Evaluating ETF Model Portfolios: The Dues & Don’ts

09/12/2019

This article is relevant to financial professionals interested in model portfolios. WisdomTree ETF model portfolios are available only to financial professionals, through various portfolio platforms.

 

I previously wrote “Debunking the Myths of a Model Portfolio Approach,” exposing the difficulties of third-party due diligence as a myth.

 

Let’s prove it by diving deeper into best practices for ETF model portfolio due diligence.

 

Ask the right questions

 

Starting at the firm level, here are a few questions advisors should ask when evaluating model portfolio providers:

 

  • How long has the firm been in the ETF business, and does it have a reputable history in model portfolios?
  • Has the firm been able to attract top talent?
  • Is the firm operationally equipped to manage model portfolios?

 

The goal is to be assured the model portfolio provider has robust operations and the support in place to manage model portfolios, as well as core competencies in providing asset allocation advice.

 

Investment Committee

 

Next up is the investment committee. The key is understanding not just who makes the decisions, but also how, and specifically what, type of decisions are being made. Starting with the “who” and the “how”:

 

  • Who makes up the committee (background, years of industry experience, years at firm, etc.)?
  • How long has the committee been in existence and managing model portfolios?
  • How are decisions made (group consensus, voting structure, breakout of voting and non-voting members, etc.)?

 

The depth, breadth and experience of an investment committee is important. It’s also crucial to understand this committee in the broader context of the asset allocation framework. This includes the “what” of decisions being made:

 

  • How often does the committee meet, and is it consistent?
  • How clear and robust is the investment process, and has the asset allocation framework changed over the years?
  • Quantitative vs. qualitative input—how much subjectivity is involved in the fund selection and asset allocation decisions?

 

Increasing usage of quantitative modeling and data analytics has refined investment processes. It’s important to understand how the people and the processes come together and the consistency of that framework.

 

Model Portfolio Objectives

 

When evaluating the actual model portfolios, advisors should understand each model’s objective:

 

  • What’s the model portfolio’s benchmark and the tracking error or style drift relative to that benchmark?
  • How often is the model portfolio rebalanced or reconstituted, and has this been consistent over time?
  • Can the investment committee deviate from the equity/fixed income target asset mix of the benchmark?

 

Don’t automatically group all ETF model portfolios together just because they have the risk tolerance “moderate” in their names. The risk and return profiles of moderate model portfolios can materially differ if they lack similar objectives, asset mixes and turnover constraints.

 

Consider the Investment Universe

 

  • Is the ETF universe open-architecture1 or confined to the asset manager’s proprietary products?
  • Which types of asset classes are considered (equities, bonds, commodities, currencies, etc.)?
  • Within an asset class, what geographies, market capitalizations and factors are considered (domestic vs. international equity exposure, large-cap vs. small-cap, etc.)?

 

Similarly constructed model portfolios can have large variations in returns and volatility if their investment universes differ greatly from one another. When evaluating model portfolio performance, ask:

 

  • How long is the live track record and is it third-party verified?
  • Does the performance justify the underlying fees of the ETFs or any strategist fees charged?
  • Are there any explanatory variables (factors) that can explain the long-term performance relative to its benchmark?

 

The questions listed above aren’t meant to be an exhaustive list but should provide a good starting point.

 

Many of these questions can be answered on an asset manager’s website provided you have the appropriate log-in credentials.

 

We also highly recommend consulting with the asset manager directly—not only to gain confidence in the firm—but also to understand the level of the support that advisors can expect.

 

  • How much access do advisors have to the investment committee?
  • How does the asset manager communicate model portfolio rebalances and their investment committee’s views on the market?
  • Who is the dedicated point of contact at the firm ?

 

Communication and transparency are vital in the due diligence process. WisdomTree designed the experience for advisors using our model portfolios with those two things in mind. We also encourage financial professionals to compare other model portfolios with ours by visiting our Digital Portfolio Developer tool page or contacting a WisdomTree representative.

 

 

 

 

 

1Unrestricted architecture means that a model portfolio may include ETFs other than WisdomTree ETFs. However, the model portfolios are expected to include a substantial portion of WisdomTree ETFs

Important Risks Related to this Article

This content is for information only and is not intended to provide, and should not be relied on for, tax, legal, accounting, investment or financial planning advice by WisdomTree, nor should it be considered or relied upon as a recommendation by WisdomTree regarding the use or suitability of any model portfolio or any particular security. This content is intended for use only by a financial advisor as a resource in the development of a portfolio for the financial advisor’s clients. The financial advisor is solely responsible for making investment recommendations and/or decisions with respect to its clients without input from WisdomTree, including with respect to investing in accordance with any model portfolio or any particular security. WisdomTree is not acting in an investment advisory, fiduciary or quasi-fiduciary capacity to any financial advisor or its client and is not providing individualized investment advice to any financial advisor or its client based on or tailored to the circumstances of any individual financial advisor or its individual client.

 

This content has been prepared without regard to the individual financial circumstances and objectives of any investor, and the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Investors and their advisors should consider the investor’s individual financial circumstances, investment time frame, risk tolerance level and investment goals. Investors should consult with their own advisors before engaging in any transaction. Using an asset allocation strategy does not ensure a profit or protect against loss, and diversification does not eliminate the risk of experiencing investment losses. There is no assurance that investing in accordance with a model portfolio’s allocations will provide positive performance over any period. The model portfolios are provided “as is,” without any warranty of any kind, express or implied. Information and other marketing materials provided to you by WisdomTree or any third party concerning a WisdomTree model portfolio, including allocations, performance and other characteristics, may not be indicative of an investor’s actual experience from an account managed in accordance with a model portfolio’s strategy.

 

This content, and any assistance provided as described herein, including portfolio construction and asset allocation stress testing, assessments, discussions, output or other assistance (whether by WisdomTree personnel or digital tools) (the “Assistance Tools”) are for information only and no material or Assistance Tools are intended to provide, and should not be relied on for, tax, legal, accounting, investment or financial planning advice. This content and the Assistance Tools are intended for use only by a financial advisor as a resource in the development of a portfolio for the financial advisor’s clients.

 

 

About the Contributor
Associate, Asset Allocation

Ryan Krystopowicz joined WisdomTree in March 2016 as a member of the Distribution Team and has transitioned over to the Asset Allocation Team as a Product Specialist, ETF Model Portfolios.  He is responsible for maintaining and delivering data and content associated with WisdomTree Model Portfolios.  Ryan also supports model development and decisions, as well as contributes to the commercial success of Model Portfolios by supporting the sales and client solutions team.  He started his career at a Registered Investment Advisor working as Research Analyst and Assistant Trader. Ryan received a degree from Loyola University of Maryland and is a holder of the Chartered Financial Analyst designation.