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Most advisors recognize that constructing bond portfolios with individual bonds rather than mutual funds or ETFs can be beneficial for high-net-worth individuals and families that require a more sophisticated cash flow approach. Fixed income ladders can be a great tool to satisfy the individualized needs of those investors while providing a structured framework to portfolio construction. But due to the complex opportunity set and institutional nature of the bond market, advisors find it difficult and time-consuming to construct bond portfolios using individual bonds. Perhaps even more time-consuming is monitoring and updating a laddered portfolio of bonds, especially so if an advisor oversees many of them. So, what if advisors could handle laddering faster and with greater precision, while also creating more efficient ladders and being able to update them more cost-effectively?
Technology now makes that possible.
Just as direct or custom indexing has become more widespread in equity investing, a new wave of tech-supported innovation has reached the fixed-income world enabling the creation of what is effectively a personalized custom index for an individual investor in the form of a laddered bond portfolio. At our firm, this takes the form of asset class-specific investments that blend the potential benefits of passive investing, which can result in lower costs, with the portfolio customization features of managed accounts. Our objectives are to improve after-tax and risk-adjusted results by seeking a predictable income stream and low sensitivity to rising interest rates.
This new approach to laddering bond portfolios isn’t the fixed-income version of “robo” investing. Algorithms aren’t replacing advisors or bond market experts. Quite the contrary, as an outsourced service they are empowering advisors to deliver better-performing, more efficient portfolios. Instead of algorithms generating one-size-fits-all generic allocations, the new approach enables advisors to customize the strategy by indicating their clients’ preferences, whether that involves credit quality considerations, concentration issues, varying maturity ranges or anything else, such as state residency factors when investing in municipal bonds.
Customization is possible because creating the models and working behind the scenes is a team of portfolio managers and quantitative analysts whose full-time job is to create and monitor client portfolios. Our team, for example, engages in on-going research into the economics and performance of fixed-income markets, and incorporates their findings as well as the latest research from others into their work. Based on thorough research and advisor-indicated requirements and preferences of clients, our team can adjust models to meet advisor and client needs.
For advisors and their clients, adding to the efficiency of augmenting a technology-enhanced portfolio creation process overseen by portfolio specialists is our traders’ ability to access a wide network of bond dealers. With illiquidity a hallmark of so many fixed-income markets, having dedicated traders and portfolio managers who are able to quickly and efficiently source the best combination of prices and liquidity from multiple dealers adds to our ability to deliver on the client’s fixed-income goals and objectives.
Finally, there is the matter of costs. While there are no easily identifiable or allocable costs associated with constructing and managing bond ladders in-house, the process is time consuming. Since most advisory firms have a rough sense of what an hour of an advisor’s time is worth, it is clear that in-house portfolio construction isn’t “free” and, in fact, often costly — not to mention the many alternative uses of advisor time that would be far more productive.
Outsourcing fixed-income portfolio construction carries an overt cost, of course, but that is probably lower than the true cost of an advisor or team carrying out the process in-house. Offsetting that cost, however, are the possibility for higher returns and portfolio yields, as well as potentially increased portfolio value that comes from more efficient portfolio construction and the likelihood of better trade executions.
Given the possible advantages that could accrue to advisory practices, investment performance and client satisfaction, it may be time to take a closer look at a more tech-enhanced way of constructing fixed-income portfolios.
Hunter Willis is a portfolio manager at Envestnet’s quantitative asset management unit, QRG Capital Management, Inc. He is a CFP® professional and CFA® charterholder. Ye Tao is a quantitative analyst at QRG Capital and is also a CFA® charterholder.
The information, analysis and opinions expressed herein are for informational purposes only and do not necessarily reflect the views of Envestnet. These views reflect the judgement of the author as of the date of writing and are subject to change at any time without notice. Nothing contained in this piece is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. Intended for investment professionals only.
Nothing contained herein is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. Investing carries certain risks and there is no assurance that investing in accordance with the portfolios or strategies mentioned will provide positive performance over any period of time. Investors could lose money if they invest in accordance with the portfolios or strategies discussed herein. Past performance is not indicative of future results.
