Rethinking Portfolio Construction with New Financial Technologies

Today’s portfolio performance environment is harsh. Regardless of whether they are pursuing long-only cash strategies or emerging-markets derivative swaps; operating in developed or frontier markets; or practicing an investment philosophy or a trading strategy, managers find the quest for alpha ever more challenging. At the same time, managers have not had ready access to new technology or have not been shown its full benefits –- largely because many technology solutions have been dedicated to individual tasks. Yet technology has to be able to reach holistically across the entire spectrum of investing.

The question for managers today is how to transform technology from a set of disjointed tools into one that provides sleek, market-beating analysis.

It is interesting to compare the evolution of investment technology with advances in the dealer community. Initially, technology on Wall Street was simply an automation tool for operational aspects of the business. Technology then became transaction-based, moving into trading and order-and-execution management, which grew exponentially more efficient and productive.

Despite all the changes, however, buy-side portfolio managers have failed to broadly embrace technology (with the exception of spreadsheet software) and continue to question its ability to deliver substantial performance benefits.

There are several reasons for this. First, the required technology has often simply not been developed. Second, managers may remain unaware of the technological benefits and power available to them. Third, their own culture (like other business functions in the past) often resisted new technology.

These factors have led to the hodgepodge of today’s financial technology offerings: Bloomberg terminals; spreadsheets; narrow vendor solutions for specific needs; and one-off, in-house projects, with predictably scattered results.

There are two key steps firms need to take in portfolio construction and analysis to develop a base of technology from which they can derive alpha-generating strategies: Adopt a well-rounded approach to technology that can empower firms in novel ways, and think about how the technology is delivered.

When it comes to technology, investment professionals are typically provided with tools that help with clerical and operational functions. Rather than using technology to come up with and implement new ideas, they find themselves integrating systems and data, often relying on siloed tools like spreadsheets to tie together disparate sets of analyses. A more effective use of technology would be to construct analyses from the bottom up, in real time, off underlying source data, as opposed to preaggregated reports that offer only a rear view. A manager can then more easily manipulate data sets of any size in seconds. This allows the manager to perform real analysis as opposed to working from a set of pre-canned reports. Lastly, virtually any what-if questions can be posed to test their impact on the portfolio. These include everything from geopolitical questions to inquiries on microsectors to specific data.

Here, manager ideas can be reflected in the analysis, rather than getting lost in inflexible, preaggregated reporting. In many firms, every time a new analysis is called for, managers need to get into the IT queue and wait for new developments. With a better-rounded approach to computing tools, a manager could immediately understand how various portfolio construction directions will affect risk and, eventually, how performance relates back to risk and to asset allocation. Not only is time reduced, but as source data is used, the likelihood of errors being carried through the analysis is reduced as well.

Why shouldn’t there be a single solution that seamlessly aligns with a firm’s unique investment process? By bringing analytical advances into the equation, managers’ entire portfolio construction process can be streamlined and enhanced, just as automation introduced efficiencies into operational processes years ago. Technology can transform work on the buy side from a clunky, time-consuming process into an engine that integrates manager and analyst ideas without stifling investment creativity.

Managers need to move beyond the present inquiry- and report-based technology traps to one in which they access, integrate, interpret and analyze pertinent information from start to finish. That is the new benchmark for portfolio construction. As such capability becomes more the norm, those who fail to take advantage of new approaches not only will produce suboptimal results but also may eventually suffer viability issues.

Related to this goal is the institution throughout a firm of more appropriate levels of transparency and audit. Lastly, if essential personnel in the firm understand what the portfolio manager is attempting to achieve, they can direct their processes to that end. All levels of the enterprise should have complete transparency into the analytic approach behind each portfolio. Use of only desktop tools closes off this information to all but the decision maker, whereas a seamless, holistic and comprehensive analytics approach keeps everyone in the loop.

In most firms the ability to track and audit decisions and the process that led to them at discrete points in time is impossible. A holistic approach takes down the silos and uses the firm’s entire knowledge base to produce a more robust approach in challenging times.

Peter Chirlian is the CEO of Morristown, New Jersey-based Armanta, a data analytics and business intelligence provider.

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