Anything that can help control investment risk is an awesome thing. That’s why portfolio rebalancing is a best practice must-have. Let’s look at how a rebalancing strategy can help reduce risk and ensure your clients’ investments remain aligned with their overall financial plan.
What is portfolio rebalancing?
Portfolio rebalancing is the process of ensuring that an investment portfolio retains the appropriate balance of risk and reward in line with your client’s financial objectives and desired level of risk.
It is inevitable that some portions of a portfolio will outperform others. As a result, the portfolio can naturally skew towards too much or too little risk. Rebalancing involves selling some of the assets that are performing well and reinvesting the funds in other areas.
So, for example, if a portfolio that began with a 50/50 split of stock and bonds had a period of underperforming bonds and overperforming stocks, the 50/50 split may skew more towards 60/40. To rebalance the portfolio in line with the original 50/50 objective, you could take the gains from the high-performing stocks and reinvest them in bonds.
What are the benefits of rebalancing?
Control risk: The fluctuating nature of the stock market means that the risk associated with a portfolio also fluctuates. Rebalancing helps manage the risk by proactively adjusting the portfolio in line with your client’s original goals. In short, a failure to rebalance a portfolio could result in an ‘all your eggs in one basket’ syndrome which could result in your client’s portfolio moving out of line with their objectives or missing out on an investment as it comes back into favour.
Stay on track: Think of rebalancing as periodical readjustments to the steering wheel to keep your clients on course to reach their financial destination. It helps to keep your clients’ long-term strategies in mind by adjusting their asset allocation in line with their financial goals and tolerance for risk. This can help to protect their portfolio and maintain their investment income.
7bps saving via rebalancing process: Switching from an annual calendar rebalancing process to a tolerance led approach can increase the investment performance by an average of 7bps. On average a client holding £440,000 x 0.07%* = a rebalancing
dividend of £308 - higher than the average Betafolio cost.
*Please refer to our Rebalancing Research paper
The Betafolio approach to rebalancing
Our rebalancing strategy is based on ‘drift’. This is known as tolerance-based rebalancing.
Here’s how it works: When assets in a specific asset class drift over or under 10% from what they should be, we re-balance the portfolio.
This is based on research that suggests the ‘drift’ approach can result in superior gains as it involves continuous monitoring of the portfolio’s performance, as opposed to an annual rebalancing review.
We do this because our research has shown rebalancing for market movements provides better outcomes, compared to rebalancing just before a client review meeting or arbitrary annual date in the diary.
Tolerance-based rebalancing helps us ensure that portfolios remain in line with risk parameters and return objectives all year round as well as improving performance.
Please refer to our research paper for an in-depth review of rebalancing approaches.
Discover more about our investment philosophy
From risk and return to asset allocation, you can read our core investment beliefs here or get in touch for a chat.
