What is investment portfolio rebalancing?
Portfolio rebalancing is the process of selling and business investments in order to return to the target asset allocation.
Why is portfolio rebalancing necessary?
This is best explained by using an example. If on the 1st of January we have an investment portfolio with the following asset allocation:
US equities: €300,000
European equities: €150,000
Emerging market equities : €100,000
Japan equities: €100,000
Global smaller companies (equities): €100,000
A-grade government bonds: €100,000
A-grade corporate bonds: €100,000
Cash and money market funds: €50,000
Total portfolio value: €1,000,000
What happens if on the 31st of December, 12 months later, the investor’s portfolio looks like this:
US equities: €330,000 (up 10%)
European equities: €161,250 (up 7.5%)
Emerging market equities : €112,500 (up 12.5%)
Japan equities: €106,500 (up 6.5%)
Global smaller companies (equities): €113,000 (up 13%)
A-grade government bonds: €95,000 (down 5%)
A-grade corporate bonds: €93,000 (down 7%)
Cash and money market funds: €51,000 (up 2%)
Total portfolio value: €1,062,250 (total gross return: 6.22%)
Now, if we look at the new asset allocation, 77.5% is invested into equities, compared to 75% before, of which 21.23% are in global smaller companies and emerging markets, compared to 20% previously. The investment portfolio no longer has the same expected return and volatility, in other words, risk profile. These differences are not great this year, but they could be if they were left unchecked or if we had a particularly volatile year in the markets, which happens. Therefore, in order to maintain the same risk profile as before, we should sell some equities and buy some bonds.
Are there any other reasons for rebalancing?
Yes, even if the investor’s risk profile has not changed and the asset allocations are the same as their original percentages, sometimes the investment manager reviews the optimal asset allocation of the portfolio and if there are changes then rebalancing will be done in order to match the new target asset allocation. This could be because of changing economic conditions making certain asset classes more or less attractive than previously.
There may also be tax reasons to undertake rebalancing, for instance, in the UK rebalancing can help you can use up your annual capital gains tax allowance.
Also, an investment manager may undertake rebalancing due to their investment philosophy. An investment manager who has a momentum-based investment philosophy may rebalance less often than one that has a value-based investment strategy (or a hybrid one).
What are the different rebalancing methods?
There are different ways that portfolio rebalancing can be done:
- Manual rebalancing: this is when the portfolio is reviewed at regular intervals, either by the investor themselves or by the investment adviser or manager.
- Automatic rebalancing: this is when the portfolio is automatically rebalanced, either by the investment platform, or via the fund manager if the client invests into a risk-rated portfolio.
- At set dates (calendar rebalancing): the rebalancing takes place either quarterly, semi-annually or yearly. Monthly rebalancing is also possible but not very common because of greater transaction and administration costs. This can be done manually or automatically.
- At certain triggers (threshold rebalancing): the rebalancing takes place once the asset classes diverge too much from their original and target allocations. This can be done manually or automatically.
- A combination of the above.
How can Aisa International help you?
We offer reviews at least one per year and rebalancing will be considered as part of the investment review. Depending on your investment portfolio, this may be done automatically or we may have to do it manually, with your permission. Rebalancing is just one of the reasons for an annual financial and investment review.
Useful links
- https://aisainternational.fr/investments/the-mathematical-argument-for-investment-diversification/
- https://aisainternational.fr/investments/active-vs-passive-investment-management/
- https://www.investopedia.com/terms/a/assetclasses.asp
- https://www.quantilia.com/value-carry-momentum/#:~:text=In%20essence%2C%20momentum%20strategies%20perform,strategies%20helps%20to%20manage%20risk.
- https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/tuning-frequency-for-rebalancing.html
- https://www.quantilia.com/value-carry-momentum/#:~:text=In%20essence%2C%20momentum%20strategies%20perform,strategies%20helps%20to%20manage%20risk.
The views expressed in this article are not to be construed as personal advice. Therefore, you should contact a qualified, and ideally, regulated adviser in order to obtain up-to-date personal advice with regard to your own personal circumstances. Consequently, if you do not, then you are acting under your own authority and deemed “execution only”. Additionally, the author does not accept any liability for people acting without personalised advice, who base a decision on views expressed in this generic article. Importantly, this article is dated and is based on legislation as of the date. It should be noted that legislation changes, but articles are rarely updated. Sometimes a new article is written; so, please check for later articles. Additionally, check for changes in legislation on official government websites. Finally, this article should not be relied on in isolation.
