If you’re like almost every other wealth management firm, you’ve either created a centralized rebalancing group or you’re thinking of doing so. The goal of centralized rebalancing is to increase efficiency and consistency without sacrificing customization and tax management.
At Smartleaf, we’ve seen firms cut the cost of managing portfolios while both reducing dispersion and increasing the level of tax management and customization they offer their clients. We work with firms at every stage in this transformation, from those who haven’t yet started to those that have 100% of their portfolios managed centrally. We'd like to share what both we and our clients have learned.
Just so we’re clear, what is centralization?
In a traditional “rep (or advisor) as PM” approach, each client-facing advisor is a part-time rebalancer of the their own clients’ accounts. Centralization means that daily portfolio review and rebalancing is instead delegated to a small group of full-time rebalancing specialists.
How efficient can a centralized group be?
It’s too early to say there are any efficiency standards, but we are starting to see the benchmarks going up. We know one centralized group of three portfolio managers that handles over 36,000 customized, though still relatively simple, accounts. That’s a 12,000:1 ratio of portfolios to people. For complex portfolios with individual issue fixed income and tax-managed open-architecture UMA, we’re seeing roughly 1,000 accounts/person, inclusive of the bond trader.
In rough order of importance, these are the reasons we hear firms give for creating a central rebalancing group:
- Freeing up time for advisors: This is the top priority for most firms — freeing up advisors to spend more time with prospects and clients.
- Efficiency: Central groups specialize in one thing — rebalancing — thus they become experts at it.
- Consistency: With centralized rebalancing, every portfolio is rebalanced with the same approach. However, this doesn’t mean every portfolio is the same, just that the process of managing every portfolio is the same.
- Dexterity: As a side benefit of efficiency and consistency, clients get more rapid implementation of the firm’s best thinking. With distributed (non-centralized) approaches, it can take weeks or months for firm-recommended tactical shifts to be implemented across the firm’s entire book. However, with a central group, it can happen in one business day.
- Compliance: The heart of compliance is having a process and following it.
- Customization: Yes, customization, but also tax management. Centralization can mean more, not less customization and tax management. This is a result of increased efficiency — if something can be done at a lower cost, more of it can be provided, more often. Centralized groups can offer advanced tax management, tax-sensitive transition, risk-customized asset allocations, multiple product choices for each asset class, social criteria (ESG) restrictions, life cycle asset allocation paths, etc. — everything required to create and maintain a portfolio that helps meet an individual client’s needs. The most tax efficient bank trust department we know is highly centralized.
What do I need to do to set up a centralized rebalancing program?
There’s more to centralizing than just creating a team and giving them responsibility for rebalancing. A successful centralized program requires a larger commitment to rethink a firm’s wealth management offering. The three key steps are:
- Specialize: A traditional portfolio manager wears multiple hats: they’re responsible for advising clients, for rebalancing, and for selecting securities. They’re an advisor, a rebalancer and a one-person Investment Policy Committee. Any firm creating a centralized rebalancing group has already concluded that this generalist approach is inefficient and probably does not serve clients well. Dividing these responsibilities among different groups allows for specialization in which each group develops expertise within their function. The specialist role of the advisor is to engage with and guide clients as well as to design customized solutions for each client by setting customization and tax-management parameters. The role of the Investment Policy Committee (IPC) is to analyze markets and recommend optimal asset allocations and product. Finally, the role of the central rebalancing group is to monitor portfolios for adherence to the client’s customization parameters and the IPC’s advice — and rebalance as needed.
- Rethink your rebalancing workflow: If you ask firms why they manage assets the way they do, the answer will often come down to some variant of “because we’ve always done it this way.” If you dig further, you discover that many of these existing workflows were designed to work around the limitations of obsolete technology. With a central rebalancing group, you will want to think deliberately about your workflow. What balance do you think is appropriate between tax sensitivity and drift? What is the maximum drift you’re comfortable with? Do you have different rebalancing thresholds for portfolios that have traded in the last month? That haven’t traded in six months? It is these types of questions that firms must ask themselves in order to better understand their own rebalancing needs and capabilities.
- Rethink your client experience: If you centralize, you don’t really have the option to build your client meetings around discussing the reasons for individual stock trades — but that's the point. Instead, the client meeting is centered on achieving the client's goals and demonstrating that firms have managed their portfolio(s) in a professional and fiduciary manner. This is achieved by showing that:
- portfolios are reviewed daily
- value is being added by tax management
- decisions follow the firm’s best guidance
- advisors are adhering to all the client’s customization requests
Creating a centralized rebalancing group is beneficial to a firm’s stakeholders. It’s more efficient, allows for greater levels of customization, decreases dispersion and increases compliance. Clients get more time with advisors and more consistent portfolio management. Firms cut costs, improve compliance and deliver brandable, consistent services.
If you’re interested in building a new centralized program or improving an existing program, contact us.
For more on this topic, check out What is Rebalancing Automation?