incentivized to include their own ETFs. But more and more funds with meager assets are suddenly spiking to reach hundreds of millions of dollars in AUM in just a few days, all because they were added to a major issuer’s model. The consequences could be significant for advisors who are increasingly relying on model portfolios, and who want to provide unbiased fiduciary advice to their clients, but don’t know where to start.

“We see this trend, and it’s a little disturbing,” said Joe Mallen, CEO of Modelist, which builds customized portfolios for fiduciaries. “I don’t blame anyone for doing that. We just think that the relationship of who’s designing the model for the advisor should be one that suits the advisor, not the asset manager.”

Follow the Leader

Earlier this month, the iShares Systematic Bond ETF (SYSB) grew to more than $600 million from just $67 million in a matter of days after it was added to one of BlackRock’s portfolios. The reason for BlackRock’s decision came down to expense ratios, Mallen said. However, BlackRock stated in a client communication shared with VettaFi that the firm is reducing “overweight to growth by adding to value, and pivoting from quality to momentum.” SYSB charges 25 basis points, while a comparable iShares bond product, IUSB, has a fee of just 6 basis points. That spread could generate more than $1 million in annual revenue based on the funds’ assets, according to Mallen.

A recent VettaFi report pointed out spikes and falls in other funds due to model adjustments:

• The iShares S&P 500 Value ETF (IVE) added $3.2 billion in one day.
• The iShares MSCI USA Momentum Factor ETF (MTUM) pulled in $1.3 billion that same day, its highest in over a year
• The iShares MSCI Quality Factor ETF (QUAL) was likely used to fund these shifts, losing $4.2 billion in one day.

A New Model. As more advisors rely on model portfolios to free up time with their clients, they’re spending less time doing due diligence, said Aniket Ullal, head of ETF Research & Analytics at CFRA Research. What might help in the future are tools that not only compare ETFs, but model portfolios, as well. “Should [advisors] be more aware? I think the answer is yes,” he added. “They need to know who’s the provider, what kinds of funds they tend to select, and then also choose the right model provider. You may want a model provider who’s agnostic to which funds are included.”