Separating portfolio implementation from insight
Institutional investment management has evolved significantly over the past few decades, progressing from static multi-manager portfolios to sophisticated strategies that use detailed risk models and total portfolio management methods.
As asset owners and investment managers embrace technological advancements and respond to evolving investor needs, implementation practices have had to respond too, ensuring portfolios and costs are managed as efficiently as possible – maximising total return.
The advancement to EPI, separates implementation from insight within a total portfolio to maximise implementation efficiency, improve customisation and reduce costs.
Enhanced Portfolio Implementation (EPI) – The Evolution of Investment Management
In a traditional multi-manager approach, each underlying investment manager in a total portfolio is independently allocated a pool of capital to manage in line with their respective investment objective, portfolio guidelines, and operational process. However, there are operational inefficiencies with this structure:
- Each manager's portfolio is held in separate custody accounts, typically requiring at least five accounts for a diversified portfolio, plus additional ones for cash or currency.
- Independent trading by each manager can result in offsetting trades, leading to unnecessary execution and transaction costs without changing fund exposure.
- Manager allocation changes require each to independently buy or sell securities, adding trading costs due to a lack of netting between transactions.
- Fund restructuring or manager transitions often require a specialised transition manager, adding costs and delays.
- Customising or applying fund-level restrictions requires coordination with each manager to ensure compliance.
EPI addresses these inefficiencies by aggregating manager model portfolios and executing them centrally within a single account. This approach also separates implementation from manager insight within a total portfolio. Instead of each manager managing a separate pool of capital, managers submit periodic model portfolios – at least weekly, though often daily - allowing the EPI process to trade after the manager, reducing conflicts around trade timing.
The EPI portfolio manager aggregates the model portfolios of each manager into a composite target for the fund and rebalances it as needed to align with stock level changes and changes to manager allocations, aiming to minimise active risk relative to the target. Having this robust portfolio management process that includes risk-based management, quantitative trade construction, and efficient trading, is essential for maximising implementation efficiency.
Exhibit 1: Enhanced Portfolio Implementation framework
Source: Russell Investments, for illustrative purposes only.
Benefits of Enhanced Portfolio Implementation
EPI offers three key benefits to investors: alpha preservation and cost reduction, portfolio control and customisation, and potentially lower management fees.
By centralising trading and portfolio management, it reduces trading volumes and execution costs, while avoiding potential offsetting trades between manager models. The result is fewer custody charges and reduced portfolio turnover, offering improved cost efficiencies. The simplified structure also improves the efficiency of managing inflows, outflows, and changes to manager allocations at the total portfolio level.
Customisation is easier in an EPI structure, as Environmental Social Governance factor (ESG) overlays or exclusions can be applied at the portfolio level rather than across multiple manager portfolios.
The reduced operational burden on managers, who only need to submit model portfolios without conducting physical trades, also enables the potential for lower management fees. The EPI approach benefits managers by using less of their capacity, which, in turn, strengthens fee negotiation opportunities for investors. Overall, EPI delivers a more efficient, flexible, and cost-effective portfolio management solution.
ESG integration – decarbonisation overlay
As regulatory requirements have evolved with respect to climate change and carbon emissions, asset owners have had to act accordingly. As an example, a large UK-based asset owner required a portfolio strategy that would complement active management while solving for reduced carbon exposure, net zero commitments and a heightened stakeholder focus on decarbonisation.
By adopting an EPI approach, the asset owner was able to significantly streamline ESG implementation while maintaining insights from underlying portfolio managers. This resulted in a 25% reduction in both carbon footprint and fossil fuel reserve relative to the benchmark. Additionally, it provided a greater total portfolio control of decarbonisation and other ESG-related objectives, while enhancing overall implementation efficiency.
Exhibit 2: Transition from traditional model to use of ESG Overlay within EPI structure
Source: Russell Investments, for illustrative purposes only.
Given its adaptability, EPI offers a scalable solution for asset owners seeking to balance operational efficiency with active returns. By centralising trading, reducing redundant transactions, and allowing for flexible customisation, EPI represents a pivotal step in maximising portfolio efficiency.
As investors continue to push for innovation in portfolio management, EPI can be a critical enabler of future investment strategies, supporting operational enhancements and long-term performance goals.
To learn more about our Enhanced Portfolio Implementation download our research paper.