Next-generation portfolio rebalancing: Save time and improve results

James: [00:00:02] Hello everyone and thank you for taking time out from your busy schedule to join us today. I hope you all enjoyed the long weekend. My name is James Burton, managing editor of Wealth Professional Canada, and I'm delighted to introduce today's webinar, which is titled Next Generation Portfolio Rebalancing. Now, as everyone knows, rebalancing can be a time consuming task and is often considered a necessary evil. But what if there was a way to focus more on growing your business? New solutions can make a real difference to daily tasks mapping, modeling, tax compliance and what if scenarios. In this session we've created, says Matthieu Cardinal, vice president of Business Development and Strategic Partnerships, and Mike Blicker, senior product manager. They'll share their insights and expertise around recent developments in the portfolio rebalancing industry and importantly, how you can reap the benefits. Now, a really important reminder. There's a Q&A box to the right of your screen. If you have any questions that come to you during the presentation, please write them into the box. I'll be monitoring them and I'll put them to our experts at the end of the presentation. So without further ado, I want to hand you over to Matthieu, who will take it from here. Thanks so much.

Matthieu: [00:01:13] Thank you very much, James. Hello, everybody. Pleasure to be with you today. My name is Matthieu Cardinal. Working with Croesus and helping, of course, delivering best in class solutions to our users across the country. Croesus has been in business for 35 years, delivering portfolio management systems and automatic automated rebalancing solutions. We're going to talk about that specifically today. Again, a pretty interesting national footprint that we have with over 15,000 users, about $1.3 trillion in assets on the platform and across the country, around 15,000 users comprised mainly of IAs, PMs and their assistants. So very much looking forward to continuing servicing the wealth management industry. Today we're going to talk about next generation rebalancing systems, how we can improve the processes, saving time and results, using the best of breed solutions that we have out there, and also tackling the various tasks that make for rebalancing processes. With me today is Michael Blicker, our product manager at Croesus. Hi, Michael. How are you doing?

Michael: [00:02:27] I'm doing great, Matthieu. Thanks for the intro here.

Matthieu: [00:02:31] Perfect. Thank you very much for being with us. So we're going to start off this presentation. And Mike, I think we're going to start with looking how that process of rebalancing goes by and actually what it was like not so long ago to take care of the rebalancing process if you were a portfolio manager.

Michael: [00:02:51] Great, great. So let's start this presentation off with a brief history of a rebalancing. So with the advent of portfolio management systems to track and report on client portfolios, we needed a way to calculate the potential trades with respect to our clients investment policy statements. We need to create those tasks manually and to track the completion of those tasks to see if we had actually indeed corrected for portfolio drift and if we didn't have the tooling within RPMs, we modeled that within a spreadsheet. Now many firms still do track within spreadsheets, either because the rebalancing tooling is too cumbersome to use, or some of the data feeds like alternative funds isn't necessarily available. Right. So. We've attached an example here of a generic template for for portfolio drift calculations without spending too much time on on this slide. The main takeaway point here is that it's a very time intensive process, especially if you're using this type of sheet to model in what if type events for ad hoc calculations or rebalancing actions. And more on this later. So whether you're using rebalancing tooling or not as part of your firm's ongoing operations, it's still taking a lot of time. And here's an example of account opening workflows and evaluating portfolios for drift workflows. There's still a lot of management oversight for each one of these steps as part of these workflows, and it's being tracked internally using rebalancing tool tooling mostly manually. So most of these steps still need to be initiated in sequence manually.

Matthieu: [00:04:28] So as we can see, Michael, indeed, we want to rebalance and survey, of course, the modern portfolio theory to reduce portfolio risks and optimize returns. So when considering that, what should a PM take into account when rebalancing?

Michael: [00:04:46] Well, the most important point is that what we ought to be rebalancing our firms is whether we want to choose a manual based rebalancing process or an automated or semi-automated process. So where we're defining automation not as a system of doing the rebalancing for you, but as a proactive system that provides you with the proposed orders for you and your team to review for simple as well as complicated or complex portfolios. That compares against the parameters of your models of the investor's IPS and their goals. So with this example here, in this slide we have portfolio drift. The system automatically computes the orders you and your team verify and then maybe make some ad hoc adjustments and then you send those orders to the market. So automation is important so that the tooling can take away that manual oversight of when and what positions to rebalance. Maybe you're doing it ad hoc, some portfolios quarterly, some monthly. Ultimately, it's your choice, and the system should be running on autopilot sometimes in the background for you. So the benefits of using modern rebalancing software, they're clear from an operational standpoint you have better visibility of pre and post trade compliance issues, assignment of orders to trade desks. But you can also assign tasks to various members of your team with reduced potential for for manual errors. And from an investment management maybe rebalancing using the incorporation of custom mandates and generation of alpha through tax advantageous scenarios. So more on this later on. And rebalancing is really a series of supervised workflows. So your system takes clearly some inputs and some outputs where the inputs are taking into account, let's say account data, portfolio data, cache data typically served up from back office systems, maybe some cash flow systems and other third party services. The rebalancing tool is going to take into account all of those parameters, compare them to existing models, for example, and security constraints. And it's going to update what we call the daily snapshot. So for most systems, rebalancing doesn't really have a task manager, but most of the time these tasks are initiated manually and it can be very time consuming. So ideally these scenarios are going to be automatically calculated before you even get into the office and present it to you and your team. So we want to move towards more of a semi autonomous type workflow. And rebalancing used to be a solo team effort where workflows were done end to end in-house. And that can still be true today. But leading firms have adopted a collaborative approach where there are specialists on your on your team or external to your team that, let's say, manage and update models. So if you're managing with sleeves or a unified managed account approach, you can have an external firm supplying a model and updates to you, or you can have a dedicated compliance team at your institution validating that everything is aligned with mandates and security restrictions. And in summary, that rebalancing tool needs to accommodate multiple stakeholders, assigning the right permission structure to these tasks and everything needs to be supported through the platform and not lost in a bunch of email chains and Excel spreadsheets. So at a very minimum then you're balancing software should identify those jobs to be done at a very high level, assign them to the right people or teams, and then your rebalancing tools should automatically run tasks to identify for portfolio drift accounts and debit deposits and withdrawals, etc. It identifies everything that you might already oversee manually within a business day. And a modern tool needs to accommodate a variety of investment management approaches. So if you're rebalancing some of your portfolio is the relationship level, some of you account level, some of you sleeve level depending on how you're choosing to household or how you're choosing to automate some cash flow decisions and considerations, perform some ad hoc rules around cash flow management issues. The tool should also be configurable to adapt your firm how your firm is managing today. And that's really important to consider because separately managed account and unified managed account adoption, it's on the rise along with goals and mandate driven approaches. So within the United States, for example, you're starting to see the adoption are approaching around 62% amongst advisors. And on UMA, adoption is also on the rise too. So for the registered investment advisory space and the independent broker dealer channels, it's ranging from 34 to 47% of adoption. And that technology chosen to rebalance portfolios needs to be configurable for these types of management approaches. So for tax efficiency, generating the fewest number of transactions between virtual sub accounts or sleeves, if there are two different managers at the sleeve level, for example, or being able to calculate on the fly transferring of cash between these based on each individual sleeves, cash or asset management targets, or proposing cells and specific accounts to minimize exposure to capital gains.

Matthieu: [00:09:47] So yes Mike. So as we can see, the rise of SMAs and UMAs is quite there. This trend has been ongoing and will keep on rising. It could impact the IS and PM's work, though maybe they could spend more time tracking the individual portfolios within these strategies. So given that trend, how do you think, Mike, we can best leverage technology to optimize time and resources while we balance it.

Michael: [00:10:12] Sure. Sure. So we've identified a crisis here, four pillars in particular that we think are going to that every modern rebalancing tool should incorporate. So that includes robust modeling, cash management, intrinsic compliance and predefined tasks and workflows. All of these are going to end up saving a team time to supervise portfolios today. So let's start first with the robust modeling. So that means being able to construct centrally manage models. So if there's an internally managed models, it's part of your asset management teams or externally managed models that you need to sync with your rebalancing software. In addition to being able to show a history of changes within the underlying model for model performance calculations or even evaluating past suitability for compliance tracking, that all needs to be supported within the tooling. And we need to also be able to incorporate security substitutes, especially if we have multiple custodians or back office systems. And lastly, there needs to be able to define targets at the asset class or subclass level for the purposes of rebalancing. So in this example here we have a portfolio assigned to a models of models or composite model and one is large cap growth at 70% and once a small cap at 30% each with its defined color spans. And for this example, let's assume the composite model is applied at the portfolio level and that we've always rebalanced large cap growth back to its target for the small cap cap value. However, we want to be adaptable so that we are rebalancing the target on some portfolios within the lower range for other portfolios and back to the lower end of the tolerance bands for others. Still, your modeling may be more complex, your restrictions might be very specialized and so on, but the tooling needs to be able to calculate the proposed orders seamlessly and at scale, given each portfolios preferences. And for cash management, the system needs to be able to input cash flows from internal systems and should also tag anticipated deposits or withdrawals within certain portfolios. So based on ongoing interaction with your clients, advisors can map and set aside cash or conduct automated rebalancing within those cash flows that have been set aside. The same applies to an external system or portfolio management system as already mapped those pending transactions. Lastly, modern tooling should be able to sync or export those planned cash flow events to other financial planning softwares or systems. So for intrinsic compliance, we need to be able to identify a proposed or pending trades that generate breaches pre or post trade and that those against firm wide as well as portfolio specific restrictions. So for portfolio is drifting off model, for example, a daily run should identify that and show proposed transactions to resolve that breach according to the breach severity. And with that in mind, maybe there are scenarios that there's a reason for the breach to exist. So the tooling should allow for the attachment of notes so that other members of your team can see and compliance team can review those. Similarly, if a portfolio engineer, for example, needs to evaluate the impacts of model updates, they should be able to run a what if type of analysis against existing portfolios to identify upcoming potential breaches ahead of committing their other model updates. Lastly, rebalancing software should be able to create scenarios or portfolio groupings based on recurring tasks. The system should propose to you which portfolios require your attention for accounts and debit or withdrawals that may generate debits, for example, or portfolios that are just not compliant. As we presented earlier, the system needs to be proactive for you, not a system that requires you to manually identify those portfolios of interest. So your team should be able to define pre-existing workflows in an if then type framework. For example, new accounts that you want to rebalance the target or you might want to progressively invest certain portfolios for dollar cost averaging over a period of six months, for example. Or if we want to change from Model A to Model B, what should happen? Or if you want to swap one security like Apple, pro rata for three other securities within our portfolios using a swap mode, rebalancing all of those tasks should be definable and executable ahead of time. They may be semi-automatic or automated in their entirety. So two quick examples here for automated workflows. The first, we have a new account. We've recently assigned a model and we want the system to automatically rebalance to target on time one and then to perform a compliance check on time to another example. Maybe at the end of every quarter, we want to review for tax loss harvesting opportunities across our portfolios or could be at the end of the year, generate the proposed orders and then make our review, make some ad hoc changes and then submit those those proposed orders to the market to the appropriate trading desks after review. Taking a step back from from workflows and processes. Rebalancing should not only be based on asset classes, but also on custom mandates. So if you're currently managing joint accounts or a client is demanding a specific ESG preference or you wish to evaluate a portfolio by risk objective, the tooling needs to be able to support all of that in the same idea. You may wish for the tooling to suggest potential trades given different market conditions. So being able to stay fully invested as part of one mandate or an active rebalancing mandate that suggests certain trades based on specific market conditions or market direction. And our technology also needs to account for investment management strategies that other managers at other firms might be doing outside of your firm. We may not wish to replicate another manager strategy, or we may want to rebalance with those strategies and applications in mind. And if we have this type of holistic view, we can also evaluate against other alternative asset classes or even cryptos, for example, not applicable most of the time in Canada. But if clients have a different tax residency in a foreign EU country, for example, we need the tooling to account for multiple currencies, but also for any other tax implications based on that client's tax residency. A modern rebalancing tool will account for all of that. 

Matthieu: [00:16:33] Great stuff, Mike. Lots to take into consideration, of course. And I see that we do have a question in the chat room. We'll get to that right after the presentation. So moving over to gold based rebalancing, yes, of course, gold based investment strategies are ever more popular. And so when we look at rebalancing for those like for you to dive into that concept a little bit as well as maybe direct indexing, as we know that owning the underlying security is becoming more and more popular as well. And so this next chapter we'll tackle those two topics. But also, I would like for you to talk a little bit about I apply to rebalancing as a tech provider. We we play around with those technologies, of course, are looking at the best way to implement them. So as part of the rebalancing, how I can play a role and bring potential benefits to users.

Michael: [00:17:27] Sure. Sure. So let's first start with the way that we we we view a portfolio with our rebalancing tool. When viewing the same portfolio, we can use a moderate rebalancing to evaluate against multiple types of classifications. So in this example here we have an asset based classification, but we might also want to consider rebalancing based on on risk mandates, on ESG mandates, on even goal based mandates here. So for goal based mandates, a modern tool will support the ability to group accounts based on different goals. So on the left, we have percentage of completion towards the goal. We have a retirement goal, a vacation home and a new boat. And we're tracking against those goal completions. And on the diagram on the right, we've heard the counts from the same relationship or multiple relationships for shared goals or a retirement goal that's based on on registered accounts. The software should support all of these types of groupings. And like goals, investment preferences are becoming more custom and personalized and direct indexing is becoming more popular. Most firms decide to own mutual funds or exchange traded funds because they're just easier to manage and purchase as a basket. And it's great method of having specific exposure to an industry or class. However, the setback is we're not able to track an index perfectly if it's an index based ETF, and we're not able to harvest losses against individual securities. However, based on lower transaction costs, drive to even zero trading commissions at some firms and fractional share ownership, direct indexing is gaining popularity. So within the US, for example, it's grown from 100 billion a um, in 2015 to 350 billion, um, in 2020. This trend is largely driven due to rebalancing technology, finally being able to support all of those different types of transactions. So with rebalancing technology, we can finally create custom direct indexes on a per client or per portfolio basis. On the left, we've created a custom index of the top ten S&P 500 Holdings, and we've now changed the weightings with an over emphasis on Tesla here, Amazon and Microsoft based on clients preference. On the right, we've created a custom variation on the S&P top ten index that also takes into account the client's preference for genomics, robotics and cybersecurity ETFs. The tool should also be able to quickly create these types of custom indexes or variations of an index and apply them to one or to multiple portfolios, along with defining the rules and restrictions within each and with modern rebalancing software, the drive towards personalization and scalability, along with the potential tax savings advantages, are now operational scalable. Finally, whereas previously this was not possible due to being a very time intensive process to make all of these calculations on a per client or virtual basis. We're bouncing should also reflect the ideas and experience of the manager too. So if we anticipate market volatility in your term, the rebalancing should be able to model in those potential. What if type macro events like what would happen to my or what my portfolios look like if we had a 20% decline in US equities, or if we have a 1% rise in interest rates and we think this might lead to 5% decline in certain subclasses, what would that imply? The tool should be able to save our preferences as well so that we can come back to update or review these assumptions later within the tool. So while we're bouncing historically been reactionary to certain types of problems to identify problems and then solve those problems, modern tooling should allow this type of anticipatory view to to portfolios. And on that idea, this is where we think AI and machine learning will find their way into portfolio rebalancing eventually, not to predict prices, but to identify potential jobs to be done. So if we have more underlying volatility, maybe the system might propose to the tighten tolerance bands around certain models or based on volatility. The suggestion system may be able to forecast the number of portfolios that may need rebalancing or to choose a preferred rebalancing mode based on bearish market conditions, for example. So modes might be tax loss harvesting or swapping of certain securities. Each one of those modes should be activated based on maybe potential certain market conditions. In a compliance mindset, maybe we want to view the suggestion systems to identify upcoming potential pre trade or post trade compliance breaches. And with that, that completes it on my end. Thank you.

Matthieu: [00:22:09] Thank you very much, Mike. These last two use cases leveraging AI will be interesting to see unfold. We can think about predictive analytics and even prescriptive analytics that will be supported and underpinned by AI technologies. So stay tuned and look for more to that to come on that front. So a couple of items to retain from today's presentation, if I can sum it up. So the importance of what if scenarios and modeling are very important. Of course, during the rebalancing process, the famous daily task plan, the daily run. Very useful and it should be predefined when the PM and your team will start working in the morning. And finally, tax optimization works when rebalancing, tax loss harvesting and such a great way, of course, to generate additional value for your clients. So with that, Mike, if I could just if we could just wrap the presentation here. Could you provide a couple of tips to portfolio managers you want to start improving on their rebalancing practice?

Michael: [00:23:17] Well, first off, it depends on if your team is, let's say, centrally managing models or not. The move towards SMA and UMA adoption, of course, is on the rise. So being able to centralize your models within the rebalancing tool and being able to make, let's say, changes, whether the changes are being made internally by a member of your team or externally, that's definitely critical. Being able to create those those jobs to be done or those scenarios on a day to day basis, I think that's critical so that you're not having to manually oversee within a spreadsheet whether those tasks have actually been done or not, or whether a member of your team has actually had the time to review those things. That's a huge manual oversight today. So we're handing off the work to another member of the team. So being able to track all those changes within the rebalancing tool is super important and then being able to model in, as you mentioned, that to those what if type events within the actual tooling ahead of committing the trades? I think that's absolutely essential today. So being able to see what the potential impacts would be to those portfolios and to be able to save those those draft, let's say proposed orders to model in what might happen within a portfolio that is absolutely critical as well.

Matthieu: [00:24:25] So thank you very much for that summarization. Mike, I'll just end by saying that we are of course eager to have discussions with you all on automated rebalancing. Feel free to reach out to us. You might have seen in the presentation of some of the screenshots of our solution to that effect Coesus Central. So we'll be happy to have those discussions with you and to further cater to your needs. With that, I'll turn it back over to James.

James: [00:24:54] All right. Thanks so much, both. That was a great presentation. Now we have a couple of questions came in, so I shall put them to both of you. First of all. So how would you handle automated rebalancing of illiquid securities?

Michael: [00:25:15] Probably ask how they're being priced right now because they're illiquid. Maybe like the current price might not be reflective of where the market should be on those liquid securities. So if we have a data feed, that'd be great as a starting point. And then it depends on how we're accounting for those illiquid securities within our asset class schemas. So I would say it depends.

Matthieu: [00:25:37] And of course, it would have to be ingested within the system in the first place. So the back end and connecting to the back office is critical to that sense.

James: [00:25:46] Yeah. Okay. So the second one is for asset location considerations. How would you pull in data from external accounts, i.e. assets held overseas? Is this an integration or a manual input?

Michael: [00:26:02] Well, again, it depends on what those schemas, those asset class or subclass schemas look like. So we're assuming that it's another account, that it has its own asset classification schema. We'd have to apply or a model might be applied to that specific account. So ideally the rebalancing tool should be able to factor in the independent considerations of each one of those accounts. And you or your team might have to then consider how you might want to amalgamate or combine those different together. Maybe there's an overriding schema. Maybe not. I mean, it depends on how you're managing. I mean, there's no right answer here. It just depends on the way that you want to view those specific assets. So you might be grouping those securities under different classes or subclasses. It really depends. Again.

Matthieu: [00:26:50] Integrations can be possible with data aggregators, but we have to look at how the client works. Ultimately, how do we assets and such can be taken into consideration can be ingested in the system, but we have to work closely with the client on that regard.

James: [00:27:06] Yeah. So I've got one. So this might be this might be hard to answer specifically, but you know, how much have you quantified how much time potentially could be saved by something like this to the average PM? You maybe wants to spend that time on other parts of their business. You know, we talked about, you know, growing a business, maybe that might be being able to scale, maybe that might be client relationships. But how much time could this potentially free up?

Michael: [00:27:39] Well, first off, if you're arriving to the office and something's automatically, all the proposals are automatically calculated for you. You're already saving a ton of time, identifying not only those portfolios of interest that may have drifted based on whatever parameters you might be considering, but also just being able to automatically assign that specific task or that scenario to specific team member to to oversee or to do, and then being able to see again whether or not it's actually been traded or not. Right. So you already may be saving 25% of your time per day, just automatically creating those daily runs, maybe even more depending on how many portfolios you're overseeing. So a minimum of 25% time saved, I would say.

Matthieu: [00:28:25] And James, just to complement on that, we've worked closely with one of our clients assessing the time saved, using centralized tools on rebalancing. And yes, the 25% reduction mark in time is certainly a conservative estimate. In that particular case, we're looking at a firm with around $16 Billion in the management, 25,000 accounts and about 300,000 positions. And rebalancing would take them about 3200 days person a year. So you add up those salaries. And of course we were talking about six figure salaries here where it generates quite a substantial cost to take care of rebalancing the traditional way with those type of Excel spreadsheets that we saw earlier. Keep in mind also that manual entries can generate errors, fat finger type errors, or sometimes you'll see partial transactions and not being fully executed. Sometimes you have to reverse operations. So there are errors also that are prone to the manual inputs. And these errors in turn can generate generate additional risks for the firm reputational risks, especially when you deal with high net worth. Or we'll try network clients and you want to avoid those. So time saving. Yes, a very conservative 25%. But then again, think about these other types of benefits for firms, including reputational risk management, by shifting over to a centralized rebalancing, a modern tool like we have. 

James: [00:30:04] Yeah. Okay, excellent. Just one more for me. And that's kind of maybe a bit more general, but the the growing trend towards SMAs, is that something you see continuing? Is that how do you see the future?

Michael: [00:30:20] Matthieu, if you want to handle that one.

Matthieu: [00:30:22] Yeah, sure. Definitely. So we saw a couple of stats on the rise of SMAs and UMAs. Definitely it's the way to go in the industry. We see more and more demand from from the firms themselves because they benefit from economies of scale and moving towards that type of account management benefits to the end clients also better servicing their investment needs and again to race to zero we were talking about earlier I think this type of management provides for more efficiency and ultimate benefits for the clients. So definitely, especially on the UMA side, we hear on the street that this practice is being more and more implemented at big firms. Again, economies of scale are at play here, so IAs are required more and more to spend more time facing clients doing the business dev and reaching outwards to to develop a holistic relationship with their clientele. That service a number of needs and we see some type of into commoditization, I'm sorry of the investment management itself being taken care of through centralized teams and UMA type of practice. So that's kind of what we see on the market and certainly expect more and more a um to be to be controlled or managed through UMA practice.

James: [00:31:43] Yeah. Okay. And maybe just to wrap things up, sort of a final message to portfolio managers, companies, what would be your big takeaway? I know. I know you did wrap things up, Matthieu, but maybe just a final message.

Matthieu: [00:32:01] Well, I think if you're PM you want the best of breed solutions. You're entitled to it and you want to move away from those old spreadsheets. So there are better ways, more efficient ways to take care of the rebalancing processes. And you want to look for ways basically to enhance collaboration within your team, make workflows just more readily accessible, and making sure that compliance is on board, free trade, post-trade compliance. So having those checks and balances already baked in, in place those notifications and basically servicing an ever growing a um, to, to the rebalancing process. So to that effect, technology is there to serve you.

James: [00:32:47] Excellent. And then finally, Mike.

Michael: [00:32:51] I think that sums it up well. But again, just having those those those what if type scenarios that you can define that are specifically custom to you and your team being able to model in potential changes ahead of committing them. These these types of tasks are typically done off the main system. Being able to see what it would be like live within your rebalancing toolkit is going to save you a lot of time but also just make you maybe potentially aware of potential breaches, for example, that might be triggered or other kinds of considerations you might want to evaluate. So it's it's important to all have that all within the same toolkit, I would say.

James: [00:33:32] Yeah, okay, fantastic. Well, I'm pretty sure if anyone else has got any other questions, both Matthieu and Mike will be happy to take them via email or we can fool them on, so please do get in touch if you think of a question after this ends. But thanks for a great session, Matthieu. Mike, I appreciate your time and insight. That was great.

Michael: [00:33:51] Thank you very much, James. Looking forward to another one.

James: [00:33:54] Yeah, absolutely. And thanks, everyone for attending. Enjoy the rest of your day. Many thanks.

Matthieu: [00:33:58] Thank you.