Front office leadership series
Contributors
Shirley Zhang
CFA, Senior Market Strategist
SimCorp North America
David Bardsley
Head of Wealth & Asset Management Advisory
KPMG Canada
Our Front Office Series unveils the breakthrough strategies reshaping investment management. Five game-changing articles reveal exactly how tomorrow's winners are pulling ahead—and the specific moves your firm needs to make now. Which strategies will define your competitive advantage?
Part 3 of 5: Pushing the boundary of portfolio construction
As front office operations accelerate, portfolio construction has emerged as the critical intersection where strategic investment decisions converge and materialize. Shirley Zhang, Senior Market Strategist at SimCorp, explains,
In today's challenging investment landscape, where generating pure investment alpha grows increasingly elusive, portfolio construction has become the battleground where every basis point of outperformance is fought for.
This evolution has transformed portfolio construction into a scientific discipline that must skillfully balance an intricate web of competing inputs, constraints, and objectives. Success requires a sophisticated optimization framework capable of simultaneously addressing multiple dimensions of investment complexity: from capturing alpha signals and implementing comprehensive risk controls, to seamlessly integrating compliance requirements, minimizing transaction costs and market impact, capturing tax efficiency, and delivering mass customization.
This sophistication extends beyond mere execution mechanics to the fundamental conceptual framework. David Bradsley, Head of Wealth & Asset Management Advisory at KPMG, notes, "The conventional method of constructing portfolios by diversifying across asset classes often leads to unintended risk factor exposures. Forward-thinking firms are now intentionally curating their risk factor exposures—incorporating market, currency, and risk premia considerations—which not only enhances diversification and streamlines tactical asset allocation but represents a fundamental shift from traditional allocation frameworks."
Case Study: Real-world impact for a global institutional investor
A leading global institutional investor—a SimCorp’s client—managing over $340B AUM, launched new quantitative strategies, creating a need for sophisticated portfolio construction tools that could match their ambitious investment objectives.
- Building and testing quantitative equity long-short strategies
Despite their extensive experience in fundamental equity strategies, the client encountered a transformative shift when expanding into global multi-factor quantitative strategies. These new strategies required more than just a rebalancing system. The client needed a sophisticated platform that could rigorously test alpha signals and validate diverse portfolio construction methodologies before deployment. - Managing multi-dimensional complexity
The strategies' multi-factor, long-short nature introduced layers of complexity that required careful balance. The team faced the dual imperative of managing ex-ante risk while maximizing alpha factor exposures across both long and short positions. Additionally, the portfolios' substantial size and exposure to less liquid markets threatened significant trading costs that could erode returns without proper management. - Coordinating multiple portfolios under one umbrella strategy
Though each strategy had unique objectives and constraints, they all operated under a unified P&L center with a shared risk budget. Ths integrated structure demanded advanced trading cost and risk management capabilities that could simultaneously optimize at both the individual strategy and umbrella fund levels, ensuring cohesion across the entire investment platform.
- Advanced portfolio optimizer: A sophisticated mathematical solver that rapidly identifies optimal solutions to complex investment problems, enabling both high-frequency portfolio rebalancing and comprehensive strategy back-testing.
- Multi-portfolio optimization: An enhanced computational approach that simultaneously evaluates risk factors and trading implications across all strategies—both individually and collectively—ensuring cohesive portfolio management.
- Integrated market-impact models: The optimizer's advanced algorithms excel at handling non-linear optimization problems, incorporating market-impact models directly into the portfolio construction process rather than as an afterthought during the trading phase.
- Successful strategy launch and on-going alpha capture
The client successfully launched their global quantitative equity strategies, rapidly growing assets under management and expanding their strategy suite based on initial success. The API-first architecture enabled continuous testing of signals, factors, and strategies while automating portfolio rebalances—a critical advantage in volatile market conditions. - Seamless risk management across portfolios
The optimizer's open architecture provided flexibility to use either natively embedded or imported third-party risk models. This allowed simultaneous risk and alpha factor control at both individual portfolio and umbrella fund levels, with handling of long-short exposures within a unified framework. - Enhanced trading decisions
Trading performance improved through intelligent constraints including minimum trade sizes, round-lotting parameters, and integrated market-impact modeling. The multi-portfolio optimization capability further enhanced execution by facilitating cross-trades between strategies, significantly reducing external transaction costs and market impact.
The Path Forward: The Future of Portfolio Construction
Our experts share five key insights that will shape next-generation portfolio construction:
- Investment success depends primarily on strategic asset allocation frameworks. A 2020 Vanguard study confirmed the seminal Brinson, Hood & Beebower findings that asset allocation—not security selection—drives the vast majority of portfolio return variability over time1. This underscores why leading asset managers are prioritizing robust, technology-driven portfolio construction processes.
- Risk management now operates as an integral component of the construction process itself. Zhang emphasizes, "The sequential approach of building portfolios first and assessing risk later has given way to unified optimization frameworks where performance targets and risk parameters are evaluated simultaneously. This integration creates inherently more resilient portfolios capable of withstanding diverse market environments."
- The multidimensional complexity of today’s portfolio requirements—spanning factor exposures, ESG criteria, tax efficiency, and trading costs—demands exponentially more sophisticated optimization capabilities. The ability to handle non-linear relationships and competing constraints now differentiates industry leaders from followers in the pursuit of sustainable alpha generation.
- This evolution extends to portfolio structure itself, with forward-thinking institutions designing "all-weather" strategies organized around risk factor contributions rather than traditional asset classifications. These approaches, often implemented through dynamic overlay mechanisms, deliver superior adaptability to changing market regimes—a critical advantage in today's heightened volatility.
- Sustainability continues to be an important objective for investment managers, driving the integration of comprehensive scenario testing as the emerging frontier in sophisticated total portfolio design. Bradsley concludes,
By simultaneously optimizing for both financial resilience across diverse economic conditions while advancing sustainability goals, leading firms are creating truly holistic investment approaches that satisfy both performance objectives and evolving stakeholder demands.
Footnotes
- “The Asset Allocation Debate: Provocative Questions, Enduring Realities”, Vanguard Investment Counseling & Research (August 2020).
Next in Series: The OMS/EMS evolution
Join us for Part 4 where we explore how the traditional divide between order and execution management systems is dissolving—and why this convergence is critical for your trading desk. Learn how leading firms are abandoning fragmented "swivel chair" operations to build unified trading platforms that enhance execution quality.
Read the previous articles in the series