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Automated Rebalancing & Specialization

This is part 2 of a series on how automated portfolio rebalancing technology is changing the wealth management industry.


“Will I lose my job?”

This week, we look at the implications of automated rebalancing on how your firm is organized: who does what and how things get done.  

Let’s start with a question that some people ask explicitly — and surely more people ask silently: will I lose my job? “Disruption” is a sexy term in Silicon Valley — every startup wants to “disrupt” this or that. But to people who work in the industry that’s being disrupted, it can be a bit more unsettling.  

There’s good news here. The answer to the “will I lose my job” question is "no." The reason is that Rebalancing Automation does not replace advisors — it frees up their time so they can focus on prospects and clients.  

Who does what and how

For advisors, spending more time with prospects and clients means spending less time on market research and rebalancing. These tasks will become separate functions, handled by specialists. Here’s a summary of what we see:

  • Investment research will be centralized
  • Advisors will be freed to focus on developing customized solutions for their clients  
  • Rebalancing will be centralized  

We’ll talk about each of these in turn.

Managing a customized portfolio can be broken into three separate parts:

  1. Market research and recommendations — finding combinations of securities that provide the best return for a given level of risk, determining appropriate risk levels for different client types, providing market commentary, etc.
  2. Creating customized solutions — ensuring that portfolios meet the individual needs of each investor. For example:
    • Individuals may have legal restrictions on what they trade (e.g. a lawyer representing IBM can’t trade in IBM)
    • It may be prudent for Exxon employees not to own energy stocks
    • The investor may wish to adopt ESG (Environmental/Social/Governance) constraints such as “never buy tobacco stocks”
    • They may not need further exposure to the real estate sector given outside holdings
    • And, importantly, each taxable account will be tax-managed differently, reflecting each investor's unique combination of tax basis, tax rates, constraints, withdrawals, transfers and deposits
  3. Rebalancing and trading — from time to time, all accounts need to be rebalanced (traded to bring them in line with recommended asset allocations, holdings and constraints). Rebalancing can be prompted by many things: price changes that cause relative holdings weights to drift; updated “buy” and “sell” recommendations; tax loss harvesting opportunities; client requests to add or withdraw funds, etc.  

Traditionally, all these functions were performed by one person — the advisor/portfolio manager — in a highly interdependent way. The portfolio manager would start with a client’s existing holdings, filling in missing sectors with recommended securities, selling only those legacy holdings that were overweighted or had “sell” ratings. Every tax-loss-harvest sale required selecting a substitute security; every decision to defer gains of an overweighted position required deciding what other securities to underweight. Every cash-out request required balancing the competing goals of minimizing taxes, managing the portfolio's overall risk characteristics and moving the portfolio towards more highly ranked securities.

Automation changes this, separating these functions (research, customization and rebalancing and thereby allowing them to be handled by different specialist groups:

  1. An Investment Policy Committee: responsible for market research and recommendations
  2. Advisors/Relationship Managers: responsible for designing a customized solution
  3. Overlay Manager/Trader: responsible for rebalancing and trading

The advantage of specialization, in wealth management as in most endeavors, is that it enables a triple win in terms of efficiency, consistency and, most importantly, quality. Specialists become experts at what they do, both faster and better than generalists. The three functional areas we list — market research, designing a customized solution and rebalancing — require very different skills that are best performed by people who have the time (and inclination) to do them well.

There may be a useful analogy to manufacturing before and after the advent of mass production. It used to be that every manufactured item — a clock, a shoe, an axe — was built by one person, start to finish. It was expensive and, romantic notions of “hand built” aside, low quality. That’s the current state of portfolio management. Automated rebalancing brings customized portfolio management into the modern era.

Next week: the implications of automated rebalancing for how your firm handles compliance


Related: Part 1Part 3 Part 4Part 5 
President, Co-Founder