Press Room
Custom-Built
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With demand for personalized advice growing, financial-services firms are overhauling their technology to mass-produce separately managed accounts (SMAs) with a high degree of customization. But mass customization of individual accounts requires a highly automated, efficient process—analogous to a manufacturing plant in the automobile industry. Just as cars roll off an assembly line with standard features such as AM/FM radios and air bags, as well as custom extras such as CD players and moonroofs, financial-services providers must be able to churn out investment portfolios that meet the unique needs of each client.
Individual clients have different circumstances and expectations—unique asset-allocation models, expected rates of return, risk tolerance and tax situations, as well as legacy holdings in company stocks and social restrictions. Whereas some financial-services providers sell standardized model portfolios as “customized” offerings, “We’re customizing each portfolio for each client,“ explains Todd Smurl, managing director of portfolio management at Compass Bank.
In April, the Birmingham, Ala.-based bank—which ranks among the top 50 banks in the country, with $4.5 billion in discretionary assets—expects to go into full production with Smartleaf’s overlay portfolio management platform. Compass will utilize the Smartleaf technology to build customized portfolios that are capable of combining equities, mutual funds, exchange-traded funds and fixed-income instruments within one account, known as a unified managed account, or UMA.
With the help of Denver-based consultant Prima Capital, Compass selected eight equity managers to feed their model portfolios into the Smartleaf system. Rather than hire external managers for fixed income, Compass plans to run the high-grade fixed-income instruments internally. About a dozen client-facing Compass investment professionals who service the bank’s high-net-worth clients will interface with the system. “We're very excited about the ability to customize and the workflow automation that overlay portfolio management brings to the table,“ says Smurl of the Smartleaf technology, which allows the bank to leapfrog the process of establishing a traditional SMA structure.
Under the traditional SMA operating model, asset managers have to hire portfolio managers to oversee hundreds of accounts and establish a back office to handle account administration. They also need a staff to buy and sell orders and marketers to entice brokers to sell their services. The new overlay management platforms eliminate the need for an entire layer of infrastructure because the sponsor is buying the managers’ models and taking over all the managers’ roles: portfolio construction, trading and reconciliation in the back office. In exchange, the sponsor is receiving a discount on the money managers' fee.
The Father of Portfolio Manufacturing
Last winter, James Hollis, managing director at Cutter Associates, coined the term “portfolio manufacturing” to describe the automation of the investment-management process. Hollis picked up the analogy after he read “The Machine That Changed the World,” a book written by a couple of M.I.T. professors that revolutionized the car industry. Industry sources say portfolio manufacturing is part of an ongoing revolution of the separately managed account business that is being driven by technology aimed at streamlining operations and cutting costs, much as the assembly line did for auto manufacturing.
Brokers, trust banks, private banks, high-net-worth managers and mutual funds will need to reengineer their business processes, technology and cost structures in order to compete in the new portfolio “manufacturing” environment, notes Hollis. Trust officers, for example, currently look at information and make unique investment decisions for every client. “They're making all these different portfolios on their own parameters without a lot of consistency—[there’s] no quality control,” asserts Hollis.
But portfolio manufacturing technology still is a maturing market. In 2004, Hollis conducted a survey of 100 technology providers and found that only 20 offered solutions that qualified as manufacturing platforms. Among the portfolio manufacturing technology players he identified are Life Harbor (acquired by Vestmark), Smartleaf, Tamarac, Upstream Technologies, Financial Engines and Folio FN. Another potential contender is Odyssey Asset Management, which mainly operated in Europe for private banks but recently opened a New York office.
Portfolio manufacturing systems are able to customize investment portfolios against model portfolios—standard equity and bond portfolios as well as ETFs and mutual funds—that track a benchmark. They factor in raw data such as rankings of securities, client risk, expected return goals and tax-lot accounting—all of which goes into a mathematical software program called an optimizer.
While optimization has been around since the ’60s and was popularized in the ’80s by Barra’s risk management software, optimizers now can scale to handle a high volume of retail accounts. “The math is the same,” says Mark Hoffman, chief executive officer of Upstream Technologies. “But with modern technology, you now can use that optimization function on thousands and thousands of accounts,” he says. One Upstream client, American Century, loads its expected return rankings for the universe of securities, along with its current portfolio and its model or the benchmark it’s supposed to track into Upstream’s optimizer. Then Upstream generates the buy and sell lists—“the trade orders to get you there,” explains Hoffman.
“Upstream is kind of like the Mapquest for users; you tell me where you are and where you want to go, and we’ll produce the directions on how to get there,” continues Hoffman. Upstream IMS, a comprehensive investment management system, also factors in liquidity constraints and transaction costs as part of the equation and integrates with Lava Trading’s direct-access trading platform, so each retail account can have its own automated trading strategy.
Many third-party portfolio manufacturing tools allow portfolio managers to implement their own trading models—their best buy and sell ideas—in the context of client constraints, according to Alan Robertson, managing director, wealth advisory group, Northern Trust Company.
“The technology has the potential for changing the economics for portfolio management,” says Bob Hollinger, a partner in Boston-based consultant Barrington Partners. Not only will portfolio manufacturing help portfolio managers develop their models, but it also can monitor the performance of the portfolios on a day-to-day basis, according to Hollinger. “It can identify wherever there is a drift or deviation from the portfolio objectives and identify specific actions to be taken to bring the portfolio back in line with its model,” he says.
Some offerings even track the reasoning behind trading decisions, according to Jeff Augustine, a consultant to Upstream Technologies and a former senior vice president at Putnam Investments who ran portfolio construction for an SMA program. If the system rejects a trade for a particular account—because there’s a restriction against owning IBM, for example—the best of the portfolio manufacturing systems will store the reason so that there’s an audit trail, he relates.
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