The investment management industry seems to have come full circle. After years of increasing complexity — moving from mutual funds to separately managed accounts (SMAs) and unified managed accounts (UMAs) — we’re witnessing a fascinating shift back toward simplicity. But this time, it’s simplicity with a purpose.
The evolution of portfolio construction
The industry’s journey has been driven by a noble goal: providing clients with increasingly sophisticated and customized investment solutions. We’ve built platforms that can help accommodate different managers for equities and fixed income, helping to offer increased flexibility in portfolio construction. Yet many advisers are now asking a fundamental question: How do we stack these pieces together into something meaningful for our clients, without sacrificing scalability in risk management and growth of the business?
ETF blends appear to show improved client retention rates and greater demonstrated staying power compared to some of the more complex alternatives. This trend could suggest that customization remains important, but there’s also significant value in packaging solutions in a way that helps enhance the client experience and promotes long-term investment discipline.
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Finding balance: Core and satellite approach
One of the current challenges for many advisers is finding the right balance between scalability and customization. Many advisers are adopting a hub-and-spoke approach, maintaining a core allocation while offering targeted solutions for specific client outcomes. These solutions might include customized tax management strategies or focused exposure to alternative asset classes.
Advisers aren’t necessarily seeking to reinvent their entire approach or move away from using a model portfolio. Instead, they’re looking for ways to shore up their core strategies by stacking specific elements to address individual client needs. This “tug of war” between standardization and customization represents one of the most significant challenges — and opportunities — in investment management today.
The alternative investment dilemma
One debate that has arisen in our industry over recent years centers around the integration of alternative investments into ETF structures. The fundamental appeal of alternative investments lies in two key characteristics:
- Their ability to zig when markets zag
- The illiquidity premium — the additional return investors earn for accepting limited liquidity
While several fund providers have ventured into this space, there are legitimate concerns about whether this approach truly serves clients’ interests. When we package historically illiquid investments into highly liquid vehicles, we risk creating a fundamental mismatch. Advisers might want to carefully consider whether these new structures truly deliver the intended benefits of the underlying asset class. They might also ask: Will clients genuinely capture the advantages of private credit exposure? Or are they simply holding another ETF that happens to have different underlying assets?
More importantly, we should consider questioning whether these structures can maintain their promised liquidity during market stress. What happens when everyone rushes for the exits simultaneously? The ability to honor redemptions during challenging market conditions is an important consideration.
Human behavior: The financial industry's persistent challenge
The most significant challenge in investment management typically isn’t portfolio construction — it’s human behavior. While markets have historically delivered strong long-term returns, the average investor consistently typically captures only a fraction of these returns. Even professionally managed portfolios in recent years seem to have struggled to get close to or match their index targets.
As Morgan Housel astutely observed in his book, Same as Ever: A Guide to What Never Changes, many investors believe that adopting a long-term perspective eliminates the need to manage short-term challenges. The reality is that a 30-year investment horizon consists of 30 one-year periods, each requiring investors to stay the course through uncertainty and volatility. That level of commitment and patience is difficult to achieve, especially as our lives, circumstances and goals change.
Best practices for modern portfolio management
Given all this, what are some ways advisers can help strike a balance between utilizing advanced investment strategies and creating more simplicity for their clients? The firms who are actively pursuing this balance typically share several key characteristics:
- They design portfolios based on who their clients actually are, not who they wish them to be. This might mean sacrificing theoretical portfolio optimization in favor of structures that clients can stick with through market cycles and offering solutions like buffered ETFs, which can provide psychological confidence for the consumer.
- They align their communication with their portfolio management style. There’s little value — and potential harm — in providing weekly updates on a portfolio that rebalances quarterly. This misalignment in communication can create unnecessary anxiety and prompt ill-timed requests from clients.
- They understand the power of 1%. While advisers may never completely bridge the gap between theoretical and realized returns, even modest improvements in investor behavior can generate significant value. Moving from a 5% to 6% realized return can potentially mean hundreds of thousands of dollars in preserved wealth over time.
Looking ahead
Investment management is always evolving. As we navigate the latest evolution, the key to progress lies not in choosing between simplicity and sophistication, but in thoughtfully combining them. Some of the most effective solutions will likely be those that maintain sophisticated underlying management while presenting a straightforward experience to clients.
For advisers, this could mean simultaneously focusing on portfolio construction and creating an investment experience that helps clients maintain their commitment through various market conditions. After all, the most well-designed portfolio in the world provides little value if clients can’t stick with it when it matters most.
1/25 – 4186911W – AE Wealth Management, LLC (AEWM) is an SEC Registered Investment Adviser (RIA) located in Topeka, Kansas. Registration does not denote any level of skill or qualification. Information regarding the RIA offering the investment advisory services can be found on brokercheck.finra.org. Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. The personal opinions expressed by Ben Sullivan are his alone and may not be those of AE Wealth Management or the firm providing this report to you. This information is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. None of the information contained herein shall constitute an offer to sell or solicit any offer to buy a security or insurance product.
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