From the May 2011 issue of Investment Advisor • Subscribe!

Should You Use a Rebalancing System?

If you frequently use model portfolios, a rebalancing system may make your firm more efficient

One of the more common questions I hear from advisors is whether it is time to begin using a portfolio rebalancing system. Improving efficiency and creating scalability within your firm is critical, and evaluating your trading processes and procedures often proves to be a fruitful exercise. The good news for advisors is that there are a number of rebalancing systems available. There are several technology firms that offer robust, customized solutions, and most custodians also offer a rebalancing program as part of their platform. Companies like eAllocator, iRebal, RedBlack, Tamarac and TRX are some of the better-known firms that have built technology solutions for meeting advisors’ trading needs. Be aware that selecting and ultimately implementing a rebalancing system is no small task. Therefore, be ready to dig in and do your research, and take time to develop a strong set of criteria for evaluating the systems you are considering.

One of the primary considerations for deciding if a portfolio rebalancing system is appropriate for your firm is how actively you use model portfolios to meet your clients’ investment needs. If using model portfolios is a big part of your practice, then you are initially a good candidate for one of these systems. If you don’t use models, then it will be challenging to find significant benefits that warrant the time, effort and expense of implementing a rebalancing system. For those advisors who have yet to incorporate models in their investment process, you might want to consider using them for a certain segment of your client base to see if it makes you more productive. For example, perhaps a pre-determined size or type of client might be the best candidate for model portfolios, which also will allow you to gain scale in your practice.

In my experience working with advisors, many have unique steps and procedures that they follow in their trading process. Some firms follow long, carefully drawn out, procedures, evaluating all the potential and actual implications of each transaction, while others narrow the process down to a short list resulting in buys and sells. The reality for advisors is that your trading process is truly your own—likely refined over time—and you need to select a rebalancing system that works best with your process. Changing or adjusting its trading process is one of the hardest things for an advisory firm to do. Therefore, with all the choices available today, be critical in selecting the rebalancing system that can best follow your current trading process and procedures. Too many advisors start with a rebalancing system believing that they will change their process to better fit the program—perhaps because they were more focused on price than any other selection criteria. However, in the end they find that they are disappointed and ultimately gravitate back to their previous way of processing their trades.

Training, training, training—you can’t do enough of it when you start working with a new rebalancing system. Whether you are a sole practicioner or you have several staff members who will work with the software, a thorough training process will be critical in achieving success. These systems can be very complicated and given that the ultimate product is submitting a number of trades (perhaps a large number), then you must provide ample time and resources for understanding the product. Just a simple typo or a misunderstanding of what a certain feature does can easily lead to a trade error—perhaps a significant error. Therefore, be patient as you go through the training process. Make sure that you execute a number of “test” rebalancing exercises and that you also have several checkpoints in place prior to submitting your trades to the custodian.

These systems are quite powerful, and their usefulness and value have been well documented. Remember, the only benefits that truly matter are the ones that are realized by your firm.

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