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Fund Managers Try Financial Planning as Indexing Cuts Profit

As investors flock to low-cost index funds that generate only modest revenue for fund companies, many asset managers are seeking new markets.

What several companies, including some of the biggest, have hit upon is a form of financial planning, “a service for which investors are still willing to pay” high fees “that active management once enjoyed,” Don Phillips, a managing director at Morningstar, said.

Fund companies have introduced an assortment of services to assist financial advisers, or to take the task off the advisers’ hands entirely. By Morningstar’s estimate, advisers have invested nearly $35 billion in model portfolios provided by big fund companies and other so-called turnkey asset management providers. That compares with $13.6 billion at the end of 2016.

The roughly two dozen turnkey portfolio providers include household names like Vanguard, State Street Global Advisors and Pimco, along with less well-known managers. Some of them, especially Vanguard and State Street, have been beneficiaries of the shift to index funds. But as Mr. Phillips suggested in a commentary in the company’s magazine, asset managers can reap lucrative fees from advisers who use their model portfolios well beyond the more meager ones earned from the E.T.F.s included in the portfolios.

State Street, for instance, charges a 0.2 percent “strategist fee” to advisers using its model portfolios. The expense ratio on the SPDR Portfolio Large Cap E.T.F., the largest holding in the moderate-allocation model portfolio, is just 0.03 percent, about one-seventh as much.

Fund providers may do well for themselves by offering model portfolios, but how will investors who use them make out? There are plenty of skeptics. Mark Balasa, chief investment officer of Balasa Dinverno Foltz, said advisers like him have a number of advantages over fund management companies — along with some disadvantages, too.

One point in favor of turnkey providers is “the simplicity of it,” he said. “You sign up somewhere. There’s really easy onboarding. Communication is simplified through a portal or app.” Another edge is “a trusted brand, a big name that provides a level of comfort.”

Traditional advisers have a major advantage, Mr. Balasa said: They can cater to the wants and needs of each client when creating a portfolio.

Take an employee of a company that has a dominant weighting in the S&P 500 or another index, such as Microsoft or Apple, whose wealth is largely tied up in the employer’s stock. An adviser could limit that exposure by using options or changing the E.T.F. mix.

Other investors might want to avoid companies that make weapons or tobacco products, a desire that might not be respected in a fund provider’s model portfolio. Nor would other specific preferences. One of Mr. Balasa’s clients “can’t stand Jamie Dimon,” the chief executive of JPMorgan Chase, he said. “Anything with JPMorgan in the portfolio and he comes unglued.”

Advisers can also make additional adjustments for tax management, allocating assets to taxable and tax-deferred vehicles in the most efficient way, and selling winners and losers to limit capital-gains tax, he said. This can add as much as two-tenths of a percentage point to annual returns, he said.

Fund providers contend that their methods have advanced to the point that the portfolios they build are attractive options for investors and advisers, even taking the tight relationship between them into account.

Vanguard has captured nearly half of the money invested by advisers in turnkey provider model portfolios by doing what it does with its funds in general: offering a lot of choices with low costs.

Don Bennyhoff, senior investment analyst in the Vanguard Investment Strategy Group, said the company offers 64 model portfolios of Vanguard E.T.F.s with allocations of varying risk profiles, similar to its conservative, moderate or aggressive allocation mutual funds. And while Vanguard dominates the turnkey provider universe, it also tries to appeal to investors who make their own trading decisions.

“The idea is that if there are investors who feel confident doing it on their own but would like a little tool, we provide model portfolios,” Mr. Bennyhoff said.

Purchases and sales of E.T.F.s within these Vanguard model portfolios may be done one at a time, he said. The hypothetical Microsoft employee who might be better off with limited exposure to growth stocks, for instance, could follow a conservative model portfolio or lighten up on domestic tech or growth stocks by tweaking the allocation of a riskier one.

State Street, which has $1.4 billion in model portfolios marketed to financial advisers, according to Morningstar, offers a range of five portfolios with varying risk profiles. The allocations, which are made among SPDRs, State Street’s brand of E.T.F.s, are based on forecasts by the firm’s Investment Solutions Group, a team of strategists. As with Vanguard, investments in the State Street portfolio components are made individually.

Pimco, which Morningstar said manages $518 million in assets in its model portfolios, emphasizes its expertise in fixed-income investing. It provides pure “Pimco fixed-income models, which can be paired with an all-equity model or individual equity positions selected by the adviser,” said Agnes Crane, a Pimco spokeswoman.

Other companies, like Vanguard, say their model portfolios can be combined with other investments to create custom allocations.

Mr. Balasa said remaining open to a variety of options is crucial if these turnkey portfolios are to be useful to investors.

“When they use their own funds only — ‘red flag’ may be too strong, but that would make me look very hard,” Mr. Balasa said. “No one has a corner on the best of everything.” He said he seeks providers that “have open architecture and are transparent about why they pick what they pick, and share their methodology.”

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