Jonathan Wauton: Bridging the gap between model and bespoke portfolios

‘Wealthtech’ can help keep a check on risk while empowering portfolio managers

Jonathan Wauton


Centralised model portfolios provide a wide range of benefits to wealth managers, including low costs, company-wide consistency and an easy way of assigning clear risk mandates to clients. They can, though, also be restrictive.

By preventing portfolio managers from using their research and expertise to deviate from a standardised model with original investment ideas, wealth firms could be compromising on quality and suitability for clients. Using technology, however, wealth managers can put the power back into the hands of their portfolio managers without the danger of deviating from their clients’ chosen appetite for risk.

When it comes to adding value, discretion is essential for investment managers. Not only does generating independent investment ideas give them a chance to maximise returns, they can also minimise losses by positioning for macro events and cutting laggards.

The risks of leaving model portfolios to their own devices

Just think about Brexit – ahead of the 2016 referendum, an unmonitored model portfolio with massive exposure to UK equities could have really suffered when British domestic firms tanked. By altering that same portfolio to anticipate every potential referendum outcome, however, an investment expert could have been able to mitigate some of this volatility or perhaps even profit from it.

As well as letting managers add their own suggestions to model portfolios, active discretion enables them to include the ideas of their clients. This can be critical when building a bespoke portfolio for an investor with a particular set of investment requirements.

Although discretion is significant, ensuring a client is never placed outside their comfort zone is also of critical importance to portfolio managers and advisers. According to a 2015 study by the Financial Conduct Authority, 60% of wealth manager and private bank portfolios presented either ‘unclear’ client suitability or a ‘high risk of unsuitability’.

This is a significant issue – after all, when a client’s portfolio falls short of expectations because they were unknowingly exposed to risk, the custodian of their cash will be at fault.

To prevent such a scenario from occurring, consistent oversight is required. This can ensure client portfolios never move beyond agreed risk parameters – whether through the investment decisions of its manager or changes in macro conditions. At the same time, it also allows central investment committees to ensure portfolios are altered and rebalanced as efficiently as possible – keeping dealing costs to a minimum.

A quant-based answer to the model portfolio problem

Although ideal, providing discretion to portfolio managers while consistently ensuring clients always receive the service for which they are paying is a complicated and time-consuming task – just ask any compliance officer.

As with most things in the 21st Century, however, a clear solution now lies in technology. By combining automation and customisation, quant-based offerings can blend the best parts of model and bespoke portfolios with an unmatchable degree of speed, accuracy, and ease.

As an example, such services allow managers to add non-model assets to a model portfolio while also giving CIOs and compliance officers a guaranteed, ongoing view of the suitability and consistency of all their clients’ assets. They can also offer on-demand risk reporting and trade optimisation, automatically calculating the optimal and minimal number of trades needed to bring a portfolio in line with suitability through a rebalance.

Technology enables firms to bridge the divide between model portfolios and bespoke discretionary portfolios, blending a model portfolio with non-model assets, such as ETFs, funds or individual stocks, while ensuring suitability against centrally-set constraints.

The benefit to clients is clear in terms of maintaining suitable levels of risk within portfolios. For investment firms, CIOs gain visibility and control by setting constraints based on client needs; compliance officers see consistency and suitability; and portfolio managers can exercise discretion and demonstrate the impact of portfolio changes through instant reporting.

Equally, some digital offerings can be highly configurable, allowing wealth managers centrally to set the amount of discretion available to individual advisers or groups of advisers. Some are also scalable, allowing users to generate one-off portfolios or batch thousands with ease.

Thanks to digitalisation, then, there is now no need to choose between the low costs and consistency of model portfolios and the opportunities for high alpha and downside protection offered by active management.

Jonathan Wauton is co-founder of Tiller


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