A New Dawn For Portfolio Rebalancing

This post is published in partnership with Exo Investing, an intelligent investment portfolio management service platform based in the UK that specialises in portfolio rebalancing and volatility reduction.

I confess that I’m very much a “buy and hold” investor. I believe stocks represent actual ownership of businesses and as an investor, I’m a part owner of these entities. Through years of reading corporate annual reports and financials, I had developed an interest in screening and pick individual shares. Portfolio rebalancing was never high on my agenda because I could never find the time to do that.

I didn’t fall into this approach on purpose. It was very much an accident.

I tried the indexing approach a few years ago where I selected a diverse range of index funds and attempted to work out an asset allocation plan. It was a minefield that I wished I hadn’t stepped on. The 3 most pressing questions that I faced at the time were:

  1. What was my risk profile?
  2. How did my risk profile translate into an asset allocation plan?
  3. How frequently should I review and reallocate (i.e. rebalance)?

Granted, I discovered stock picking, developed a passion for it and have the luxury of time to do so. Not everyone is on the same boat as me. At the time time, the emergence of robo-advisors (e.g. HL+ portfolio, Nutmeg, Moneyfarm in the UK and a range of them in the US) have largely answered #1 and #2, the question of portfolio rebalancing still eludes me.

What is rebalancing and why is it important?

Rebalancing is a fancy way of saying buying and selling your assets to return to a predetermined allocation. I won’t bore you with the intricacies as you can read them here.  

The rationale of rebalancing is logical.

  • Based on the premise that your individual risk profile (and assuming it remains unchanged) will translate into a particular blend of asset allocation, built on their past and expected returns and volatility.
  • Given that past performance is not a prediction of the future, it means that your assets will perform in a way that deviates from expectation.
  • As a result, by definition, the blend of assets will diverge from its original risk profile relative to time. The portfolio has become unbalanced.

The Investopedia article has an excellent example of equity fund performance and overweighting. If left unchecked, this asset imbalance could alter the overall characters of the portfolio, (i.e. becoming over/underweight in certain assets, thus changing its ongoing overall return profiles) and making it unfit for your risk profile.

A balanced portfolio should achieve maximum growth and minimal volatility in a given risk profile.

Why is rebalancing so difficult?

Sounds logical? Yes. Easy to achieve? Absolutely not.

Personally, there were several problems associated with rebalancing.

Frequency of review

It’s recommended that one should review the portfolio at least annually if not biannually. If you are a DIY investor like myself, then you’ll know that it’s no easy feat. You need to first have the knowledge to know your risk profile and that of your assets. You also need the temperament and time to dedicate to this endeavor.

Buy/sell timing

Let’s say you managed to acquire the knowledge and found the time to do the review. You’ve also decided to tweak the portfolio slightly, now it’s time to execute the rebalancing act. If you are like me, you will have a target buying/selling price and only want to execute if that’s been hit. Consequently, it can take a lot of patience and tracking of the price movement until that target has been reached. Not an efficient use of time.

Cost of transacting

Let’s say that you do rebalance frequently (every 6 months) and each time there are 4 buy/sell actions. That translates to at least 8 trades per year. Under my broker’s current pricing, that represents £96 per year. This level of pricing is decent. However, if you rebalance more frequently then the cost will quickly add up, dragging the portfolio performance.

Tax implications

Every trade will result in you making a profit or loss (break even trades are loss-making after commissions). Hopefully, you’ll end up with more of the former than latter. For every £$ of profit, this will be classified as a capital gain and will attract Capital Gains Tax (CGT) at the prevailing rate. The simple truth is that the more profitable trades you make, the greater the gains you realise and the higher your CGT liability will be.

An alternative to manual rebalancing

For the above 4 reasons and combined with my interest in picking and following individual companies, I did away with portfolio rebalancing years ago. Instead, I buy the companies that have been carefully researched and then hold them for a very long period of time. I don’t even bother with asset mix (e.g. whether to buy bond or equity) because equity performance beats bonds in the long-run.

However, if I was to start investing today, I would have taken an entirely different approach.

The investment product landscape has shifted fundamentally thanks to a young British start-up, Exo Investing.

Exo is a fully AI-driven wealth manager that is offering automated and intelligent portfolio rebalancing.

Unlike other robo-advisors currently on the market, which offer pre-packaged portfolios that are balanced at a set interval, Exo checks your portfolio daily and rebalances as/when necessary. Something no one else is able to do at the moment.

With a fully quant approach, Exo’s proprietary algorithms scan over 2.5m data points for every decision it makes, ensuring your portfolio stays optimised and limiting the variance against your risk level, preferences, outlook, and goals. With this approach, there are no pre-set portfolios to be put in, every client’s portfolio is also completely unique.

Figure 1. The portfolio’s asset allocation will automatically change over time in order to be balanced to your desired risk-return profile.

Exo’s underlying methodology, algorithms, and expertise originate from their technology partner, ETS Asset Management Factory, who has been operating this model for institutions and UNHWs for over 30 years.  I will write a detailed post exploring their technology in the future but here are the key characteristics:

  • It invests in ETF instruments;
  • Every portfolio is unique;
  • You can add your asset preferences;
  • Portfolios are checked daily
  • No transaction costs are incurred during the rebalancing process (critical given how frequently rebalancing could happen);
  • The Total Expense Ratio (TER) is around 1% on a £10,000 portfolio (0.75% of management fees + c.0.25% of ETF expenses), which is on par with an actively managed fund.

What are my thoughts?

Having seen it in action and after having a detailed discussion with their team, my initial thoughts are:

  • This is an excellent platform for DIY investors who don’t want to actively monitor the portfolio, especially as it rebalances cost-free. In fact, I think it’s the first of its kind!
  • The service is not aiming for outperformance (alpha) by definition since it’s aiming at reducing portfolio volatility while providing market returns. Basically, it tries to improve the return/risk relationship (Sharpe ratio)
  • Exo is competitively priced versus other ‘robo-advisors’, but higher than execution-only platforms.
  • The platform is new to the market and its historical track record is unknown. However, given that its technology partner, ETS, has been applying the technology for the past 30+ years at an institutional level, I am inclined to look more favorably on this aspect.
  • The minimum investment amount is £10,000, which is fairly mid-range. It’s definitely reserved for the more affluent cohort of the market. However, they are currently running a launch offer of a reduced minimum investment of £5,000 and if you fund an account by the end of November you will receive 1-month fee free. Use this link to take advantage of their offer.

Wrap up

I cannot stress how critical it is to rebalance your portfolio given that it can significantly lower the volatility and boost return in the long-run. I think Exo is filling a significant gap in the market, where informed investors realise the importance of rebalancing but may not have the time/knowledge to do so.

On balance, I am tempted to run an Exo portfolio and an index one side by side for a couple of years and see the outcome.

Have you heard of Exo? Are you a customer? What’s your experience been so far? I’d love to hear your thoughts.

Time to check out Exo.

If you’re ready to start a portfolio, use this link to receive their launch offer of £5,000 minimum investment and 1 month free.