The ability to customize model portfolios at scale is a key requirement of top investment advisors and family offices. With the use of target overrides in the rebalancing and trading process, advisors can become equally responsive to the needs of its clients, investment managers and portfolio managers simultaneously. Some call it a proverbial “holy grail.”
But how did a firm that pioneered the Outsourced Chief Investment Officer (OCIO) business model – and prides itself on creating decades-worth of bespoke investment solutions managed and delivered by an entrepreneurial team of advisors and investment officers – reach such a towering outcome?
Let’s dive into the journey of this particular OCIO into the world of scalable customization across a diverse book of household-level business where clients and wealth managers expect things to happen – and happen fast.
How Do Target Overrides Work?
In short, a target override is a rules-based method of overriding a target allocation without having to create a whole new model to meet the specific needs of one client, or affect the rest of the portfolio.
Our use-case firm, who co-sponsored development of the capability with RedBlack, utilizes target overrides at the asset class or super sector level to compensate for multiple allocations. Target overrides are applied along with equivalents, restrictions, and other levers with an infinite number of end points.
Customizing Models at Scale
In our use case, the firm can apply a 60/40 model and augment with target overrides to modify allocations to client-specific needs. The approach offers simplicity and scalability without losing the ability to tailor models to client needs.
With more than 800 active target overrides as part of its rebalancing and trading ecosystem, each one is a specialized rule on top of all other equivalents and rules. The firm uses 40 models to implement bespoke client allocations at scale by applying target overrides. This gives them a level of dexterity and specificity, at scale, without portfolio managers or investment officers feeling that they are compromising in some way or beholden to the models.
Next Phase: Cash Overrides
Cash overrides are often used with clients who are looking to meet a model cash target (not a reserve) that becomes part of the model percentage. This ensures everything else in the portfolio works appropriately and places a hard stop on that cash. Thirty percent or more of our use-case firm’s clients utilize some kind of cash override that exists outside of the model.
Initially, the key challenge was that cash targets are typically driven by unexpected model features. Therefore, cash had to be handled separately in a scalable and best-practice manner, and eliminate the need to trim the trade level or do an exemption to exclude the cash.
This led to a second phase of our use-case firm’s journey to customize at scale – making cash targets different than what’s in the model, but without using a cash action to do it. With the cash overrides in place, the firm gained an even greater level of confidence in the RedBlack system to do rebalancing across a broader book of business.
Institutionalizing Proprietary Knowledge
The rules-based framework of target and cash overrides is a sound way to institutionalize proprietary knowledge in terms of client needs and investment strategies, increasing rebalancing and trading efficiencies, and maximizing the amount of time a firm’s high-paid, client-focused talent spends on certain types of work.
Portfolio managers and investment officers are some of the most knowledgeable and best-paid assets in an organization. They also want to be explicit in how they do their jobs. Yet many spend too much time doing rebalancing manually in spreadsheets or handling mundane trading tasks, which can add up to hundreds of thousands of dollars in person-hours per year. When a firm is trading hundreds of millions of dollars every day, there is no margin for error or delays.
In the past, when a client wants a subsector to be X and another Y, such records recording on paper or in a spreadsheet and saved on a hard drive eventually disappeared. Once the process is standardized and automated in RedBlack to accelerate speed and accuracy, knowledge of clients’ needs and wants are memorialized forever within the system, rather than getting lost or walking out the door with a portfolio manager or advisor. Trading is streamlined, and middle- and back-office tasks are pushed down the food chain, giving portfolio managers and investment officers more time to add strategic value and respond faster to client needs.