Mutual Fund Portfolio Rebalancing: When, Why and How Should You Do It?

An investor can participate in various asset classes through MF schemes which offer a spectrum of options to the investors/advisors. Mutual Funds are one of the most tax-efficient and transparent investment vehicles with professional expertise in Equity, Arbitrage, Fixed Income, Precious Metals and REIT MFs.

Rebalancing becomes very important when an investor is experiencing stability in a certain asset class. This could be due to some unforeseen reasons and hence that asset class is not growing as expected for the long term. In such a scenario, the possibilities of achieving the goals may have to be included.

Rebalancing can be viewed in two ways; The first easy option is to opt for multi-asset mutual fund schemes or balanced advantage funds for automatic re-balancing, which is professionally managed by the fund manager; And another option is to look at the different asset classes with their respective performance, valuation, taxation and exit costs, if any, and act accordingly.

strategic rebalancing

One has to rebalance based on the level, timing and tenure of the goals. For example, retirement funds may have a large allocation to equity during the accumulation phase, which needs to be rebalanced with debt during the consolidation or withdrawal phase.

Not taking the right decisions in asset allocation due to greed or fear can have a long-term impact on the retirement corpus and plan.

strategic rebalancing

In the case of tactical rebalancing, an investor or advisor believes that some amount of asset rebalancing will reduce some of the additional return or loss in the portfolio.

These are AA options where one needs to review the asset on a regular basis and analyze the asset class on the basis of valuation, market movement, tax implications, exit cost etc.

How to Rebalance Your Mutual Fund Portfolio?

1. Introduction

A well-defined and systematic asset allocation framework is integral to long-term wealth creation. With market dynamics changing day by day, an ‘invest and forget’ mindset may not always work for investors who properly, actively track the market and aim to achieve better risk-adjusted returns. aim for. Enter portfolio rebalancing – a method of allocating investment funds across and within asset classes.

2. Methods of Rebalancing

set a frequency

Typically, the most common intervals for review are semi-annual and annual. Interim fluctuations in the values ​​of asset classes should ideally not warrant any action unless circumstances warrant. A higher frequency means higher impact costs (due to redemption) and higher capital requirements (due to increased investment).

set trigger

Strategic play of asset allocation on a base asset allocation model determined by an investor and his tolerance in terms of price movements. As an example, let’s say the base model is 50% equity – 50% debt and the tolerance band is +/- 10%. When the portfolio structure changes to 60% equity – 40% debt, 10% of equity risk will be reduced and 10% of credit risk will be increased to bring the model back to premise (ie 50% equity – 50% debt).

3. A Combination

The purpose of this approach is to combine frequency and trigger. Depending on which of the two occurs first, a change in the base asset allocation may be required. For example, an investor’s base asset allocation model might be 70% equity – 30% debt with a trigger of +/- 7.5% and a 12-month rebalancing frequency. If, in less than 12 months, the equity share of the portfolio rises to 77.5%, the investor wants to reduce the additional exposure (i.e. 7.5%) and allocate it to debt. Alternatively, if, after a period of 6 months, the equity share rises to 75%, the investor can hedge the surplus risk (i.e. 5%) and allocate it to debt.

conclusion

There is no suitable rebalancing method. Investors should take into account their investment horizon, knowledge about the markets, risk appetite and nature of goals, among other factors, to find out what works/does not work for them. If in doubt or unsure how an asset allocation model is built or rebalanced, it is recommended to consult a financial advisor. , It is important to have a clear understanding of what an investor wants and then decide which option works best. MF schemes that offer automatic balancing through their valuation models like Balanced Advantage Fund or Multi-Asset Scheme or by re-balancing themselves to take an active call. This asset allocation increase and decrease will be subject to exit load/taxation and will require skill/time and effort.

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