In spite of the fact that "doing rebalancing on a per account basis is costly and inefficient," Daryanani says that many firms are doing exactly that. When  asked why, he offers two possible explanations. First, he says, "If you locate assets properly, rebalancing is tough."  Daryanani estimates that it takes 18 to 20 minutes to rebalance a typical Regent Atlantic "household" manually. Second, portfolio management software may play a role in the decision making process. "Centerpiece [now Portfolio Center] allows you to create asset allocation targets for households; however the base version of Advent Axys does not. To generate the household information in Axys, I'm told you must buy an additional reporting package that costs in the neighborhood of $15,000."

    Setting asset allocation targets at the household level is only a starting point, however. As Daryanani correctly points out, rebalancing is part art and part science. For an automated system to work, it not only has to be rules based, it has to have some "artificial intelligence" built into it. According to Daryanani, iRebal is the only software program on the market that combines a rules-based approach with artificial intelligence.

    Daryanani created the intelligence through trial and error. Each week, he developed multiple scenarios, had the program generate solutions and then shared the solutions with investment professionals at the three firms. If the program came up with solutions that matched the expert's expectations, it was a success. If the results differed, the rules were "tweaked" in order to generate the appropriate solutions.
    Daryanani says that getting the software to recognize when not to rebalance was a challenge. For example, if in order to be perfectly rebalanced you had to buy and sell three asset classes, but you could get very close to "perfection" by just buying and selling one asset class, advisors in "real life" would chose the latter course. After over a year of tweaking, the developers now believe that the program can generate "real life" results for about 99% of the cases they handle.
    The rules based system has a number of factors that influence recommended actions. For example, holdings are categorized at the asset-class level (large-cap stocks), the subasset-class level (large-cap value, blend or growth), and the individual-holding level (ABC fund and XYZ index fund). Most advisors would agree that getting the asset-class weightings right is most important, the subasset class somewhat less important and, unless there is some specific issue regarding an individual holding, the individual-holding level is least important. Hence, the program assigns more weight to asset-class decisions than to individual-holding decisions.
    One of four "flags" can be associated with each ticker on the sell side: must sell, desired sell, can sell, don't sell. So, if there is a holding that you don't want to sell due to a zero cost basis or client instructions, you can code it as such. Buy-side transactions are usually easier: Most firms have one or two "preferred" investments for each subasset class. Other factors that influence each recommendation include taxes, location and transaction costs.

    If a rebalancing trigger is tripped, the program will first rank every possible sale in order of desirability, suggest the "best" sale(s), then assume you have the cash in a given location and suggest the "preferred" buys. The software is smart enough that it knows not to do certain things, such as purchase a muni bond in an IRA. You can also set rules at the household level so that, for example, if a rebalancing generates too great a capital gain, the program will automatically scale back the rebalance to an acceptable tax threshold.
    The software itself is surprisingly simple to operate. It only takes a couple of mouse clicks to launch the program and, depending on how many accounts are involved and the complexity of the solutions, the results can be delivered in as little as a couple of minutes (the subset of Regent Atlantic accounts we worked with during a live demo comprised about 95 "households" and the results came back in a little over two minutes).
    Users have the option of running all the firm's accounts at one time or dividing them into smaller groupings. iRebal can be instructed to alert the user when an operation is completed, so that they can be productive while awaiting the program's results.
    When the program completes its run, the information can be viewed in a number of different ways. The best way to start is with the "Client Details" report, which is actually a summary of all the households. It includes information in spreadsheet form, such as date of last rebalance, a dollar amount of the positions that are out of balance, and the implications of a rebalance (gains and losses, trading costs, and an approximation of the dollar benefit likely to be generated by the rebalancing). There is also a check box next to every account so that a trader or manager can approve the rebalancing.

    Clicking on any individual "household" brings up a screen that contains all of the details for that household. This screen contains parameters for the household, the individual accounts being monitored, overall positions, a summary of each asset class along with the recommended trades and much more. In order to get so much information on a single screen, the developers had to make ample use of abbreviations. Whenever you need more information, you can hold the mouse over an item and additional information about the item appears.
    When all suggested actions are reviewed and approved, modified or rejected, the recommended trades can automatically be uploaded to the custodian(s) for execution.

In Summary
    iRebal is expensive, but it could be a bargain for firms large enough to benefit from its power. For example, if your firm could potentially eliminate one skilled full-time position by deploying iRebal, it is almost certainly worth the cost. If it encourages you to improve on your asset location and tax-loss harvesting, and your clients achieve better results due to the program's recommendations, that alone might also justify the cost. As word of iRebal spreads, I suspect that there will be a waiting list for the limited number of licenses Mr. Daryanani and his friends will be selling over the next couple of years.

Joel P. Bruckenstein publishes Virtual Office News ( Reach him at [email protected].

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