Here are some ideas to make the job easier when you have to check under the hood and tune up those portfolios.
One of the ironies of passive asset allocation
strategies is that there are times when they are not so passive. If an
advisor's asset-allocation models are customized to fit the needs of a
particular client, there is a significant investment of time in setting
up, monitoring and potentially rebalancing the client's portfolio.
Some advisors have set up their rebalancing triggers
based on an arbitrary, percent out-of-mix flag. Let's say that you use
1% as the benchmark. When the portfolio skews more than 1% away from
the original percentages identified in the asset allocation for each
asset class, rebalancing would occur. This sort of tight rebalance
trigger could create a lot of work for the advisor and/or the staff
responsible for the trades to keep up with rebalancing. With a wider
percent, say a 25% to 30% variance selected, it could open up the
portfolio to greater risk.
With a largely flat market, maybe the percent is not
so important. But, when the market is experiencing higher volatility,
having a wider percent variable could inadvertently cause buy/sells
that were counter to the client's best interests. So, some advisors
have installed timing triggers to account for potential speed bumps in
a particular asset class's performance. As an example, let us say we
had 15% of a portfolio in small-cap growth and the asset class grows
out of mix. A timing trigger would establish a buffer where, if it
falls and then rises within the time frame, no trade would have
occurred and no harm done.
However, if we do this, do we not now have to
install both down-market timing triggers and up-market timing triggers?
And, conceivably, they would be different. With a down-market trigger,
it might be wise to have a shorter time period to mitigate the
potential downside risk. With the up-market trigger, it could have a
somewhat longer period.
Other advisors have embarked on calendar
rebalancing, preferring to rebalance perhaps once each year toward the
end of the year. This technique would seem to ignore market conditions
and simply be reactive to the condition of the allocation at the point
of rebalancing (time of year, conditions of the market at that time,
etc.).
Frankly, there could be other triggers involved.
There could be general economic triggers, market condition triggers,
asset class freeze triggers (under special conditions) and others. What
this creates is an active trading strategy, rather than a passive
strategic asset allocation, and it is sometimes referred to as dynamic
asset allocation. The Society of Asset Allocators and Fund Timers
(SAAFTI) was founded upon this principle. Renamed the National
Association of Active Investment Managers (NAAIM) in 2004, the
organization (www.naaim.org) is dedicated to the idea that active
management of investment accounts can mitigate downside risk and
improve risk-adjusted returns over that of the static allocation
technique.
Critics of active timing strategies point out that
research has shown timing accounts for only around 6% of a portfolio's
overall performance. They also point out that 91% of a portfolio's
performance is achieved through the power of the mix of assets by
class. Furthermore, critics argue that transactional costs and
potential tax liabilities make this an unattractive alternative to
clients.
Whether you embrace traditional strategic allocation
techniques or venture into the world of active trading in and out of
asset classes within an allocation, there is still a lot of work to do
in managing the portfolio and optimizing returns for the client within
their risk constraints.
The question is, what methods are available to
optimize and rebalance portfolios? Some advisors choose to use a
makeshift Excel spreadsheet, while others prefer a developed software
platform. With Excel, it is possible to construct a fairly
sophisticated asset rebalancing spreadsheet with several triggering
mechanisms.
You can even use conditional formatting to reveal by
color when a particular asset is, for example, a buy, hold or sell
position based on those triggers. To build this yourself, you need a
high degree of knowledge in developing Excel spreadsheets that use Web
queries and other data-linking techniques. The advantage of using Excel
is its flexibility; the disadvantage is the time it takes to develop
what you want and keep it compliant. With a developed software package,
the likelihood is that it uses approved methods; the time needed is to
learn the software, not develop it. A disadvantage might be that you
would have to accept whatever rebalancing tools are included in the
package, with whatever flaws-less flexibility, for instance.
Whatever your choice, there are a few questions you may want to ask:
1. Does your broker-dealer or custodian offer a rebalancing tool?
2. Does your method tie trades from your B/D or clearing platform to your software?
3. Can you do batch rebalancing?
4. Can you set upper and lower limits on certain asset classes, such as bonds?
5. Can you set locks to exclude certain asset classes from rebalancing?
6. Can you set minimum transaction amounts?
7. Can you set a specific dollar or percent cash buffer?
You also may want to explore what other tools are
included in a particular software solution, such as asset allocation
proposals and Monte Carlo tools.
One program that seems to fit the bill is an
offering from ASI Advisor Software (www.advisorsoftware.com). In May,
Advisor Software Inc. unveiled the latest version of its ASI Portfolio
Rebalancing Solution, which enables financial services enterprises to
streamline portfolio rebalancing. This new release delivers a
competitive advantage for financial services companies, further
automating time-intensive rebalancing processes and boosting advisor
efficiency, according to the company. With this version, advisors can
rebalance more than 100 accounts simultaneously. Additionally, key
features include cash buffers, locking enhancements and tolerance
bands. The company has provided TDAmeritrade with its
portfolio-rebalancing tool, among other well-known providers.
Another program worth looking at is BridgePortfolio
(www.bridgeportfolio. com), which offers a comprehensive back-office
outsourcing solution that includes asset allocation, portfolio
management and reporting. With automated features for data capture and
delivery through a Web portal to and from clients, such a solution
potentially could save thousands each year in operational costs.
On the expensive side, iRebal (www.irebal.com)
stands out as a high-end, feature-rich program at $50,000 a year. This
might sound expensive, but when compared to the internal costs of
providing similar services-if done by advisors and staff at this level
(up to $1 billion AUM, 1,000 clients, etc.)-the cost for a fairly large
firm could easily reach two to three times this amount, or more.
Earlier this year, it was acquired by TD Ameritrade, which may
introduce a new marketing strategy at some point in the future.
A couple of others to look at are Tamarac Advisor
(www.tamaracinc.com) and eAllocator (www.eallocator.net). Both of these
have interesting features, global rebalancing capabilities and the
ability to rebalance individual portfolios or families of portfolios.
If you are intent on doing it yourself, automation
features are a way to speed up the process of producing rebalanced
portfolios. Having systematic ways to create the rebalance and to
effect the trades necessary to accomplish it is key to making the
process move quickly, efficiently and with no errors.
Fixing trade errors can be both time-consuming and
expensive. So getting it right the first time is necessary and cost
efficient. In training staff to perform the tasks necessary to
rebalance a client's portfolio, you should include written procedures
they can easily follow. Having a decision-tree type of flowchart in
addition to the written steps can help train employees who are more
visually oriented.
Last but certainly not least is the need to
communicate rebalancing with your clients. If your portfolio management
software permits, having the ability to batch upload reports and/or
notices and announcements to your clients via a secure, encrypted
lockbox feature on your Web site gives the client quicker access to the
information while saving your firm money in ink, printing, paper and
mailing costs. Though not all your clients may feel comfortable with
this, if 60% or more were receptive to information delivery through a
Web portal, the savings would be significant and your office could
operate more efficiently.
David Lawrence, AIF, (Accredited
Investment Fiduciary) is a practice efficiency consultant and president
of David Lawrence and Associates, a practice-consulting firm based in
Lutz, Fla. (www.efficientpractice.com). David Lawrence is a
much-sought-after public speaker on a variety of leadership, financial
and technical topics. For details, visit www.davidlawrencespeaks.com.