It's about culture and business model, not which is better for customization.
Which is better? Advisor-led or centralized rebalancing.
Advisor-led rebalancing maximizes advisor autonomy. Centralized rebalancing maximizes scale and consistency (and, perhaps, surprisingly, tax efficiency). In different ways, they each maximize customization.
Advisor-led rebalancing will be better at reflecting the individual stock and trading preferences of the investor. Centralized rebalancing, if it leverages the power of automation, will be better at reflecting an investor’s preferences for ESG and religious value constraints, custom cash management, and custom product choice; it will also be able to deliver superior tax management1. There’s no standard terminology to describe these two types of customization. Let’s call the first – the type you get with advisor-led rebalancing – “trade customization”. And let’s call the second – the type you get with centralized rebalancing – “portfolio customization”.
So what are the reasons firms choose one or the other path?
Advisor-led rebalancing, "trade customization” and maximum advisor autonomy
Firms that decentralize rebalancing focus on giving each advisor wide latitude to do what they think is best for each of their prospects and clients, within firm-set guidelines. The firm sees its main job as providing support for their advisors, consistent with the demands of the compliance department.
Because the advisor is given so much autonomy, there’s plenty of leeway to involve clients in trade decisions. Some advisors, even with discretionary accounts, will choose to consult with clients before trading.
From an advisor’s perspective, there’s much to like about firms that aim to provide advisors maximum autonomy. Who, after all, doesn’t like autonomy? There is a downside, however. The advisor’s very freedom means that in a lot of ways they’re on their own. In particular, they end up spending a lot of time with the tiny details of managing and trading portfolios, which takes away from time they could spend with clients and prospects. And because it is so time consuming, the advisor is limited in what they can do. This will almost always mean compromises when it comes to time-intensive tasks like tax management, ESG constraints, religious value constraints, etc.
From a firm’s perspective, the upside of a focus on advisor autonomy is that it works well with a growth strategy based on attracting already successful advisors with large books of business. These seasoned advisors can join a firm and bring their clients with them. Precisely because the firm gives maximum leeway to each advisor to manage portfolios in their own way, it’s very easy for clients of newly hired advisors to follow along — they can continue to enjoy the same client experience they had before.
The downside, for the firm, is that advisor-led rebalancing is expensive and unable to support broadly delivered programmatic customization and tax optimization. It’s also inconsistent: the autonomy given to each advisor also means that the experience a client receives will very much depend on the advisor they work with. It may all be good, but it won’t be consistent. This makes it hard to promote and brand the service the firm provides. It’s also a problem for compliance.
Centralized rebalancing: consistency, efficiency, “portfolio customization” and tax optimization
Firms that centralize rebalancing start by thinking carefully about what their firm stands for and how clients should be served. The firm decides what client experience they want to offer, and then they set out to deliver it, efficiently and consistently. These firms typically create an investment policy committee (sometimes comprising all the advisors) to establish capital market beliefs and high-level recommendations.
Centralizing rebalancing does not mean that investor-facing advisors are uninvolved. It’s the investor-facing advisor that designs a customized solution for each client, selecting customization parameters for each account (e.g. “aggressive growth, but no energy sector, include tax budget, and use ETFs only”). But day-to-day rebalancing and trading is handed over to a central group that has the responsibility of implementing customization, transition, risk control and tax management.
From the firm’s perspective, consistency of service makes it easier to brand, promote and cross-sell the firm’s services. It’s also more compliant. And because it’s more systematic, it will be easier to provide clients with a richer digital experience. With advisor-centric approaches, desktop and mobile applications tend to be little more than document vaults and contact links. But with centralized implementation, you can systematize executing client requests, like a cash withdrawal, that have been entered through a digital interface. You can provide clients with real-time feedback on the effects of their choices (for example, seeing the tax cost of imposing a “never own tobacco” constraint). And for prospects, you can generate in real-time multi-year tax-sensitive transition plans.
An open question is whether firms that centralize rebalancing can still attract high-performing “breakaway” advisors to join the firm — and bring their clients with them. Anecdotally, the answer seems to be yes. It really depends on the type of service the advisor provides. If, at heart, they’re traditional stock pickers or traders, it will be a difficult fit. But if, at heart, they’re financial planners, it’s easy. They get to outsource to the central rebalancing group the time-consuming task of rebalancing, enabling them to spend more time on their clients.
The trend: towards centralized rebalancing
Both approaches have their advantages, but the trend is towards centralized rebalancing (and offering high levels of programmatic customization and tax management). There are two main drivers of this change: competitive pressure and the improvement of rebalancing technology.
1. Competitive pressure: The continued growth of low cost, passive ETFs, as well as the spread of low-cost robo advisors, has put pressure on firms to cut costs and/or improve service. Centralized rebalancing is more cost scalable and efficient because it's more automatable. And it fits in better with firms focuses on delivering a consistent client experience.
2. Improvement of rebalancing technology: It used to be that the only way to deliver a customized, tax-sensitive solution was to have a client-facing advisor manually manage each account. This is no longer true. With improved automated rebalancing technology, the situation is reversed. A centralized rebalancing group can now deliver a higher level of tax management and more customization options that can be provided by almost any advisor managing portfolios manually. And centralized rebalancing groups can deliver the service at lower cost, which makes it economically feasible for firms to offer more customization and more tax management to more clients, including the mass affluent.
For entirely understandable reasons, some advisors will look askance at this trend — it’s a threat to their, well, autonomy. And not every firm built around advisor autonomy will or should change. Firms built around advisor autonomy have hired advisors and attracted clients who like what they’re doing today. And that’s not easy — or even necessarily desirable — to change. So, expect to see both types of firms for a while.
But we — and most folks we speak with — think the trend towards centralized rebalancing will be a win for all concerned — clients, firms AND advisors. For clients, it means lower costs, more customization, better tax management, a greater focus on financial planning and more time with their advisor. For firms, it means lower costs and a superior, more brandable service. For advisors, it means less time dealing with rebalancing minutiae and more time to focus on the long-term interests of their clients. And that's a win for everyone.
1. When you automate something, you can offer more of it, and centralized processes are more automatable. Hence their ability to offer more, not less, customization and tax management.