Tuesday, July 11, 2006

Rebalancing and Program Trading

This post has to do with rebalancing a portfolio and program trading (for big portfolios). Some investment firms have multiple portfolios/funds that are set up for certain goals. For instance, one fund might be a regular long/short fund where it takes long positions as well as short positions. Another fund might be levered, so it will basically have the same positions as the long/short fund but in greater percentages (through borrowing). If the long/short fund has a 1% position in Microsoft (MSFT), the levered portfolio might have a 2% position in MSFT- so it's a 2x fund. This ration can be any number, I'm just using 2 for simplicity.

But sometimes things get out of whack because of a variety of reasons. Let's say the stock doesn't trade that much so the 2x fund is unable to get enough shares, or more shares are sold out of the 1x fund. If money leaves the 1x fund, stocks will need to be sold and this will throw off the 2x fund as well. This is where rebalancing and program trading come into play. Ideally rebalancing might happen once per quarter, but it can happen more frequently. Rebalancing basically means how it is read- rebalance the portfolio. Using software you can figure out which stocks are out of line and you might need to bring these positions up or down (you can also do this on Excel, it just takes a little longer).

Once this is figured out, most trading software platforms can automatically generate the trades and then you just need to send them to a program for trading. We use program trading because generally when you rebalance a portfolio it's a small amount of shares (percentage wise), but possibly hundreds of trades. With program trading we basically send all the orders to a program and it gets all the trades done. We just have to sit back and wait....I wish! We have to monitor the positions and trades to make sure things go smoothly, but using programs definitely saves some time.

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