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What should be the strategy to rebalance your mutual fund portfolio?


Why rebalance mutual fund portfolio?

Nitin Rao, Head Products and Proposition, Epsilon Money Mart said “Portfolio review and rebalance is one of the critical aspects of the investment journey. Investors should review their portfolio at least once every six months or post a trigger event. This helps them to gauge if the portfolio is performing in line with their investment objective or if a change is needed. Investors should analyse the portfolio basis the risk and return matrix and reconsider action towards underperforming investments.”

“Investors should take into consideration various parameters such as time horizon, investment strategy, fund manager, top sectors, top holdings and so on for rebalancing their portfolio. An ideal mutual fund portfolio should have between 6-8 funds. This avoids the risk of over-diversification in the portfolio and provides a concentrated approach. Investors should look at maintaining an equity-debt balance in the portfolio as per their risk profile and should rebalance the portfolio if the allocation to either debt or equity changes from the desired weightage,” he said.

What should be your allocation strategy while rebalancing your mutual fund portfolio?

CA Manish P. Hingar, Founder at Fintoo said “Rebalancing your mutual fund portfolio should not be done too often. One should review their Mutual Fund portfolio once a year and check if any of the funds are underperforming with a more significant margin compared to their benchmark and peers. If yes, then we should look for switching to better-performing funds.”

“However, rebalancing should be done only if one’s portfolio gets overexposed to one particular asset class i.e., deviates from the ideal asset allocation. In a Bull market, the equity holdings would continue to grow and compound in size relative to the Debt allocation and it will end up potentially higher. So, one can rebalance keeping in mind a tolerance band of +/-10%. Also, looking at the market conditions if you anticipate equity markets to go down in the short term, then you may reduce your equity exposure and increase debt exposure to reduce your risk in uncertain volatile market conditions,” he said.

When to rebalance your mutual fund portfolio?

Atanuu Agarrwal, Co-founder, Upside AI said “Chopping and changing allocations often is generally not a good idea. Like any other equity-linked instrument, equity mutual funds also need to be viewed as long-term investments. Trying to time the market or chasing historical returns often leads to lower returns. I think it is prudent to review your investments annually, possibly just prior to the financial year end to optimize tax.”

“Any permanent rebalancing should be driven by changes to your strategic asset allocation based on prevailing circumstances or revision in goals. Also, any changes to scheme objectives or fund manager of a mutual fund should be reviewed to make sure it still fits within your asset allocation. Of course, consistent underperformance (over ~3y timeframe) against the benchmark could call for rebalancing as well,” he said.

Mutual fund portfolio rebalancing example

Mr. Deepak Singh – Chief Business Officer at Reliance Securities said “The first mistake that many investors make is investing in a large number of funds. They only realise after a few years that they need to clean up their portfolio and reduce the number of schemes. Rebalancing your portfolio entails reviewing and restoring the original target asset allocation.”

“If you previously had a 70:30 equity-debt allocation, you may want to reduce your exposure to 60:40 based on your risk tolerance. Assume you begin the year with an Rs. 1 lakh portfolio that is perfectly balanced, with 70% or Rs. 70,000 allocated to Equity Funds and Rs.30,000 allocated to Debt Funds. If the equity market performed well over the horizon, the equity portion of your portfolio could increase from Rs. 70,000 to Rs. 100,000, while the debt portion of your portfolio would increase from Rs. 30,000 to Rs. 50,000. So, in that time frame, your portfolio increased from Rs. 1 lakh to Rs. 1.5 lakh,” he said.

“The current equity-debt ratio is 66:33. This means that your equity portion is now 4% lower and your debt portion is 3% higher than before. This is where you should perform deviation-based portfolio rebalancing while keeping your upcoming expenses and age in mind. Rebalancing should ideally be done once every two years to help reduce the number of funds and clutter,” said Mr. Deepak Singh.

Example for rebalancing mutual fund portfolio in different market scenarios

Satish Prabhu, Head – Content Development – India, Franklin Templeton said “If your target asset allocation is 50% (equity):50% (debt) basis your risk appetite and the equity markets rise, your allocation may change to 70% equity:30% debt. This will not just skew the portfolio towards equity but will also make it more risky. At regular frequencies of 6-12 months, one must rebalance the portfolio to their target allocation (50:50). In this case one may sell equity or buy debt to make it 50:50.” 

“Similarly, if the market falls, the allocation will be skewed towards debt. To rebalance, one may buy more equity or sell some debt. Buying/ selling for rebalancing may involve tax incidence/ exit loads. Manual rebalancing also suffers the stigma of emotions as one may forgo rebalancing to reap higher profits when markets rise. To avoid the above hassles, one may look at hybrid funds which provide a readymade strategic or dynamic asset allocation in a single fund. These funds are agnostic to emotions while rebalancing as well as more tax efficient than the manual process,” he said.

Note: Allocation mentioned in the article is for illustration purpose only.

Rebalancing mutual fund portfolio example with any asset class

Mr. Arun Kumar, Head of Research, FundsIndia said “If the exposure of any asset class (equity, debt, gold etc) in your portfolio deviates by more than 5% from your original planned asset allocation, then rebalance it back to your original asset allocation by selling the overexposed asset class and buying the underexposed asset class. If the deviation is within 5%, then you can continue with your current asset allocation. This can be done once every year.”

“However, in rare cases where the asset allocation deviates by more than 10% during the year, you can rebalance immediately without waiting for the usual yearly rebalancing date,” he said. 

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.

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