Tracking Preference

Tracking Preference is a Client Profile setting that indicates to Rebalancer the desired level of sensitivity a portfolio should exhibit towards the taxes and expenses involved in rebalancing. In order to be analyzed by Rebalancer, a portfolio must have a tracking preference set. There are four tracking preferences supported.

• Prioritize taxes and trading costs over target (1)
• Balanced Approach (4)
• Prioritize tracking target over taxes/costs (7)
• No Tax Management (0)

Competing Goals

Rebalancer’s analytics always try to minimize tracking error and the costs of trading and taxes. In practice, however, these often become competing goals. The tracking preference applied to a portfolio can be thought of as a bias that tells Rebalancer how much importance to place on either goal, tilting Rebalancer’s recommendations further toward one or the other.

Prioritize taxes and trading costs over target (High Tracking Error Preference)

A high tracking preference gives more weight to taxes and trading costs.

Prioritize tracking target over taxes/costs  (Low Tracking Error Preference)

A low tracking preference does the opposite, telling the system to increasingly ignore the impact of taxes and trading costs in favor of reducing tracking error.

Supported Tracking Preferences

Zoe’s Rebalancer supports 4 tracking preferences which ultimately correspond to numbers between 0 and 7.  

The higher the tracking preference assigned to a portfolio, the more sensitive it will be to taxes and expenses. A setting of 0 turns off tax management completely and places the priority on reducing tracking error. For this reason, a tracking preference of 0 is called Clone in the user interface (because it instructs Rebalancer to essentially trade a portfolio directly to its target).

Options for setting tracking preference are described in more detail below:

Tracking Preference Clone

As discussed above, the Clone setting (sometimes referred to as Tracking Preference 0) instructs Rebalancer to always attempt to trade the portfolio directly to its assigned target. When tracking preference is set to clone:

• No tax management is performed on a portfolio, and Rebalancer’s wash-sale prevention features are disabled.
• Never buy/sell restrictions are obeyed.
• Minimum trade size is obeyed.

The Clone tracking preference is most often used for non-taxable accounts where the client is not concerned about the number of trades or turnover.

Tracking Preferences 1 through 7

The remaining tracking preference settings are typically used with portfolios that require tax management, but may also be applied to non-taxable accounts to help manage trading costs. 

At tracking preference 1, Rebalancer recommends trades that make the portfolio track closely to its assigned target, while also:

• Obeying the wash-sale rule (when tax rates are not set to 0).
• Avoiding the sale of lots with short-term gains that are about to go long-term.

As tracking preference is moved closer to 7, Rebalancer’s recommendations track less closely to the portfolio’s assigned target, and become much more sensitive to the cost of trading, the impact on capital gains, and any rankings applied to securities or sectors in the portfolio. Here are the additional factors considered:

• The tracking preference of the portfolio.
• The tracking error created by holding a security despite its absence from the target.
• The tax burden generated by selling a security.
• The tax burden avoided by waiting to sell a security until it goes long term.
• The amount of time before a security tax status goes long term.