Morningstar’s Model Marketplace

Wireframe for the upcoming Morningstar Model Marketplace

At this years Morningstar Investor Conference our CEO, Kunal Kapoor, announced Morningstar’s plan to launch a Model Marketplace in 2018. Since then we have been doing some work to define exactly what this means for Morningstar, for Strategists\Asset Managers and for Advisors.

What is a Model Marketplace?

In a recent blog post by Michael Kitces he described a model marketplace as the following:

A Model Marketplace is a centralized platform where financial advisors can select from a series of third-party-created investment models, but retain control and discretion to implement the trades themselves (in an efficient manner) by leveraging trading and rebalancing software….. And the emergence of Model Marketplaces appears to be supported by asset managers themselves, who are seeking new paths to distribute their (otherwise increasingly commoditized) investment products, along with new revenue opportunities from adding a layer of fees for model management itself.

To read more about the overall concept please see here

Model Marketplace Participants

There are a number of different actors involved throughout a model marketplace workflow. Depending on the context of the marketplace (allows 3rd party asset managers vs. closed architecture or internal) the players may go by different titles. So as to common this up we will try and simplify independently of marketplace type. The key difference between a Model Marketplace and a TAMP is that the responsibility for following the model and executing the trades falls on the individual advisor or the firm as opposed to a third-party.

Model Marketplace Participants

Strategist:

Is essentially an asset manager or portfolio manager creating strategies and delivering the IP through the Model Marketplace (as opposed to a registered vehicle like a mutual fund). Within the context of an in-house Marketplace these individuals may be in the CIOs office with a focus on manager research, analysis and portfolio construction. In a scenario where 3rd party strategists are allowed on the network, then these strategists may be Asset Managers or other advisors.

Examples Strategists Include:

  • Blackrock
  • Vanguard
  • Horizon
  • Envestnet PMC
  • Dorsey Wright
  • Morningstar Managed Portfolios
  • In-house Strategist team at a wire house or broker dealer
  • ABC Independent RIA

Strategist UI

This is a technology provider who supplies the Strategist with the software to manage the creation, publishing and management of strategies onto the model marketplace. In some cases, the UI provider will be the same entity that provides the Platform and in other cases the UI provider may be a 3rd party who utilizes APIs on the platform to manage the strategies e.g. Morningstar Direct Cloud.

Morningstar Direct — Can research, create and edit Strategies

Examples of Strategist UI Providers:

  • Morningstar Direct Cloud
  • Inbuilt UIs from the Model Network Providers

Model Hub:

This is the technology provider who enables a Strategist to publish models, using the Strategist UI, to a number of different 3rd party Model Marketplaces. The Model Hub will provide an open platform, primarily accessed by APIs, which enables the services needed to transfer models throughout the network.

MMI Model Hub

Services include the publication of:

  • A definition of the model portfolio (holdings, weights)
  • Performance information: Performance information associated with the model being shared.
  • Sales and Marketing Content: Additional content which would traditionally be included in a fact sheet and other commentary and education on the strategy

The ability for the strategy creator to make model available to a selected number of relevant Model Hubs who sit on the Model Network.

The ability for a Model Marketplace to “subscribe” to notification changes to Strategies they are interested in.

The ability to send a notification of changes or updates to model hubs for strategies to which they have subscribed.

The ability to communicate usage data back to the Strategist. This could include data such:

  • Advisors subscribing to specific strategies.
  • AUM invested in specific strategies.
  • Peer comparisons between different strategists and strategies.

Examples of Model Hub include:

  • Fiserv
  • MMI
  • Vestmark
  • FolioDynamix

Model Marketplace:

The Model Hub provides a user interface (UI) through which the advisor can view, research and select Strategies from different Strategists. This experience may be built into the advisor’s platform or may be a standalone experience managed by the advisor firm.

Morningstar’s Model Marketplace

For smaller Broker Dealers and RIAs we expect that the Marketplace will generally be included within the firm’s Advisor Platform as this will give the advisor the ability to select and then execute their strategies through the same platform. For larger Broker Dealers and Wirehouses we have seen that the Marketplace is a standalone experience, almost like a reference library, where employees of the firm can access the latest updates to Strategies which they then execute on a separate platform.

Examples of Model Marketplace Providers (announced):

  • Morningstar
  • TD Ameritrade
  • InvestEdge
  • Riskalyze AutoPilot
  • Oranj

Model Execution:

There are two primary forms of how the models being produced by the Strategists are executed and traded on and ultimately end up in client portfolios.

TAMP-like Execution: The model marketplace is delivering the strategies and trade signals to a centralized desk — typically at a large Broker/Dealer. The centralized desk then executes the trades across many accounts on behalf of the advisors following the various strategies. Given the platform breadth involved in this model, the amount of money in motion and need for careful trade-order management is crucial.

Advisor Execution: Execution responsibility falls to the individual advisor and can be done manually or more typically through rebalancing software embedded in the Advisor Platform.

Advisor Platform:

Advisor platforms are the general platforms that advisors use to manage and run their business. These platforms traditionally include capabilities such as performance accounting and reporting, a client portal along with the integration or inclusion of a CRM, Financial Planning, Investment Research, online account opening or other advisor services.

The key part of an advisor platform, in the context of a Model Marketplace, is the availability of a Rebalancing service. The re-balancer generates the trade files needed to turn the strategy a funded portfolio in the individual investor’s account. This is why we have seen initial Model Marketplace announcements coming from advisor software providers who have access to a re-balancer.

The Advisor Platform will also need to include some sort of billing capability and depending on the strategy deployed the ability to transfer payment from the individual account, to the advisor and possibly to the 3rd party Strategist providing the strategy to the advisor.

Examples of Advisor Platform Providers:

  • Morningstar Office
  • Tamarac
  • Addepar

Custodian:

Traditional Custodian utilized by the Advisor to manage their clients’ accounts.

Advisor:

The individual, or firm, providing regulated advice to the individual investor. The advisor, in the context of a Model Marketplace, has discretion over the individual investor’s account and is the fiduciary on all actions taken on the individual investors behalf.

It is up to the advisor to:

  • Select the best investment approach for the needs of the individual investor.
  • Choose an appropriate strategy from a 3rd party through the Model Marketplace or create their own bespoke strategy for the client.
  • Ensure that this strategy is successfully executed in the most efficient means possible.
  • Decide whether to update the individual investor’s portfolio when a Strategist notifies the advisor, through the Model Hub, that they have made a chance to the underlying allocation. The advisor can decide whether to execute this change or not.
  • Liquidate the portfolio, or portfolios of the portfolio, depending on the cash needs of the individual investor.

Within Morningstar’s Model Marketplace the advisor will be the only fiduciary on the account. Although the Strategist will recommend a strategy and will be responsible for updating it over time it will be the advisor’s decision whether to execute this strategy and whether to rebalance\reallocate based on trading signals from the Strategist. It will also be the responsibility of the Advisor to ensure that the platform is successfully executing trades generated from changes to the underlying strategy.

Strategy Types:

We have identified 2 different and distinct strategy types which can be made available through a model marketplace: Managed Strategies and Security Level strategies.

Managed Strategies:

Build upon mutual funds, ETFs or other managed products. Generally strategic in nature, more goals-based, when tactical will be tactical at the macro level. Easier to implement and to manage. This will be the primary Strategy type made available through the Morningstar Model Marketplace.

Security Level Strategies:

Models with underlying stocks and bonds as the securities. More alpha-seeking, and may include complexities like options overlays to either boost income or manage volatility. Much more complicated to implement.

The model hub would need to be able to send signals around corporate actions (dividends, stock splits, mergers, etc.) and deal with the lower liquidity inherent in single securities compared to ETFs and MFs.

The trade rotation become key, because if you have $1 billion following a strategy and all the advisors go to trade something at once it is going to move the market and create significant tracking error.

Executing security-level strategies is complex and may inch a model marketplace towards a level of involvement that would require a model marketplace to take on a fiduciary status for execution.

For the Morningstar model marketplace, we will initially focus on Strategists and Advisors who wish to transact around Managed Strategies rather than security level strategies. This will hopefully minimize complexity for both the Strategist and the Advisor.

Fees and Billing

In a traditional advisor-client relationship the advisor will charge the client’s account on a regular basis for services rendered. They will do this by generating a “fee file” using their advisor software platform which will in turn be submitted to the custodian holding the clients account. The custodian will debit the clients account by the amount due and will credit the account of the advisor.

With a Model Marketplace, however there are two additional parties involved who expect payment for services rendered:

1. Strategy provider

2. Model Marketplace provider

Morningstar envisions three primary methods of payment for the Strategist depending on the type of strategies made available on the Marketplace.

“No fee” strategies with proprietary funds\ETFs

In this scenario, a Strategist will publish no fee strategies made up of the Strategist’s own ETFs or Mutual Funds. Although the advisor may change the underlying composition of the investment options (swap in one bond fund for another) the majority of investment options will belong to the strategy provider.

Strategy Subscriptions

The Strategy Subscription model is very similar to the one employed on Apple’s app store. In this case a strategy or strategy family will be available for use, by an advisor, for a fixed subscription paid on a periodic basis. This fee will be independent of the AUM assigned to the strategy by the advisor or the number of accounts to which the strategy is applied.

Asset based Pricing

Asset based pricing is the traditional model used for the collection of fees associated with strategies. Today you see it used both in TAMPs and the newer B2C robo-platforms. The strategy provider receives a basis points fee, somewhere between 5 and 60 basis points. In the most common scenarios the platform provider tracks monies owed by the advisor\investor to the strategy provider. This fee is collected by the platform, either from the advisor or directly from the investor’s account, and disseminated to the strategy provider on a periodic basis. The investor “owes” the fee to the advisor platform and the advisor platform “owes” the fee to the 3rd party strategist.