The first being our ability to hold multiple ETFs per line of index or asset class. The second, an updated section on how we invest your cash. In our continued focus on transparency, we wanted to take this opportunity to also write a post about how our system actually allocates your capital.
Regardless of which of our three portfolio management styles you select (starter, investment plans or custom portfolios), your portfolio will have a target/policy asset allocation. These are the weights that the combinations of equities and bonds should make up based on the risk profile you have selected.
As asset allocation is key the next thing to consider is the ETFs we use to build this asset allocation. The various ETFs will have different prices that constantly change in the market. When clients fund their accounts, our software will allocate the funds in the most accurate way possible to construct the chosen asset allocation whilst taking into consideration the costs of the ETFs it needs to buy. It does so by three key steps. Firstly, ranking all the assets in the portfolio based on the difference between the current live weights (zero for new portfolios) and the selected target weights. Therefore ranking all asset classes from most to least outside of tolerance. Secondly, considering the prices of the asset or ETFs. If the funded amount is relatively large then the allocation across the assets is very straightforward. However, when the initial funding or monthly contribution is very small our system will go down the list of most to least underweight asset classes and allocate the funds where it can to the ETFs that have prices equal to or less than the funded amount.
Lastly, the system will always allocate the funds our clients invests. As long as the funded amount is more than the price of one unit of the ETF with the lowest market price (it is mathematically possible to buy at least one unit) the cash will be allocated. This means that for portfolios with very low monthly contributions a build up of ETFs with the lowest market prices could result. This is because, despite the first two ranking priorities, the allocation is so small that the best the system could do was allocate the funds. Once the portfolio is rebalanced however any overweight asset classes will be sold and re-allocated to underweight asset classes.
Due to the market movements of the ETFs, we also build in a safety margin into calculating the number of shares we buy. This is to avoid rallies in prices causing overdrafts in client accounts. This safety margin does result in a small cash residual being left over after a portfolio has been funded and invested. Any residual cash, however, is re-invested in our next rebalancing window as the system aims to continue investing cash as long as it is able to buy at least one unit of one asset.
We hope delving into the logic of how your funds are invested provides further clarity in how our system works. From ranking the most to least overweight assets, to buying the ETFs we are able to the aim, to lastly having a safety buffer to protect from overdrafts the aim is always to allocate your cash as mathematically accurate as possible.