A question that we get most often is whether an advisor should use security models or class models. Security models are the most common strategy used by advisors, but is this the best for your firm? This can be a difficult question to answer, as every firm is different and unique.

Luckily, AdvisorPeak supports both types of models. Let’s go through some of the pros and cons of each to help with your decision on what may be best for your firm.

Starting with Security models, these are the most simplified version of model. The aim of these models is to build funds around specific securities rather than a group or class. Some traders use this strategy to be more involved with the exact positions being traded. This method also ensures that your clients match your specific models exactly. Because of this, advisors who are trying a new strategy or who are new to rebalancing can find these easier to use.

With this in mind, Security models also cause more trades to occur due to their precise nature, which may result in more fees. This strategy is also more difficult to use with clients who hold on to legacy positions – changes to your trade settings may be required to make sure those positions aren’t sold. If this is a common scenario for your clients, Class models may be a better option.

Class models focus on a group of securities in an asset class rather than single securities. While core securities can still exist for clients who are not invested, the goal is to set the target for the asset class or sector rather than putting the emphasis on individual positions.

Because the model is looking at the overall class, any security in the same class is considered as equivalent when rebalanced. This strategy results in fewer trades, which lowers trading costs and reduces paperwork. This also fixes the issue of legacy positions mentioned above. Since the class is used, other trades in the same class can be placed without extra work involved.

What do these strategies look like in the real world? Consider the following scenario.

Two advisors, A and B, handle the same two clients. Both firms use the same custodian, and both have transaction fees of $10 per trade. For both firms, both clients hold the same positions:

  • 25.00% AAPL
  • 25.00% GOOG
  • 25.00% FNDE
  • 25.00% FNDF

advisor A has a Security-based equity model. In it, the following targets are listed:

  • 50.00% AAPL
  • 25.00% FNDE
  • 25.00% FNDF

After rebalancing, advisor A sees a result asking him to sell completely out of GOOG and make a buy into AAPL. This leads to a total of two trades, for a total of $20 in transaction fees.

advisor B has a Class-based equity model. In it, the following targets are listed:

  • 50.00% US Stock
  • 25.00% Emerging Market Stock
  • 25.00% Developing Market Stock

Because both AAPL and GOOG are considered as part of the US Stock class, no trades are made for the account. This prevents the advisor from having to pay $20 for the transactions to occur.

While this is a very simplified scenario, this addresses a very real need for advisors who trade positions with fees associated. This also provides a simplified way to show the client their current investment.

Take into account, however, that the second advisor ignores the precise buy of AAPL. Because of this, they may miss out on important gains caused by the movement of a specific position. While this may not be important for an advisor who develops their strategy based around the asset class, it can make a major difference to the advisor who cares about the specific securities a client holds.

What is the correct answer regarding how your firm should trade? This is all down to your own personal philosophy and research. Both types of models have their strengths and their weaknesses, and there is no single solution for every advisor. Consider what is more important to you: having specific securities, or being in a specific classification at a given time? 

And as always, feel free to call on us at AdvisorPeak should you need help with restructuring your strategies.