Year-end may be when to rebalance portfolios, but how to do it is debatable.Advisors are once again in the throes of year-end activities regarding their clients' accounts. Tax-lot harvesting and swaps are normal fare for the fourth quarter. With the separate account consulting process becoming a greater part of more advisors' businesses, portfolio rebalancing is being added to the year-end activity mix. In fact, rebalancing has been more of a focal point in recent years; but the logistics of the practice are continually under debate.
At the heart of this debate is the application of the institutional consulting process to individual investor accounts, which is actually what brings the question of rebalancing into play. When is the most appropriate time to do it, what are the best reasons for doing it, and exactly how and how often should it be done? Should advisors rebalance client accounts as a matter of course? Or should the task fall into a much broader realm of consideration?
Some contend that rebalancing should be done on a regular basis, spurring the 'rebalancing for rebalancing's sake' contention. Others are proponents of rebalancing only when capital market conditions dictate. But beyond this discussion lie other questions. What factors should be considered in a rebalancing decision? Are there overriding elements in a rebalancing decision?
Most important, is rebalancing a decision to be made on its own merit, or should it be only one branch of an entire "decision tree" involving a number of parameters that govern the management of clients' accounts?
Factors To Consider
Most experts assert that rebalancing should be contemplated within the context of the investment policy statement (IPS) that has been created for the client. It should be implemented from the standpoint of reviewing the client's complete financial picture, as well as any lifestyle changes or events that have taken place, then shifting things back to fit the guidelines set forth in the IPS. According to Timothy J. Pagliara, managing partner at Capital Trust Wealth Management in Nashville, Tenn., advisors and consultants working with institutional accounts such as pension plans, foundations and endowment funds are required by the Uniform Prudent Investor Act (UPIA) to create an IPS for those accounts. Since progressive advisors seek to apply the institutional level of consulting service to their high-net-worth clients, they should follow the same format in developing a written IPS for their individual clients.
Individuals benefit from having a written document delineating clear investment guidelines as a deterrent to making decisions based on greed and fear. "Many investors will come to an advisor and say, 'Put me in anything that works. That's fine.'" says Mark Pennington, partner and director of separately managed accounts at Lord Abbett in Jersey City, N.J. "But over time, making tax adjustments and other changes to the overall plan without sitting down with clients at least annually to review the entire holistic process can result in a client thought process of, 'I gave you X (amount of dollars). What's it worth now?'"
J. Scott Coleman, CFA, vice president and director of the investment consulting group at Goldman Sachs Asset Management in New York, recommends starting with the IPS as the first step (or branch) in the tree of investment decisions to be made. Other obvious decision branches include asset allocation, manager selection and monitoring. Donald C. DeWees, Jr., senior vice president of investments and partner in the DeWees Investment Consulting Group of Wachovia Securities in Wilmington, Del. notes that some advisors are hesitant to customize their business by using an IPS for each client because of business scalability issues.
But DeWees stresses the importance of "consistency of experience," rather than sacrificing customization for scalability in the traditional sense. This consistency can be applied and still allow advisors to customize investment guidelines on a case-by-case basis. "Every client situation is unique, but we're consistent about how we apply the investment process in almost everything we do. We have a process we go through that gives everybody a pretty consistent experience. That consistency of experience has driven a lot of referrals," he explains.
When profiling the client in preparation for writing the IPS guidelines, questions such as, 'What types of other investments do you have? Where are they housed? What is the purpose for each type of asset pool?' should be asked. The more questions asked, the more information will be gathered, all of which can paint an entirely different picture than the advisor may be able to conjure up while only considering the single pool of assets that has been entrusted to him or her.
Gathering more complete information also contributes to the advisor's ability to be a "quarterback" for the client. "It's all about the client relationship and establishing your added value," says Coleman. "If you have insight into all the moving parts and provide the right advice about how they should all blend together-the changes that should be made and the timing and tax implications of those changes-you truly become an advisor to that client."
Viewing the IPS in this manner supercedes looking at year-end only as the time for the usual activities. As Pennington states, using year-end as an opportunity to review the client's entire situation is a stellar way to add value to the relationship. "You can never underposition the holistic approach of the consulting process. When you start these conversations, it's always good to rewind and look at a summary of what's being brought to the table for the client and then, at that time, to drill down into specifics." Has anything changed for the client personally? Is the client entering a different stage of life? Have there been family events that require changes in the stated objectives? The answers to such questions enable advisors to adapt investment tenets appropriately, whether they involve basic considerations or more complicated circumstances.
Pitfalls To Avoid
In light of everything cited to this point, implementing a rebalancing program without consulting the guidelines of the IPS is unthinkable. But not having an IPS is even more unthinkable. There are plenty of resources for advisors to access for help in writing an IPS (see attached sidebar), but what are some of the pitfalls of the process?
Pennington calls concentrating on tax liabilities above all else "the tax tail wagging the investment dog."