Risk-Adjusted Returns Top Priority for Financial Advisors

Maximizing risk-adjusted returns, long-term wealth growth, asset diversification and downside risk protection remain the top priorities for financial advisors in portfolio construction, according to the August Trend Monitor report from FUSE Research Network.

Based on a survey of approximately 560 advisors across various distribution channels, FUSE found that 45% of respondents prioritize risk-adjusted returns when constructing portfolios. Another 43% place a priority on maximizing long-term wealth growth, and 42% on maximizing diversification and asset class coverage. Minimizing downside risk was cited as a top priority by 35% of respondents.

“The results were fairly consistent with prior years, which is a really good thing because we understand that advisors are settled on certain things,” said Lisa Travaglini, director of editorial at FUSE and a co-author of the report. By allowing survey advisors to pick only two options as top portfolio construction priorities, “we were able to understand that secondary factors are really important as well, but they are just not as important as the top four priorities.”

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The distribution channel influenced which of the four priorities advisors were most focused on. FUSE found that maximizing risk-adjusted returns was the primary driver for wirehouse advisors and RIAs, at 53% and 48% of respondents, respectively. Independent broker/dealers are more focused on targeting long-term wealth growth, with 47% identifying this goal as the primary driver in their portfolio construction process vs. 43% who focused on risk-adjusted returns.

Maximizing diversification was also a top goal for wirehouse advisors (47%) and broker/dealers (45%), but held significantly less importance for RIAs (31%). Minimizing costs was most important to RIAs (20%) compared to wirehouse advisors (7%) and independent broker/dealers (12%).

FUSE also found that advisors are increasingly relying on models in portfolio construction. Almost half—47%—of client assets and client accounts are being managed using models, according to surveyed advisors. The figures were even higher for RIAs, with 55% of client assets and 56% of client accounts in models.

Advisor-built models are the most commonly used models in portfolio construction, representing roughly half (51%) of model assets. Home-office models account for 20% of models, followed by standard third-party models (17%) and third-party custom models (12%).

“One of the most important trends is that portfolio construction is becoming more model-driven, but advisors aren’t giving up control,” noted Travaglini. “Models already account for 47% of advisor assets, yet advisor-built models still represent 51% of model assets. At the same time, advisors expect to increase the number of third-party model providers they use from 2.2 today to 2.9 over the next two years. The trend is toward combining the scale and consistency of models with greater choice, customization, and advisor control.”

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The majority of surveyed advisors (56%) said they build their core models from scratch. The rest were split between those who customize home office models (29%), customize third-party models (28%) or use portfolio construction software or other optimization tools to build models that cater to their clients’ risk preferences (27%). Only 6% of those surveyed said they don’t build models at all.

Currently, ETFs and mutual funds continue to drive most models, with 89% and 76% of advisors relying on them, respectively. Fifty-nine percent of surveyed advisors said they included individual stocks in their models, and 37% said they included individual bonds or SMAs each. Close to a quarter (23%) said they use direct or custom indexing solutions. Private funds and limited partnerships are used by 16% of advisors, and interval or tender offer funds by 11%. Only 9% of advisors use BDCs in their models, and 4% use CITs.

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The majority of advisors (70%) said they prefer to work with multiple asset managers on portfolio construction. A quarter of surveyed advisors said they work with three asset management firms, and 21% said they work with two asset managers. In seeking help with portfolio construction, advisors value portfolio optimization the most, with 57% choosing it as their top issue, followed by risk exposure analysis (51%), forward-looking guidance (39%) and identifying investment product underperformance (37%).

However, these priorities differ in importance between distribution channels. RIAs and independent broker/dealers are more likely to put the emphasis on portfolio optimization, at 62% and 59% respectively, while wirehouse advisors put the greatest focus on risk exposure analysis (55%).

Fuse’s survey sample was about evenly split between advisors who work by themselves (53%) and those who work as part of a team (47%). The average age of the survey respondent was 53 years old, and the average advisor AUM totaled $207 million in client assets. Independent broker/dealers represented the largest segment of respondents at 39%, followed by RIAs at 25%, those who work at national/regional firms at 11% and wirehouse advisors at 10%. The remainder represented advisors working for insurance firms, banks and other financial institutions.