A guide to the confusion-causing multiple meanings of common terms in wealth management
“Model.” “Strategy.” “Target.” You know what they mean, but when you converse with others, do they understand them the same way you do? Maybe. Possibly. Probably not. There’s an old quip describing the US and the UK as “two peoples separated by a common language.” I fear something similar is going on with wealth management. It’s not quite the Tower of Babel, but the whole situation pretty much guarantees miscommunication. So we thought we’d try to clear things up with a guide to what some common terms in portfolio management mean — or rather, the confusing range of their meanings. Here ‘goes:
“Model” is a workhorse of wealth management terminology, used by almost all wealth management firms to describe some part of their investment solution. Unfortunately, it’s also the greatest source of misunderstanding. Quick: what do you mean by a Model? A weighted list of securities? A recommended asset allocation? A recommended asset allocation with recommended products for each asset class? Something else entirely? We’ve seen Model used in all these senses. The most common, we think, is “a weighted list of securities.” For example, consider recent news of various vendors launching “Model Exchanges.” These are platforms for exchanging the intellectual capital of asset managers, i.e. weighted lists of securities.
Summary of Model Definitions:
- A recommended asset allocation.
- A recommended asset allocation with one or more “products” selected for each asset class.
A “product” can be a mutual fund, an ETF, an SMA or a weighted list of securities, (which, confusingly, is sometimes called a Model; see Model Definition #3 below).
- A weighted list of asset-class-specific recommended securities. Examples: “US Large Cap Model” = “2% IBM, 1% F,...” or “US Large Cap Model” = “100% SPY.” Calling “100% SPY” a Model strikes some as odd, but it’s useful. It allows Model to be a synonym for “product” as used in Definition #2 above.
There is almost complete overlap between the possible meanings of Model and Strategy. Some people use the terms interchangeably. If there is a difference, it’s that a Strategy usually includes a recommended asset allocation, with or without recommended products. It’s a little less common for Strategy to be used to mean a weighted list of securities.
Summary of Strategy Definitions:
- A recommended asset allocation. (Same as Model definition #1 above)
- A recommended asset allocation with one or more “products” selected for each asset class. (Same as Model definition #2 above)
- A weighted list of asset-class-specific recommended securities. (Same as Model Definition #3 above)
The term Target can be confusing, not because it has multiple meanings, but simply because it’s less common. Its sole meaning (as far as we know) is: a recommended asset allocation with one or more “products” selected to each asset class, which is the same as Model and Strategy definition #2.
Summary of Target Definitions:
- An asset allocation with one or more “products” selected for each asset class.
What is to be done?
Everybody can agree that it would be great to have the industry settle on one definition for each term. But, of course, most folks will simply suggest that the industry settle on their preferred terms. In this spirit, let us step into the fray with the following proposal for how each term should be used, based, naturally, on our own usage:
- Model: “A weighted list of asset-class-specific securities.”
As we noted above, this is probably the most common use of the term Model. Fortunately, the other meanings of Model can be covered by other terms, like Asset Allocation and Target. So we use Model exclusively to mean a weighted list of asset-class-specific securities.
- Asset Allocation: “A weighted list of asset classes.”
This is the standard definition. As far as we know, it is not the source of misunderstanding or confusion. Hence, we use Asset Allocation, not Model or Strategy, to convey the idea of a weighted list of asset classes.
- Target: “An asset allocation, with one or more models selected for each asset class.” Like Asset Allocation, Target is useful because it has only one definition.
- Strategy: The three previous terms cover what we need, so we avoid using the term Strategy entirely, which seems to cut down on confusion a bit.
We don’t actually expect the rest of the industry to conform to our standards (though we wouldn’t object). In fact, as a vendor, we try to adapt to the preferred terminology of each of our prospects and clients — which, I suppose, only helps perpetuate the problem.
We could be waiting a long time before there is consensus. In the meantime, the best practical alternative is to be attuned to how these terms are used differently. It doesn’t eliminate confusion, but it is a step in the direction of quieting the confusing babel.