Optimizing Portfolio Rebalancing: How Robo-Advisors Balance Client Accounts

When the risk profile of a client does not match the current asset allocations, the portfolio must be rebalanced. This ensures that the investments align with the investor's financial goals and risk tolerance. For example, if a client's portfolio is allocated to 10% cash, 40% fixed income, 20% alternatives, and 30% equities, changes in market performance can lead to imbalances. Let's imagine this portfolio was evaluated last month and investments in equities returned 80%. Therefore, the total investment in equities is now ￡54, and only ￡30 can be allocated per the client's risk profile. This would require selling ￡16.8 worth of equity investments to maintain the proper balance.

This process, while critical, can be automated, manual, or a hybrid of both. Regardless of the approach, the core principle remains: select asset classes based on the client’s risk profile and ensure that holdings in asset classes are suitable for that client. To minimize costs, most robo-advisors strive to automate this process, which can lead to some holdings being transferred to other clients who may have temporarily experienced losses in the equity market.

The Role of Robo-Advisors in Portfolio Rebalancing

Rather than providing personal advice, robo-advisors are often considered discretionary managers. This allows them to perform certain tasks that would be costly in a traditional advisory model. For example, they can transfer assets among clients to maintain a balanced portfolio across all accounts. This helps to minimize fees and keep costs low for the end-users.

Frequency of Rebalancing

Another critical consideration is how frequently the rebalancing is done. Constant rebalancing can drive up costs, leading to higher fees. However, strategic rebalancing, particularly during times of financial stress or significant market events, can help to maintain risk levels and protect the portfolio's performance.

Impact of Significant Events on Portfolio Rebalancing

Political and economic events can have a profound impact on portfolio rebalancing strategies. For instance, the Brexit situation poses significant political risk to portfolios. Wealth managers have responded by altering their investment strategies. Some have chosen to exit European investments, while others have refrained from investing in local British companies due to fears of potential losses. These changes require immediate rebalancing to realign portfolios with the new risk landscape.

Different robo-advisors implement these strategies in various ways. However, the core concept is to continuously compare the current market value of individual holdings to the target allocation. This process helps to ensure that all investment assets are proportionate to the client’s risk profile and financial goals.

Conclusion

Efficient portfolio rebalancing is crucial for maintaining a balanced investment portfolio that aligns with a client’s risk profile and financial objectives. Robo-advisors play a key role in this process by automating the rebalancing where possible and strategically adjusting their strategies during significant market events. Understanding how robo-advisors approach portfolio rebalancing can help investors make better-informed decisions and navigate the complexities of modern investment management.