Charles River
Tailored Portfolio Solutions
Charles River Tailored Portfolio Solutions
Capture the Personalization Opportunity with Next-Gen Technology
Portfolios personalized to an individual investor’s goals, objectives, and values are in high demand. Our flexible, efficient technology solution and embedded portfolio optimizer takes that opportunity to the next level, allowing managers and advisors to define the customization parameters as opposed to other “pre-packaged” solutions and investment products.
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Considerations for Adopting Personalization
Preparing to implement a portfolio customization program requires strategic planning. Hear more in this video.
Technology Drives Personalization Capabilities
Hear why technology is such an important component of portfolio customization and direct indexing.
INSIGHT
Direct Indexing Implementation: Reimagining Processes
Direct indexing (DI) as a portfolio personalization strategy continues to gain traction in the marketplace. Given how attractive the benefits are to investors, managers, and advisors, conversations in the industry have shifted from “why” direct indexing to “how” – how to implement these strategies, choose the appropriate provider and streamline the administration of the programs.
Even though the benefits of this approach have been widely covered, it’s worthwhile to revisit the main benefits:
1) 1. Customizing portfolios to reflect the investor’s preferences and circumstances – as the name indicates, directly investing in a representative subset of an index (or model, for that matter) allows the investors to implement certain preferences in their portfolios while still saying true to the index strategy. For instance, clients can exclude some sectors or individual securities from their portfolios and increase certain factors or exposures while still staying within an acceptable range of the risk/return profile of the strategy.
2) Held-away accounts – direct indexing equips advisors with the tools to manage concentrated stock positions, restricted holdings, or exposures in held-away portfolios. Unlike investing in ETFs or passive/index funds, the strategy enables managers to reflect clients’ specific needs by taking advantage of optimization-based customization techniques.
3) Tax considerations – similarly, the ability to construct portfolios by replicating the risk/return profile of indexes through individual securities offers clients the ability to take advantage of active tax management through tax loss harvesting. ETFs and mutual funds do not offer the ability to take advantage of holding level losses for tax management. With these instruments, losses can only be realized when the ETF or fund itself experiences a loss.
Reinventing the Portfolio Construction Process
Managers considering the launch of a direct indexing program have a number of decisions to make before technology solutions are adopted. Internally, conversations around the firm’s investment strategy and portfolio construction process must occur across the organization.
Why is this the case? Operating thousands of custom portfolios efficiently, a necessary component for wealth managers, requires the use of a scalable optimization technology. However, portfolio optimizers are not suited for all processes or firm strategies. So, it is important to understand how optimization functions in the customization process to determine what, if any, changes need to be made internally.
For example, let’s compare rebalancing principles with optimization principles:
Rebalancing
- A model or benchmark represents the target state
- The goal in rebalancing is to reduce deviation from the benchmark targets
- Customizations to the portfolio, such as restrictions/replacements, may cause undue tracking error
- Rebalancing does not consider any input aside from target percentages
- Market movements affect the price of assets, which in turn affects weights within your portfolio
Optimization
- A model or benchmark represents the target ‘state’ rather than a list of target weights
- Objective function defines “what to” achieve
- Goal is to achieve the objective by replicating the benchmark’s risk/return profile
- Customizations, such as restrictions/replacements, are implemented while adhering to that risk profile with a standard deviation that is within an acceptable range
Thus, optimization differs from a traditional rules-based process in that it permits inputs such as customizations, is oriented to a stated goal articulated by the investor and allows for some acceptable deviation. Therefore, an optimizer cannot be inserted into a rules-based process successfully and changes to the portfolio construction process need to be made and understood across the organization.
Change Management Considerations
Specific change management considerations on the direct indexing journey will vary from firm to firm, but in our work with clients, we have developed some best practices.
As previously stated, changing and/or improving the portfolio management process requires buy-in across the organization and stakeholders should understand the changes. For example, portfolio managers should get comfortable with risk/return profile replication. At the holding level, Optimization can have outcomes that differ significantly from the benchmark; post-optimization comparison needs to be based on risk analytics, not deviation based on position weight. Avoid mixing rebalance and optimization paradigms – they are different processes and will work against each other.
Data, specifically accurate data, is a critical component within the personalization process and must be considered when reviewing internal processes. Capturing client customizations and restraints is the foundation for a successful direct index program. Sources and management of data should be as much a part of the process as trading.
Finally, mindset transformation and education are not just for the firm – financial advisors and investors will need to be prepared for the coming changes, the impacts on trading patterns and trade attribution. Financial advisors need education and knowledge to help them understand the process and explain what’s happening in the portfolio to the end investor. Further, the right technology tools that provide easy-to-consume trade rationale, attribution, and analytics capabilities will help support these efforts.
Launching a successful direct index program is more than just the right technology solution and there may need to be process shifts or transformation. Yet, it is still the case that direct indexing is here to stay and with its business growth potential for managers and advisors and improved outcomes for investors, the preparation will pay off.
When customizing portfolios, the construction process takes precedence over the finished product.
This video explains the reasoning behind this strategy.
Tailored Portfolio Solutions
Charles River empowers firms with a flexible, powerful platform to offer customized portfolios at scale.