Portfolio Rebalancing Software [tool & automation]

What is rebalancing of a portfolio?

Rebalancing an investment portfolio means changing one or more holdings, so the portfolio re-aligns with a target portfolio. A portfolio can become misaligned for many reasons, for example:

The target portfolio can change (e.g. if it’s a discretionary model or an index that is updated)
Market movements (for a portfolio not allowed to drift)
Passage of time (for a fixed-income portfolio targeting a specific duration)
Holding changes done by external managers or fund managers (fund-of-funds)

What is an automatic rebalancing of a portfolio?

An automatic rebalancing application calculates all adjustments needed to bring a portfolio back in line with its target without human intervention.

Portfolio rebalancing use cases

The best portfolio rebalancing software shall be able to cater for any rebalancing strategy. Below are the 5 most common:

Target a specific cash level

Rebalance to a targeted cash level, for example, 0.1%. You tell the system which cash you’d like to target, and the system calculates which changes to make. The software considers rounding rules, minimum order sizes, and lot sizes according to your settings.

Sometimes, the current portfolio forms the basis of this type of rebalancing, i.e. scaling existing holdings up or down. You can also use a model or index as the target.

Good portfolio rebalancing software allows you to make subsequent changes to the portfolio, for example, adding new instruments, selling some altogether or adjusting a sector weight – before generating orders.

Keeping cash low reduces cash drag, which has a measurable impact on returns over time. Test our operational alpha calculator to see the potential implications for yourself.

Exposure or Duration

Some rebalancing tools can go beyond cash and rebalance to a target exposure. Targeting exposure is especially useful for portfolios that contain derivatives such as futures or options. The exposure is often delta-adjusted, but this should be a setting (not hard-coded).

Some rebalancing tools can target a specific duration, e.g. “rebalance to a target duration of 3.25”, which will then adjust holdings according to pre-set algorithms to get the requested duration.

Another approach that gives you more control is for the software to show you the duration of a portfolio as you make hypothetical changes to it. You can tweak specific bond positions and see the impact for example. In practice, this approach is often the most feasible way, given how bonds are traded.

Against a benchmark (usually an index)

A type of automatic portfolio rebalancing is keeping it aligned with a benchmark. The benchmark is typically an index, such as the S&P500 index. Triggers to rebalance can be subscriptions & redemptions, corporate actions, an index change and much more.

Indicies behave differently in treating corporate actions, and the portfolio rebalancing tool shall support all such cases.

The software shall also support blended indices and perform auto-rebalancing of portfolios in these cases.

Rebalance to model portfolio(s)

A model portfolio is similar to an index, but you internally manage it. Commonly, rebalancing by mutual fund managers and asset owners is done across multiple model portfolios. A simple case to illustrate the point:

Fund A:

Model A: 60%

Model B: 39.9%

Cash: 0.1%

Fund B:

Model A: 30%

Model C: 69.9%

Cash: 0.1%

It’s essential that the rebalancing of funds A and B is automatic so your team can spend less time on daily investment management workflows.

Discretionary order raising

Sometimes (often for stock portfolios), rebalancing is conducted on a discretionary basis, where you decide holding by holding what to change. Actively managed portfolios that are not model-driven rebalance like this. Triggers to change holdings can include new information about a company, market movements, corporate actions or subscriptions/redemptions.

The term “rebalancing” isn’t exactly what’s going on in these cases, but often the functionality required from the software is the same. Let’s say a fund manager wants to make some changes to 3 holdings and see the impact – doing that in one application with 3 simple clicks is ideal. The alternative - entering the full 3 orders to see the impact is a very cumbersome workflow.

The fund manager might want to iterate changes, until the portfolio as a whole is satisfactory. This process should be as fast and straightforward as possible – and the impact of each change shall be apparent immediately.

The video below shows how to rebalance 1 fund and 3 mandates at once using Limina:

See how Limina can support your rebalancing requirements

Automatic portfolio rebalancing

When considering automation of portfolio rebalancing, you can look to take two approaches:

1. Minimise the time a human spends on the process

2. Try to remove the human from the process altogether

At Limina, we believe 2 isn’t yet feasible. You still need a human to decide how to handle situations that have never appeared before, which can be anything related to holdings, cash, current portfolios or future projections.

At Limina, we measure the time users spend in the system. On average, portfolio managers spend 15 minutes daily in our system, and we’re obsessed with reducing this further! Reach out to understand how.

Artificial intelligence

AI doesn’t yet have “common sense”, making it an inferior tool for automating investment workflows (a precise craft). Instead, we look to AI for pattern recognition and suggestions. For example, “Did you forget to put the FX trade in?” instead of trying to ask AI to generate the trade.

A complete view of positions & cash

Your portfolio rebalancing system should ideally not take portfolio and cash views from an accounting system and adjust them. Instead, it should instantly build portfolio views (positions & cash) from underlying transactions and simulated orders.

The reason is that adjusting accounting holdings won’t give you all the details you need. The accounting view can’t show future cash flows such as coupons, dividends or commissions. If a settlement fails, it’s unclear whether that has been included in the view you’re seeing. The list goes on.

Cash ladder view

If you have a portfolio and cash view built from all transactions and simulated orders, you can project cash into the future, a so-called cash ladder. You’ll be able to see things like:

What would my settled cash look like over the coming 2 days if I implemented these changes to my portfolio?

How do upcoming dividends or coupons affect my cash over the coming 3 days?

What will my cash account-by-account and currency-by-currency be if I make the suggested rebalancing changes? Do I need to place FX trades as a consequence?

How to rebalance a mutual fund portfolio: order planner

Beyond look-through on mutual funds, there are additional complications for these instruments. Since the settlement cycle differs among funds and when you’re buying or selling, it’s essential to see both cash and exposure into the future.

Let’s use a simple example where you’re swapping one mutual fund for another. The buy has T+3 settlement, but the sell has T+10. In this example, you want to schedule the buy order 7 days from now to align settlement. To solve this, you need an exposure ladder (also called “order planner”) application built into the portfolio rebalancer to plan exposure out in time.

The simple example can quickly become more complex if multiple changes are involved. It also extends to rebalancing portfolios with PE/VC funds, private investments, etc.

How to adjust for T+1 vs T+2 or other settlement cycles

Assume you’re selling a European stock and buying a US stock. Since the US settlement is T+1, you can’t do that because you won’t have the cash from the European stock sale when it’s time to pay for the US stock.

The way around this is to schedule the buy order for tomorrow. So far, you’ve only needed the cash ladder and order scheduling functionality.

In this scenario, you’ll have 1 day with lower market exposure, so you might want to put a future on for 1 day (buy today, sell tomorrow). You can easily do this if an exposure ladder (also called “order planner”) is built into the rebalancing application.

Here's one of the ways Limina can display future portfolios: Order planner

See how Limina can support your rebalancing requirements

Other considerations when rebalancing portfolios

Some asset classes behave differently from others when rebalancing, not just the difference between exposure and duration-driven instruments (discussed above).

Look-through

Look-through means seeing the constituents of the fund or index derivative. For fund-of-funds and index derivatives, you can’t rebalance to, e.g. a sector or industry, without look-through. The portfolio rebalancing software will break your position down into its underlying parts for calculation, and you will be able to aggregate the sector exposures of a fund.

General considerations

You might be restricted from selling a particular holding for any reason, so the best portfolio rebalancing and trade management software must factor that in. It’s great if the automatic calculations consider the restriction so you don’t waste valuable time making manual adjustments.

Other limitations might include duration targets or even fund restrictions. These might be calculated by investment compliance software, but their results shall be incorporated into the rebalancing. Within Limina, these are modules within the same platform.

Multiple portfolios at once

There are several scenarios when you might want to rebalance multiple portfolios at once, for example:

If multiple portfolios subscribe to the same model portfolio
If you have a leader-follower setup where, e.g. 3 institutional mandates mimic a real fund to some degree (exactly or partly)

There are two ways for fund rebalancing tools to solve these:

1. From the view of the model.

You select the model and rebalance all portfolios that subscribe to it simultaneously.

2. From the view of the target portfolio.

You select the portfolios you want to rebalance and rebalance all models to each.

Neither of these approaches are reasonable solutions since you can’t see or adjust details on a portfolio level for multiple portfolios simultaneously. A concrete example: you might want to check that all cash accounts have positive cash over the coming week (not just the total).

The best portfolio rebalancing system gives you the view from multiple portfolios simultaneously, with minimal clicks.

Rebalance in minutes without spreadsheets

See cash & positions today and in the future

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Kristoffer Fürst

Front Office quant experienced across listed and OTC asset classes and global investment strategies.