Why least-risky portfolios have the highest costs

An analysis of 10,000 portfolios indicates that conservative asset allocation may have ended up costing investors dearly

Why least-risky portfolios have the highest costs

Conventional investing wisdom holds that the greater the amount of risk taken in a portfolio, the higher the costs an investor must incur. But according to a recent analysis conducted by BlackRock, reality is more nuanced.

Looking at 10,000 advisor portfolios in its proprietary risk engine, Aladdin, the investment-fund titan found that conservative portfolios tended to have the highest fees.

“Further, we find that fees, which average 0.54% across portfolios, are not related to the amount of active risk taking—either absolute risk or relative risk, indicating that advisors could obtain greater efficiencies in taking active risk with a given fee budget,” BlackRock analysts said in a report titled Factors and Advisors Portfolios.

They found that conservative portfolios, which had equity allocations of less than 30%, had an average net expense ratio of 58 basis points; moderate conservative portfolios, with equity allocations from 30% to 50%, averaged 57 basis points; moderate aggressive portfolios, investing between 65% and 80% in equities, averaged 54 basis points; and 45 basis points for aggressive portfolios that have more than 80% equity allocation.

The results were taken from portfolio data covering the period from September 30, 2017 to September 30, 2018. In their analysis, the researchers from BlackRock noted some areas where characteristics of advisor portfolios correlate with fees, all of which are related to the use of ETFs or mutual funds.

“There is a bias in the data towards using mutual funds for fixed income allocations,” the researchers noted, attributing the higher fees among conservative portfolios to the use of higher-cost mutual funds rather than fixed-income ETFs. They also found that model portfolios with no ETFs have expense ratios averaging 0.73%, three times higher than that of portfolios with the highest proportion of ETFs (0.24%).

Looking at models where the advisor provides a benchmark, analysts examined the relationship between active risk and expense levels. They found that models with high tracking error — attributed to less use of ETFs — tended to have higher fees and contain fewer funds than their peers (12 vs. 15). They suggested that higher fees and greater active risk levels were due in part to larger allocations in fewer funds.

“Advisor models holding alternative products tend to have higher fees,” the BlackRock analysts said. “However, allocations to alternatives, which tend to be more expensive, explain only part of this as these models use ETFs to a far lesser extent than other advisor portfolios (19.8% vs 41.8% with no alternatives).”


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