How do the constraints on guided rebalance affect the proposal?

Customer

November 09, 2023 20:16 Edited

I performed a guided rebalance with a few constraints and wanted to clarify the logic behind the guided rebalance constraints specifically prefering fewer trades and prefering less trades. 

For example for “prefer fewer trades” we assume that if it is set to more, then there is more of a preference to prefer smaller trades.

The goal of the rebalance is to realize the fewest amount of taxes while rebalancing the client into IPS bounds. 

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• Official comment

  

  Mckenna Gray

  November 10, 2023 20:04 Edited

  • Client constraints are the general set of asset allocation preferences that need to be accounted for when performing a rebalance. Broadly, these can be classified into IPS bounds and asset-specific restrictions.
  • IPS Constraints
    • An IPS or Investment Policy Statement is a document that serves to define the objectives for a client portfolio. In particular, an IPS defines the time-horizon and investment goals for the portfolio. Along with more general details, it also defines client-specified ranges for certain asset classes. A simple example could be that the client only wants between 20 and 30% of their portfolio in Equities and an even smaller amount between 2-5% in alternatives. Guided rebalance, if possible, ensures the proposal is within the clients’ IPS bounds.
  • Asset / Attribute Restrictions
    • Client specified restrictions are restrictions on buying/selling of certain securities within the portfolio.These restrictions could be imposed for many reasons. For instance, an executive in a big tech firm might not wish to sell their equity stake in their company. Or there could be legacy holdings the client might wish to keep.
      • Do not buy: The final allocation cannot be more than the original allocation for that asset.
      • Do not sell: The final allocation cannot be less than the original allocation for that asset.
      • Do not trade: The final allocation must be equal to the original allocation for that asset.
      • Exclude: For the asset in consideration, exclude it from the rebalance. 
  • Cash
    • Cash and cash holdings need to be handled separately since a client might want to keep a certain weighting of their portfolio in cash. Within the Fabric application, we will consider cash as a “free” source of funds to be deployed in order to achieve the rebalance objective as closely as possible. By default, all cash should be deployed. However, if the advisor over-rides this default then they must specify the level of cash to be left within the portfolio.
  • "Prefer Smaller Trades" and “Prefer Fewer Trades”
    • The sliders aren't constraints but preferences so they are handled as penalties. The way this works within the app is that the optimizer seeks to penalize the changes made to the client portfolio. It is not an explicit constraint, so we shouldn't be thinking about it as "If I have set the slider to position 4 then position 4 will result in only 10 trades"... Rather, we should be thinking of it as "if I have set the slider to 4 then the final proposed portfolio will have fewer trades than in the case of the slider being in position 3". This is different from constraints where if you say "Do not buy Apple" then the optimizer will NEVER buy apple. However, if we state a preference like "I do not prefer to buy apple" then the optimizer will try to do its best to not buy apple, but if buying a little bit of apple helps in the final optimization, then there is the possibility that Apple would be bought.

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