Rocky Road in a Waffle Cone with Gummi Bears on Top

By: Angela Meringoff
July 29, 2021

When I was a kid, my favorite order at Baskin-Robbins was rocky road ice cream in a waffle cone with gummi bears on top. I loved that you could walk into the store and mix and match your favorite flavors, toppings, and ice cream receptacle, and they would serve it with a smile. Nowadays, in my adulting years, this desire to create my own dishes is more akin to me ordering off-menu for my kids at a restaurant. I have two picky young eaters, so often a trip out to dinner involves me begging the server to beg the chef to make plain pasta with butter and parmesan cheese, and please, please, please, no “green stuff” (aka “garnish”).

As a Client Portfolio Manager at a fixed income investment manager, part of my role involves working with clients (and/or sometimes their investment consultants) to negotiate investment guidelines that dictate how we can invest the money in the account. I often think about constructing portfolio guidelines as similar to ordering food (or ice cream!) at a restaurant. Some clients choose standard guidelines, which typically allow an investment manager the most flexibility to manage the portfolio. This is like ordering the meal as written on the menu, exactly as the chef intended. The pros to this approach are that the manager’s investment team can use its standard toolkit of best ideas, which generally support the investment strategy’s historical track record, and it often comes along with the lowest price.

On the con side, substitutions at a restaurant typically cost money. Remember in the 80s when the low-cholesterol fad called for Egg Beaters instead of fresh eggs? You would often see “$2.00 for Egg Beaters” written at the bottom of every diner menu. Substitutions at a fixed income investment manager may also come along with a higher price, and it may be explicit – the manager may charge a higher fee or have higher minimum asset requirements – or the cost may be implicit, i.e., tailoring the investment guidelines away from the manager’s standard may result in a performance give-up.

Some clients have goals, objectives, and even regulations that trump cost concerns. They may love the manager’s proven track record, but a higher power (Allergies? Just kidding!) may necessitate them ordering off-menu, despite the cost or performance deviation. For example, public funds must often follow laws governing how their money can be invested, and some of these statutes are very detailed – limits on maturities, durations, sectors, credit quality, downgrades, 144As, Yankees, and tracking error, just to name a few. Liability-driven investors may wish to overweight/underweight exposures to certain key-rates, sectors, and ratings buckets to better mimic and hedge against changes in their liability values. ESG-focused clients have a multitude of environmental, social, and governance values, and often no two are the same. Insurance clients have realized gain/loss constraints, along with quality, sector, and other constraints, and often require custom benchmarks.

Speaking of benchmarks, when I lived in New York City in the early 2000s, I purchased a fresh copy of Zagat every year to help me choose which restaurants I wanted to visit. Zagat was the ultimate “benchmarker” of chefs and restaurateurs all over the City. They all wanted a 5, just like every active bond manager wants to outperform each client’s stated benchmark. And when we start talking about custom portfolio guidelines, we often get into conversations of which fixed income index, or blend of indices, will most appropriately reflect and measure the investment mandate the manager is being hired to perform.

Time will definitively tell whether a manager with custom guidelines can outperform its benchmark. In the meantime, how can an astute investor make an informed decision around which manager to hire, and whether that manager is set up for success? Is it safe to order off-menu in a manager’s “restaurant”? Performing due diligence on the following topics is a solid start:

  1. What is the manager’s experience with custom guidelines? Possibly even more importantly, what is the manager’s tone around customization?
  2. Is the manager’s investment team staffed and set up to handle portfolios that require special orders?
  3. Does the manager have technological resources to monitor compliance and administer custom indices?
  4. Can the manager accommodate required reporting on notable limits and guidelines?
  5. Will the manager’s client service efforts meet the client’s unique needs?
  6. Does the manager understand the client’s goals and objectives, and will the manager be a communicative partner?

Maybe, however, ordering off the menu isn’t required. It may dilute the strategy, introduce unintended risks or exposures, or result in higher-than-expected costs. Maybe ordering what the chef (i.e., manager) normally cooks will better diversify your overall diet (portfolio) when considered in tandem with other chefs (managers) in your kitchen (asset allocation). Every client’s situation is unique, but maybe a unique solution does not aid that situation any better than a standard solution.

Investors have their own pros and cons to weigh in making their customization decisions, and the bottom-line is to find a manager who is willing to assist in that process transparently and happily. I am thrilled to say that I have been at IR+M for almost 11 years, and while I am very obviously biased, I am proud of the way we engage in these types of conversations, with knowledge, excitement, and above all, a desire to help our clients and prospective clients solve their unique problems. Butter pecan? Mint Chocolate Chip? M&Ms? Chocolate-dipped waffle cone with sprinkles? We offer a lot of flavors and toppings, and special orders don’t upset us!


As of 7/26/2021. The views contained in this report are those of IR+M and are based on information obtained by IR+M from sources that are believed to be reliable.  This report is for informational purposes only and is not intended to provide specific advice, recommendations for, or projected returns of any particular IR+M product.  No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Income Research & Management.