Model marketplaces are popping up everywhere, like daffodils in springtime. They give advisers access to model portfolios built by asset management firms and “fund strategists.” Advisers can implement the models exactly as built by their creators or modify them to reflect their own views or the needs of their clients. A pretty cool innovation.
Model marketplaces are attracting even more attention because the model portfolios are being offered on either a no-fee or a low-fee basis. This continues the fee-compression trend that was highlighted when the robo-advisers first emerged with their low-fee offerings.
The emergence of model marketplaces has elicited statements by earnest pundits about the “commoditization” of asset management. These well-meaning observers misunderstand the significance of model marketplaces and are planting the seed of a dangerous idea.
Portfolios are not commodities
Merriam Webster defines “commoditize” as “to render a good or service widely available and interchangeable with one provided by another company.” Certainly, model marketplaces make asset management services, in general, and model portfolios, specifically, more widely available. But the model portfolios offered through the marketplaces are far from interchangeable. The suggestion that they are is harmful to advisers and investors alike.
If you think asset management has been commoditized, consider these facts from the Morningstar Inc. database. (I have eliminated obvious outliers.)
In the ETF Strategist category (50%-70% equity), returns for 2017 ranged from 17.44% to 10.33% — a 700-basis-point-plus difference.
- The 2017 returns for U.S. Value ETFs ranged from 27.11% to 18.7% — an 800-basis-point-plus difference.
- The 2017 returns for U.S. High Dividend ETFs ranged from 25.84% to 15.86% — a 1,000-basis-point difference.
- The 2017 returns for U.S. Momentum ETFs ranged from 44.13% to 26.94% — a 1,700 basis point difference.
The size of these spreads in seemingly generic product categories shows asset management has not been commoditized. Even passively managed products like U.S. Value ETFs can produce a wide range of results.
The differences show up in areas other than one-year performance results. The U.S. Value ETF with the highest one-year performance had an expense ratio that was three times that of the U.S. Value ETF with the lowest performance — 0.15% versus 0.05%. Do you get what you pay for? Not necessarily. The U.S. Momentum ETF with the highest performance had an expense ratio that was less than one-quarter of the expense ratio of the lowest performer — 0.15% versus 0.64%.
Differences like this exist everywhere in the asset management industry. Look closely at any type or category of asset manager — active mutual funds, exchange-traded funds, separately managed accounts or fund strategists — and you will find wide disparities in both performance and expense ratios. These products are not interchangeable. They are highly differentiated. Clearly, they are not commodities.
Industrialization, not Commoditization
The development of model marketplaces is another step in the “industrialization” of asset management services. Manual labor is being replaced by mechanized systems of mass production. Individual craftsmen are being replaced by assembly lines. We are seeing the efficient division of labor among specialists. Technology is allowing innovations in the manufacture, delivery and pricing of products and services.
At the beginning of the 20th century, investors bought individual stocks and bonds. In 1924, the first modern mutual fund was developed, allowing investors to buy into baskets of stocks or bonds. In the 1970s, separately managed accounts became available, giving investors another way to access baskets of stocks or bonds. In 1993, the first ETF was developed, providing investors with yet another vehicle to access stocks and bonds. That was product innovation.
In 1984, the first mutual fund marketplace was launched, making funds more accessible to investors. In the late 1980s, product turnkey asset management platforms emerged, making portfolios of mutual funds and separately managed accounts available through specialists. In the 1990s, technology TAMPs created virtual supermarkets of portfolio strategists. Now model marketplaces are deconstructing the TAMP offering and giving advisers a la carte access to model portfolios. These developments represent the evolution of product delivery.
Let’s call it what it is
Although the term “industrialization” sounds old school in our high-tech world, it far more accurately describes the transformation we are witnessing than “commoditization.” The fact that a product is more widely available and its price is dropping does not make it a commodity.
Computers, cell phones, and big-screen TVs are all more widely available and significantly cheaper than they were five years ago. But there are differences in their performance, functionality and quality. They are not interchangeable. If you think they are, ask iPhone users to switch to Samsung, but cover your ears first so you won’t hear their howls.
Let’s drop this dangerous notion that asset management has been commoditized. People might start to believe portfolios are like bags of sugar on a grocery store shelf. They are not. Asset management is being made more accessible and less expensive than in days gone by. But caveat emptor. Due diligence and thoughtfulness are still important.