As the separate account industry continues to grow, an array of companies has cropped up offering optimization tools and software to help advisors manage clients' portfolios. But it's a good idea for independent advisors using these tools to stick with the providers, and forego attempting to wield them alone. "Some advisors have said, 'We think we can buy a tool and do it ourselves,'" says David Stein, managing director of Parametric Portfolio Associates in Seattle, an investment firm specializing in index-based portfolio optimization with an active tax management strategy. "Very often [advisors] come back with their tails between their legs and say, 'Okay, you guys do it.' Unless [advisors] really understand the tools, they should be using a subadvisor because the tools are hard to use and interpret, and can be misused."
Optimization software is an essential instrument that advisors and other money managers dabbling in separate accounts need to use to provide more and more customized money management services across a growing base of accounts, says Stephen DeAngelis, president of ADVISORport. "Without [portfolio optimization] software, the only service that the money managers can effectively deliver is to match all clients up against some model," he says. Without the software, he says, advisors will have a hard time delivering a customized account that's tax sensitive.
DeAngelis believes that if an advisor is an asset gatherer, it's probably best for him to continue to use optimization tools in conjunction with a third-party organization. If, on the other hand, an advisor is a more sophisticated and technically proficient money manager, with the proper training, he could probably use the tools effectively.
Dennis Clark, CEO of Advisor Partners in Denver–whose firm specializes in low-cost separate account programs based on index products–says advisors that solely use Web-based optimization tools to solve their investment management ills aren't doing themselves any favors. "Look at where all of the fees accrue: The majority go to the relationship manager," he says. "So if I were an advisor, especially in today's environment, I would focus on that part of the value chain, or would look to outsource the investment management, of which portfolio optimization is one critical component, to an extremely competitively priced selection of alternatives."
So what types of optimization tools are out there? And who are the providers? Popular software companies that are being used by money management firms to augment their investment process that cropped up during the reporting for this story include Boston-based Northfield Information Services; Barra of Berkeley, California; and Seattle-based Tamarac. "Advisors will use the software to perform the asset management function themselves as opposed to outsourcing the responsibility," Clark says. "These software companies," DeAngelis says, "provide investment organizations with tools to run optimization algorithms to match client accounts against model portfolios and, in some cases, to take taxes into account."
Mark Balasa, a planner with Balasa, Dinverno, Foltz & Hoffman, LLC in suburban Chicago, says his firm uses both Parametric and Tamarac. With Parametric, "you give them the assets and they do all the heavy lifting," he says. Within the last year, his firm has started using Tamarac, and has found that the software the firm provides is helping to lower his advisory firm's expenses. With Tamarac, "we can drive down the internal cost because now we are not paying someone outside of us to do the optimization, the tax trading, and swapping," he says. Another advantage is the ability to customize the Tamarac software to suit clients' specific needs. "If we've got a client with a low-basis stock position, this is an awesome tool," Balasa says. "Someone that has specific issues outside of what's in this account, somewhere else in their financial life, we can customize [the software] for it."
Balasa's firm is also considering using optimization services offered by State Street. State Street's services are "just like Parametric's–but State Street has a $5 million account minimum," he says.
Balasa says he runs a pretty sophisticated firm, and believes most of the garden variety one- or two-man advisory firms lack the internal manpower to try and fly solo with optimization tools. "It does take a certain degree of internal firm resources and people who are competent in financial markets, trading, and portfolio index construction [to make these tools perform effectively]," he says.
