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The Power of Sleeving in Model Portfolio Building

The Power of Sleeving in Model Portfolio Building

September 22, 2023

Building a successful investment portfolio is akin to constructing a sturdy building: it requires a strong foundation, careful planning, and the right tools. One powerful strategy that has gained traction among investment professionals is "sleeving." Sleeving refers to the practice of dividing a portfolio into multiple sleeves, each managed separately and tailored to specific objectives or investment strategies. This approach provides investors with greater flexibility, diversification, and control, making it an essential tool in the arsenal of modern portfolio construction. In this article, we will delve into the power of sleeving in model portfolio building and explore how it can lead to better investment outcomes.

What is Sleeving?

Sleeving involves dividing a portfolio into separate sleeves, each designed to address distinct investment objectives or strategies. These sleeves can vary in terms of asset allocation, risk tolerance, investment horizon, and more. The key idea is to manage different parts of the portfolio separately to achieve specific goals while maintaining a holistic view of the entire portfolio.

The Benefits of Sleeving

Customization and Flexibility:

Sleeving allows investors to customize each sleeve according to their unique financial goals and risk tolerance. For example, one sleeve may be geared towards long-term growth, while another focuses on income generation. This customization ensures that each part of the portfolio aligns with the investor's specific needs.

Risk Management:

By separating a portfolio into sleeves, investors can implement distinct risk management strategies for each sleeve. This approach helps in diversifying risk effectively. For instance, a conservative sleeve can contain low-risk assets like bonds, while a growth-oriented sleeve may include higher-risk equities. This risk segregation helps protect capital while still allowing for growth potential.

Tax Efficiency:

Sleeving can also enhance tax efficiency. Different sleeves can be managed with tax considerations in mind. For example, tax-efficient assets can be placed in taxable accounts, while tax-inefficient assets can be housed in tax-advantaged accounts. This strategy minimizes tax liabilities and improves after-tax returns.

Active and Passive Management:

Sleeving allows investors to blend active and passive management styles within the same portfolio. An investor can choose to actively manage one sleeve, seeking alpha through stock picking and market timing, while using passive strategies such as index funds in another sleeve. This hybrid approach can lead to lower fees and potentially better returns.

Behavioral Benefits:

Human psychology often plays a significant role in investment decisions. Sleeving can help investors stay disciplined by separating their long-term investments from shorter-term, more speculative ones. This separation discourages impulsive trading, reducing the likelihood of costly mistakes.

Implementation of Sleeving

To successfully implement sleeving in model portfolio building, advisors and their investors should follow these steps:

Define Objectives: Clearly define the objectives for each sleeve, considering factors like risk tolerance, time horizon, and income needs.

Asset Allocation: Determine the optimal asset allocation for each sleeve, ensuring that it aligns with the stated objectives. This may involve a mix of stocks, bonds, cash, and alternative investments.

Select Managers: Choose appropriate investment managers or strategies for each sleeve, taking into account the desired investment approach (active, passive, or a combination).

Monitor and Rebalance: Regularly review the performance of each sleeve and rebalance as necessary to maintain the desired asset allocation.

Tax Considerations: Pay attention to tax implications when managing each sleeve, aiming to maximize after-tax returns.

Conclusion

The power of sleeving in model portfolio building lies in its ability to provide customization, diversification, and effective risk management. By dividing a portfolio into separate sleeves, advisors help clients tailor their investments to their specific needs and goals, while also mitigating risks and optimizing tax efficiency. For investors working with a financial advisor, sleeving is a valuable strategy to consider when constructing an investment portfolio. It's a versatile tool that can help build a more robust and resilient financial future.

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About the Author: Judith Cheng, CFA, CAIA – Chief Investment Officer


Judith is CIO for The Pacific Financial Group. She has extensive experience in investment strategy, analysis, and research, most recently with DWS and BNY Mellon. Her early career included diverse roles at Northwestern Mutual and Royal Bank of Canada. Her previous work has focused on portfolio construction, market analysis, manager research, and multi-asset model investment portfolios. She is skilled at managing and rebalancing investment portfolios and developing market related thought leadership. Judith is a CFA Charterholder and has earned Chartered Alternative Investment Analyst (CAIA) and Certified in Investment Performance Measurement (CIPM) designations. She has also obtained FINRA Series 7 and Series 63 certifications.

Disclosures

The information presented is the opinion of TPFG and is believed to be accurate but has not been independently verified. TPFG makes no warranties as to the accuracy of the information or any representations made or implied. Articles cited/linked to are the express opinion of the third-party author. There are no affiliations between TPFG and any third-party links. All information may be changed without notice. The information should not be construed or interpreted as an offer or solicitation to purchase or sell a financial instrument or service and should not be relied on or deemed the provision of tax, legal, accounting or investment advice. Past performance is not a guarantee of future results. All investments contain risks to include the total loss of invested principal. Diversification does not protect against the risk of loss.