Goal based Planning

Portfolio Rebalancing4 min read

Profitable investments are fickle friends. When we invest in securities, we should keep in mind that businesses have ups and downs, just like everything else. A company which is profitable today may or may not continue to be profitable in the future. Therefore, it is very vital for the investor to regularly review the investments, closely watch the business performance, understand the market dynamics of the industry, and rebalance the assets at regular intervals.

Portfolio Rebalancing is done to ensure that the asset allocations are aligned to your desired risk appetite and financial goals as per the original investment policy statement (‘IPS’)

Why Portfolio Rebalancing? 

The portfolio manager is aware of your risk appetite and long-term goals and mentions that in the IPS. The choice of assets and proportion of each asset classes is primarily depended on the overall objective defined in the IPS.

For example: Let’s say, the primary asset allocation happens to be 60 per cent in favour of equities. This will be called your original strategic asset allocation. Over the next year, there could be a change in the market value of different asset classes within the portfolio, thereby, hampering the overall asset allocation. Such modification may expose the investor to the unwarranted risk and may prolong the time taken to achieve the long term goals as per the IPS. It is crucial to re-allocate these excess funds to reduce such unwarranted exposure. 

Rebalancing will enable buying or selling assets in a portfolio periodically to maintain a fundamental level of strategic asset allocation. Hence, rebalancing shall keep the portfolio align with long term goals, desired risk appetite as well as expected return from the portfolio as defined in the IPS.

Frequency of Portfolio Rebalancing (Strategies)

There is no fixed schedule for rebalancing. However, there are a few portfolio rebalancing strategies to decide the frequency of rebalancing.

  1. Constant Mix strategy (Corridor based)

Since rebalancing allows the investors to sell high and buy low, by booking profits from outperforming assets and reinvesting them in underperforming assets, this strategy demands a rebalancing on a variation from the original asset allocation with bands. E.g., When your original asset allocation shifts from its equilibrium beyond 10 per cent. i.e. If the allocation shifts from the original 70-30 to 80-20, then the investor shall sell 10% equity and invest 10% in debt and change the allocation back to original 70-30. 

2. Calendar Rebalancing (Time based)

This is one of the more straightforward rebalancing techniques where a fixed date of a periodic interval, either annually or twice a year, is decided in advance as the date of rebalancing. The portfolio is rebalanced irrespective of the performance of the markets. This is the least costly method of rebalancing; however, it does not react to the market conditions.

3. Constant proportion portfolio insurance: 

This is the most complicated strategy in this list as it involves a floor value for the risky investment and a multiplier coefficient. The rebalancing decisions are taken if the cushioning amount, which is a function of the portfolio value, floor value and the coefficient multiplier, is triggered.

Importance of Portfolio Rebalancing

  • Risk and reward: Asset allocation is all about risk and reward. As we discussed that some asset classes might outperform the other asset classes in the same portfolio over a period of time. Portfolio rebalancing helps to avoid skewness towards a particular asset class, thereby, stabilizing the overall portfolio risk as per the IPS
  • Higher discipline: A psychological trait of the investors does not allow them to put in more money in underperforming assets and securities. Portfolio Rebalancing enforces a certain level of discipline to sell the outperformers and put the same money in the stocks that have underperformed. 
  • Regular Review: Rebalancing is a follow-up activity after a full review of the portfolio. Therefore, every time that a portfolio manager wishes to rebalance the portfolio, all the securities and the asset classes shall be analyzed, scrutinized and reviewed, thereby, able to make an opinion on individual stock holdings too.
  • Stick with the overall plan: The original strategic asset allocation and the investment strategy is tied to the long-term aspirational goals, timeframe for the money and the desired risk tolerance. Periodic Portfolio Rebalancing enables to maintain the strategic asset allocation in line with the IPS.

Rebalancing is an integral part of strategic investment management and financial plan. Therefore, It is crucial to reap the desired rewards from your allocated funds. It should, however, be done keeping in mind the costs that come along, e.g., exit load, brokerage costs, transaction costs and taxation. Therefore, too much frequent rebalancing may be very costly and may outweigh the benefits of Portfolio rebalancing.

Therefore, one should weigh the costs and benefits of the overall portfolio rebalancing activity and then decide the strategy that works best, identify the asset classes and act on it. 

Samco Support


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