A recent FundFire article found that “performance of portfolios in models-based managed account programs can sometimes diverge from the separately managed account (SMA) strategies they aim to track. Some performance differences can be expected, due to the timing of trades and rebalancing processes, overlay managers and model providers say. However, when unexpected or outsized performance dispersion does occur, it should be a cause for concern both for advisory program sponsors and the underlying managers providing the models.”

Performance dispersion impacts both large and small managers, regardless of the number of accounts under management. The reputational risk inflicted can lead to client attrition and compromised partnership opportunities.

This Insight examines the causes of performance dispersion and how Charles River’s Wealth Management Solution helps asset managers and sponsors mitigate those risks.

“As assets have grown in model-based programs, model providers have become more sensitive to performance dispersion because their name is still associated with that. They’ve got reputational risk there”

Curt Overway
President & Portfolio Manager
Managed Portfolio Advisors

What drives Performance Dispersion?

While a trade instruction is conceptually simple, specifying the security identifier, target weight, and whether to buy or sell; the timeliness and accuracy with which trade instructions are transmitted can significantly impact account performance.

The lack of an industry standard means asset managers have to access a different interface for each sponsor’s platform in order to communicate trade instructions and model updates. This is both cumbersome and error prone, and often results in miscommunication, delayed instructions, and lost opportunities.

Trade instructions lacking sufficient detail can also impact performance. Examples include using market orders in place of limit orders, and handling round lot issues correctly in accounts with smaller balances.

In fast moving, event-driven equity markets, the ability to execute trades intraday can have an outsized impact on performance. Overlay platforms that introduce significant time delays between receiving a trade instruction and executing it will disadvantage that manager’s clients. Illiquid fixed income markets pose a different challenge, forcing asset managers to locate bonds that comply with the model’s intent, and determine whether the bonds are fairly valued. Demonstrating and documenting best execution is increasingly a regulatory obligation, most notably under MiFID II. This is forcing asset managers to rethink which brokers and venues they execute with, and publish objective determinations of execution quality for both clients and regulators.

Differences in how rebalancing is implemented also impacts performance. Some programs only work with static models, where security weightings stay fixed, while others only support dynamic models where weightings can shift in response to market volatility.

Uncovering Performance Dispersion

Remediating performance dispersion requires the ability to find it. Back office accounting systems are typically incapable of providing SMA-centric views of account performance, trades and balances. This makes detecting and diagnosing account problems difficult and often impossible.

Since each account sleeve can conceivably be under the control of a different asset manager, managers need the ability to decompose performance at the sleeve level. Aggregated account performance numbers lack the requisite detail for determining which managers are experiencing divergence from their models and analyzing the underlying causes.

Measuring and attributing performance requires asset-class specific methodologies. Accounts often contain multiple asset classes and instruments, denominated in different currencies. The ability to accurately calculate return, contribution, and attribution for each account, across a variety of timeframes and user-defined classification levels is required to help asset managers identify accounts that have deviated significantly from their model or benchmark.

How Charles River helps

Charles River’s Wealth Management Solution addresses the key drivers of performance dispersion by enabling timely and accurate portfolio performance calculations, automating communication between sponsors and managers, supporting flexible account rebalancing options, and providing firms with a consolidated multi-asset portfolio, order and execution management platform. The solution provides sleeve level account visibility and a multi-asset performance and attribution framework to help managers and sponsors identify accounts and programs in need of attention.

Charles River’s Wealth Hub automates the communication of trade and account instructions between asset managers and affiliated sponsors. Instead of relying on email and legacy systems to upload instructions into individual sponsor platforms, managers access a single interface for all communications, where information can be securely received from, and distributed to, sponsors. Sponsors also use the Wealth Hub to communicate client instructions back to the asset manager.

Intra-day notification of model changes and account instructions makes firms more responsive to client requests and changing market conditions. By enabling the timely and accurate transmission of account instructions, Wealth Hub reduces potential miscommunications between managers and sponsors that can cause individual accounts to deviate significantly from the model.

The Charles River Investment Book of Record (IBOR) provides the sleeve level visibility required to accurately measure and attribute managed account performance. PMAR can help Managers generate return, contribution, attribution and risk data for each account across a variety of timeframes and user-defined classification levels. Industry-standard equity and fixed income attribution models are supported, as well as bespoke factor models.

These capabilities provide detailed insight into what sleeves, strategies and accounts are deviating significantly from their models. Sponsors and asset managers can have fact-based conversations to remediate problems based on a shared view of account performance.

Charles River’s multi-asset Order and Execution Management System (OEMS) provides asset managers with connectivity to global trading venues, extensive decision support and transaction cost analysis, and a detailed archive of each trade, including brokers and execution venues. Most importantly, these capabilities help firms find liquidity in increasingly fragmented markets.

The OEMS captures and archives firm-wide transaction history, broker quotes, market conditions and broker performance. For each order, the system draws from this database to propose an execution broker list based on account agreements and execution history. Broker quote counts are provided to indicate likelihood of execution for illiquid markets. Traders can also view the computed broker hit ratio, best-to- cover ratio, and historically executed prices and sizes with a given broker. This level of pre-trade information is difficult if not impossible for traders to synthesize from multiple applications.

Mitigating performance dispersion with technology

Having the right technology platform helps managers mitigate performance dispersion by providing visibility across the account management process. This helps firms improve processes and pinpoint operational inefficiencies that contribute to performance dispersion.

Charles River provides an end to end wealth management solution that helps both asset managers and sponsors detect and remediate underperforming accounts. Managers can securely communicate model and trade instructions with sponsors, manage and execute orders on global venues, rebalance large numbers of accounts efficiently, and measure and attribute performance at a sleeve level.