Mutual fund portfolio rebalancing: When, why and how should you do it?

An Investor can participate in various asset classes through MF schemes also which offer a spectrum of options for investors/ advisors. Mutual Fund is one of the most tax-efficient & transparent investment vehicles with professional expertise in Equity, Arbitrage, Fixed Income, Precious metals and REITs MF. 

Rebalancing becomes very important when the investor is experiencing stagnancy in a certain asset class. This might be due to some unforeseen reasons and hence the expected growth is not happening in that asset class for a long period. In such a scenario the probabilities of achieving goals might have to comprise.

One can look at re-balancing in 2 ways; the first simple option is to choose Multi Asset Mutual Fund schemes or Balanced Advantage Funds for an automatic re-balancing which the Fund Manager professionally manages; and another option is to look at various asset classes with their respective performances, valuations, taxation and exit cost if any and act accordingly.

Strategic Rebalancing

Depending on the level of the goals, timing and tenure one has to execute Rebalancing.  E.g. Retirement funds during the accumulation phase may have a larger allocation to equity, which requires to be rebalanced with debt during the consolidation or withdrawal phase.

Not taking the right decision in Asset allocation due to greed or fear may lead to a long-term impact on retirement corpus and plan.

Tactical Rebalancing

In the case of Tactical Rebalancing, an investor or advisor feels that some amount of asset rejig will add some extra returns or loss minimisation to the portfolio.

These are the AA options where one needs to review the assets on regular basis and analyse the asset class on the basis of valuation, market movement, tax implication, exit cost etc 

How To Rebalance Your Mutual Fund Portfolio?

1. Introduction

A well-defined & systematic asset allocation framework is integral to long-term wealth creation. With market dynamics changing by the day, the ‘invest-and-forget’ mentality may not work always for investors who track markets reasonably, proactively & aim to derive superior risk-adjusted returns. Enter portfolio rebalancing – a method of allocating the investment corpus across and within asset classes. 

2. Ways to rebalance

Set a frequency

Typically, the most common intervals for reviewing are, half-yearly & yearly. Interim movements in values of asset classes ideally shouldn’t merit any action unless circumstances warrant. A higher frequency implies higher impact cost (attributable to redemptions) and entails higher capital requirements (attributable to investments made).

Set a trigger

Tactical play of Asset Allocation on the base asset allocation model set by an investor and his/her tolerance in terms of price movements. As an example, let’s assume that the base model is 50% equity – 50% debt & the tolerance band is +/- 10%. When the portfolio composition changes to 60% equity – 40% debt, 10% of the equity exposure will be reduced & 10% of the debt exposure will be increased to bring the model back to base (i.e. 50% equity – 50% debt).

3. A combination

This approach aims to combine frequency & trigger. A change to the base asset allocation may be warranted depending on which of these two occur earlier. For instance, an investor’s base asset allocation model could be a 70% equity – 30% debt with a trigger of +/- 7.5% & a rebalancing frequency of 12 months. If, in less than 12 months, the equity portion of the portfolio increases to 77.5%, the investor may want to trim the surplus exposure (i.e. 7.5%) & allocate the same to debt. Alternatively, if, after a 6 month period, the equity portion increases to 75%, the investor may trim the surplus exposure (i.e. 5%) & allocate it to debt.

Conclusion

There is no apt rebalancing methodology. Investors should keep in mind their investment horizon, knowledge about markets, risk appetite & nature of goals, among other factors, to gauge what works/doesn’t work for them. If in doubt or unaware as to how an asset allocation model is created or rebalanced, consulting a financial advisor is recommended. . It is important to have a clear understanding of what an investor wants and then decide which option works the best.  MF schemes which offer automatic balancing through their valuation models like Balanced Advantage Fund or Multi-Asset Scheme or to take an Active call by re-balancing on your own. This asset allocation increase and decrease would be subject to exit loads/ taxation and would require skill / time and effort.

Author: Seemant Shukla-Chief Business Officer, JM Financial Mutual Fund.