Welcome to Insights Now, a series of conversations designed to shine a light of clarity on the complex world of investing. We've entitled our second season Asset Class. After years of very good returns, broad indices of US stocks and bonds look expensive relative to history. This reality both limits future returns and increases the risk of a market correction. Investors who want to enhance future returns or reduce risk, may need to adopt a more sophisticated approach, looking at different sectors and styles within US equities and bonds and looking at other assets to diversify their portfolios.
And that's what asset class is all about. In each episode, we look at an area of investing and speak to an expert in this area. The global pandemic, which has upended all of our lives over the last year and a half triggered wild swings in markets making it a particularly challenging time for individual investors. It also underscored the value of having a portfolio tailored to individual preferences with regard to expected return, volatility, and income while maintaining a disciplined approach to rebalancing the face of market swings.
Fortunately, technology innovation has allowed investment firms create model portfolios that can offer these attributes in a cost effective manner to individual investors and to financial advisors. Here, JP Morgan Asset Management, our model portfolio program, is run by my colleague Ted Dimmick, head of advisor in core beta solutions. So Ted, welcome to Insights Now.
David, thanks for having me.
So to start with, what are model portfolios? And can you tell us how they've grown in recent years and what the motivation was behind establishing a model portfolio program at JP Morgan Asset Management?
Great question, David. Model portfolios are a way for financial professionals to partner with an asset manager and to leverage that asset manager's insight to create a variety of portfolio types that are generally comprised of ETFs, mutual funds, and sometimes single securities that meet a variety of end client needs. They've grown tremendously over the last decade. And some forecast the market opportunity to be close to $10 trillion by 2025.
The driving force for this is primarily the fact that many financial professionals are looking for a partner to help them with their practice so they can spend more time focusing on those things that are most important to their business. And that's their end clients.
So speaking of partners, I know that our model portfolios rely heavily on the expertise of our multi asset solution team, here at JP Morgan Asset Management. Can you talk a little bit about the importance of that expertise?
Yeah. So people often hear things like tickers, and weights, and ETFs, and mutual funds. And it sounds really, really simple. The reality though, is that multi asset investing is tremendously complex. So having an institutional team with a time tested process is something that can really differentiate the key players in the model portfolio space.
Specific to JP Morgan's multi asset solutions teams, there are a number of things that go into the makeup of these model portfolios. The first and probably the thing that we're most well known for is our long term capital market assumptions. These are forward looking views across literally hundreds of asset classes where we're looking to determine what we think the return and the volatility of each asset class will be over the next five, 10, or 15 years. That informs what we call our strategic asset allocation. So what is the core mix of asset classes in your portfolio to meet your objective?
There are literally hundreds of people that are focused on coming up with that framework and those insights. We then have two more levers that differentiate our approach to investing. The first one is tactical asset allocation. So we have a deep team of experts that are looking for dislocations in the marketplace. These dislocations may present us with an opportunity to add incremental return or to reduce risk.
So while we're long term investors when the facts and circumstances change, we'll change. And then finally, manager selection and vehicle selection. So what's the best way to express the view that you want to put on? Is it something that's passive and something that you just want to use as a low cost way to reflect a view of an index? Or is it something that's a bit more active?
So do you have a portfolio manager or a way of building a exposure that's going to best reflect the view that you're putting on today? So it's not as simple as tickers and weights. And the firms that have the breadth of resources at their disposal to do that are the ones that generally differentiate the most.
And I know you've also recently acquired a fintech for over 55 IP. Can you talk a bit about how their technology improves your ability to offer personalized and tax aware solutions?
One of the biggest trends in the model portfolio space, and the wealth management space for that matter, is personalization and helping people to deal with their unique tax circumstances. The other thing that's been a problem for financial advisors is the friction associated moving a client from portfolio A to portfolio B. 55 IP is a fintech that we purchased at the back end of last year who really is focused on those points of friction and the potential for personalization.
So through a very intuitive user experience, financial advisors can chart that course from point A to point B in a manner that's aligned with their end client's tax needs and their long term objectives. And then across the journey after you create that personalized experience, they'll look for different opportunities to reduce your potential tax burden by systematically harvesting losses across the point of that journey. At the end of the day, you get something that's personalized to David Kelly's needs, and also reduces the potential for the tax bill that someone may have to pay at the end of the year.
I like that focus on the individual investor. Because I've always believed that good financial advice is just as much about understanding the investor as understanding markets. Do you think the model portfolios can help financial advisors really focus on the financial position and needs of their clients?
Yeah. I think that's one of the strongest parts of the value prop for model portfolios. And I like to just take a look at 2020 as the optimal case study for why a financial professional that incorporates models can see tremendous efficiencies in their business, and as I said, spend more time focusing on understanding their clients. And if you just look at 2020, imagine that financial professional that had to acquire new clients, maintain clients, process cash flows, terminate accounts, do manager due diligence, portfolio construction, trading.
And then think about the advisor that just was able to focus on better understanding their client and using that information to make sure that their investments were tied to the outcomes they wanted to achieve, their risk profile, and their long term goals. And that advisor was able to partner with a firm like JP Morgan Asset Management to do the investing and let them be their financial co-pilot. I think all of this really enables advisors to better know their clients and focus on the long term.
Well, sticking with knowing your clients, perhaps we can walk through some examples to highlight how model portfolios can sort of customize solutions for these clients. So let me go through a few examples. First of all, suppose you're an investor in your mid 50s and you've done a good job building up a nest egg. But you're not quite ready to retire either psychologically, or frankly, financially. How do you make sure your wealth is protected while taking advantage of market opportunities.
Yep. So thinking about this person, another thing that's important as I read through that case study is cash flow. So I'm working. I see retirement but I still need cash flow and I still need to potentially grow my wealth. In many areas, people tend to be forced with a one size fits all type of solution to solve those problems. But in an instance like this, maybe the client would want to pursue an income based model portfolio.
In the past, the only solution for income tended to be bots. Maybe you would look at dividend paying stocks as a standalone. Model portfolios actually have solutions that blend the best across asset classes to maximize income and to embrace the benefits of diversification across equities, fixed incomes, and maybe even liquid alternatives.
The other thing is that you can do with a model portfolio as well, you know what? Maybe, David, your needs annual yield of 4%, but Mary's need wants an income of 3.5% and a little bit more chance for capital appreciation. You're able to toggle across the spectrum of income and total return to meet the specific needs of the case study that you put forward.
And OK. Well let's think about risk. Suppose you're much younger and you can afford to take on more risk. Should you be in an entirely different kind of model portfolio, then?
Maybe. While the underpinnings that inform the make up of the model portfolio may be largely similar, if you're a 20 something and you've got 50 years ahead of you, you may be able to take a little bit more risk. And that risk could just be being more aggressive in the mix of your assets. So a little bit more equities or a lot more equities. Or you may want something that has some differentiated sprinkles on top. Maybe you want a little bit of thematic in your portfolio like artificial intelligence, or solar power.
Or maybe you really care about the environment. You care about the board structure of corporations. You care about things like ESG. You can use all of those preferences and embrace a portfolio that takes a bit more risk and hopefully will give you better return over the long run because time is on your side in that circumstance.
And so there are model portfolios which are tailored to those kinds of individuals.
Yes. The great thing about model portfolios is that it's not a one size fits all. If I can understand your needs, your objectives, and your time frame, there's a lot of different solutions that can be put forward as best suited for you.
All right. Last example, let's think a little bit more tactically here and think about risk. Suppose you're afraid that we are on the brink of a boom bust recession. And you think valuations have run way too high. How can you find a portfolio that actually allows you to sleep at night right now?
Yeah. So I have that conversation with a lot of people today. And candidly, sometimes the right answer isn't just moving to a different model portfolio. It could just be right risking or left risking your existing portfolio. But in those instances, David, there are a lot of what we call outcome oriented solutions that might be more suitable. So most people when they think about investment management, it generally is across that risk spectrum. So they think conservative, to growth or aggressive.
And in this instance, maybe conservative is the right path. But there are also other solutions that we call absolute return, solutions that strive to generate a positive total return with less volatility than equities, and most instances a blend of equities and fixed income, and help you sleep at night because that drawdown risk is significantly lower in a model portfolio of that kind.
And OK. So getting back to some of our earlier discussion, I mean I mentioned at the outset, this has been an extraordinary year and a half by any measure. Do you think the pandemic economy and markets have really proven the value of model portfolios?
I think they do, and in multiple ways. So first and foremost, financial professionals that had embraced the models based practice saw that business grow both through retention, additional assets, and bringing in new clients. And then I think for the end consumer of these products, what you saw is that individuals that were invested in model portfolios actually change when the market opportunity suggests that it was time to change.
A portfolio that didn't rebalance all of last year, so changing that mix of equities and fixed income, would have been significantly underweight equities relative to the point in which they started the year. A consumer that was invested in a model portfolio would have not only shifted with the markets, but would have used those dislocations to better position their portfolio. So it works for the advisors. But more importantly, it's worked for the end clients.
And finally, looking forward, looking at technology in the financial industry, and all that we've been through, what are some of the things that you see coming down the pipeline that may change the way that people invest going forward?
I think one of the most important realizations over the last decade was the fact that banks and financial institutions are no longer just competing with other banks and other financial institutions. Consumers are going to hold them up against more direct to consumer platforms and products, whether it be Amazon or Netflix. People want to get insights and advice on their terms in the palm of their hand. So technology has done amazing things to democratize access to investment insights and advice.
And in the future, when you think about trends such as personalization, customization, and fractional shares, the price point and the total dollars someone needs to get what historically had been only available for institutional clients, or millionaires, and billionaires is now going to be available for the masses.
I think as a result of that, tech is going to accelerate the innovation in the asset management space, reduce pricing, and give individual consumers more of what they want, how they want, and when they want it.
Sounds like an exciting future ahead of us. Well, listen. Thank you for joining us, Ted.
Thank you, David.
And thank you all for listening. This episode wraps up season two of our Insights Now podcast. Thank you all for listening. Please tune into our next season later this summer entitled, Investing in a Post Pandemic World, where we will refocus our attention on important long term trends and themes in the markets and the global economy, featuring guests from a variety of disciplines.
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