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Why Customization Is the Investment Industry’s Watchword in 2021

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Thomas Lee, CFA

Co-President and Chief Investment Officer

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Every investor has different objectives and needs at varying stages of their financial journey. Find out why customization offers the best way to support them anytime. 

A growing trend in our industry is for investors to enjoy more control over their portfolios. Custom indexing, which gives investors the power to specify their circumstances and views at the single-security level, is the most recent step in the evolution of customization for individual investors. Like other innovations before it, custom indexing is a disruptor that the industry first viewed as an outlier, only to see it become a norm after some inflection point. The establishment of the first mutual fund in 1924 opened investing to a broader population of investors. But the mutual fund industry was primarily active, which meant each investor faced a take-it-or-leave-it decision. In 1975 John Bogle launched the first public index fund, which provided investors with a modest amount of customization by removing security selection from the process. Index fund growth remained modest until the vehicle’s popularity began rising in the mid-1980s. The first exchange-traded fund (ETF) was launched in 1993, and the number and variety of available ETFs blossomed over the subsequent decades. By 2010 investors could use ETFs to create relatively specific multiasset portfolios with exposures to different countries, sectors, or factors. 

Custom separately managed accounts (SMAs) may seem to many like the newest in this line of innovations. However, Parametric has been managing custom SMAs for over two decades. We have direct experience with the benefits that customization at the security level has provided to investors. Customization at its core allows an investor’s portfolio to be managed consistent with their specific rules, exclusions, or tax situations. Customization also creates a flexible structure that can be adjusted through time as an investor’s needs change—because, after all, life happens. 

Why do investors want to customize?
Each investor brings to their portfolio a different set of views and objectives. Some investors may like growth stocks, while others are more partial to value stocks. One investor may be more biased toward international markets over domestic markets or municipal bonds over higher-yielding corporate bonds. Whatever the case, customization allows the investor to easily reflect these views in their portfolio. 

More differences arise when we consider what the investor is trying to achieve with their portfolio. Are they saving to fund retirement, buy a house, fund a college education, or all of the above? Every investor potentially has a different savings objective, which will likely change through time as the investor changes jobs, has children, or experiences a medical emergency. Customization allows the investor to reflect their current objectives in their portfolio, down to the security level.

But the benefits of customization go far beyond security selection. Management of gains and timely realization of losses across different tax regimes can materially improve long-term after-tax performance. Higher taxes, like those being proposed by the Biden administration, will make thoughtful tax management even more critical in the years ahead. Investors are also looking beyond financial returns and seeking to use their investments to achieve positive outcomes for society that are meaningful to them. They may choose to avoid investments in industries like gambling, weapons, or pornography or to engage as shareholders with companies where they see the opportunity for meaningful change. A customized SMA is the best way to achieve these objectives on an ongoing basis.

Create a flexible, personalized portfolio for your clients

Investors can use customization to address a wide range of individual considerations. Consider a senior executive who receives a significant portion of their compensation in company shares that vest over multiple years. The executive feels the need to support their employer and maintain a substantial position in its stock. A customized completion portfolio can address the portfolio concentration risk by adjusting the executive’s other equity holdings to recognize the oversized company stock position. This process typically involves underweighting both the company’s shares and its sector in the rest of the portfolio to achieve better risk diversification. When it eventually comes time to liquidate some portion of the company holdings, it can be done in a low-cost and tax-aware manner. The other parts of the completion portfolio can be adjusted to maintain diversification.

Customization can also be used to address liquidity events for investors. Consider a middle-aged couple who decides to purchase a vacation home. The purchase will require them to liquidate a portion of their portfolio to make a down payment on the property and complete renovations. A customized portfolio can generate the necessary liquidity in a low-cost manner by minimizing realized gains. The portfolio can also be adjusted to reflect the exposure to real estate that the couple is taking when purchasing the vacation property. These steps would be more challenging to efficiently complete in a commingled account. The couple may sell the vacation property at a future date. At this point, the process can be easily reversed, with the portfolio's allocation seamlessly adjusted to reflect the reduction in exposure to real estate.

The bottom line
All investors have different objectives for their portfolios, and their investment journey can take many different twists and turns over time. Customized portfolios afford them the opportunity to achieve their investment goals in a flexible and efficient manner. As a market leader in this space, Parametric stands ready to help investors and their advisors develop a custom solution for the future.

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss. Prospective investors should consult with a tax or legal advisor before making any investment decision. Please refer to the Disclosure page on our website for important information about investments and risks.