What is Overlay?
Overlay is the management of individual accounts by a single individual who optionally "overlays" integrated tax, expense, risk and constraint considerations using any desired combination of internal and/or third-party research. Overlay is typically contrasted with traditional SMA accounts, wherein discretion is divided among multiple internal and third party managers. With overlay:
- Third party managers provide research but do not have discretion; they are not subadvisors.
- Equities, mutual funds, ADR’s and ETF’s can be combined in a single portfolio.
- The generation of investment alpha (model portfolios) is separated from portfolio customization (managing client-level constraints, expenses and tax exposure). This separation enhances both efficiency and expertise. It frees researchers from the burden of managing individual accounts and concentrates customization in the hands of a single person, the overlay manager, who, uniquely, has a holistic view of the entire portfolio.
"Open architecture overlay", overlay which utilizes third party investment models, makes maximal use of the overlay structure but requires a very efficient and scalable overlay management process capable of supporting a daily rebalancing process for all client portfolios. The capacity for daily rebalancing is required because the overlay manager has no control over the timing of changes in the underlying third party investment models. As models change, it is the overlay manager’s fiduciary responsibility to implement those changes in the client accounts on a timely basis, even if these changes arrive on a daily basis over some time period.
Smartleaf supports all forms of overlay, including those that require the ability to trade portfolios on a daily basis in a tax, risk, expense and constraint sensitive manner.