Model portfolios managed by third party are also known by some RIA in the industry as the separately managed account. Investment advisors use them for accounts with higher AUM (asset under management). There are many benefits for a RIA to use third-party model portfolios. Most prominently, the RIA does not make trade and asset allocation decisions. The RIA is expected to know the product (KYP) but does not necessarily have in-depth knowledge about each security within the model portfolio. The hands-off management allows RIA to focus on client relationships and financial planning and less on trade executions and market research.
There are many factors driving the decision to whether purchase 3rd-party model portfolios or not. Because trades are created for each individual model portfolio, factors such as trading slippage costs, commissions, and spreads should all be considered when making the decision to whether delegate the portfolio management job to third-party provider or not. For many 3rd party model portfolios, the fees are lower than a typical balanced fund but higher than a professionally managed model portfolio built in house. This is especially the case when the model portfolio has a large portion of the asset deployed into low-cost ETF solutions or stocks.
Of course, it might seem economic and good practice to build in-house model portfolios for their clients, most RIAs do not have sufficient research and portfolio management resources to create their model portfolios. The decision to build in-house model portfolios became a lease or purchase business decision. To manage a good model portfolio, the advisor team should have at least one CFA charterholder in their team. Clearly, if the AUM is large enough, the decision to run in-house model portfolios would be optimal comparing to the high cost of 3rd party model portfolios.
Model portfolio should be one of the top priority for RIA to build in their operating and KYC (know your client) procedure. Because model portfolios must be compliant with the regulatory standards, constantly tracked, and adhered to strict investment mandate and trading policy, clients can have better understanding of potential risks and performances of their portfolio.