NISM Series XXI-B · Chapter 21: Portfolio Rebalancing

L1 · Foundation

Portfolio Rebalancing — the ground floor

Why a portfolio drifts away from its plan, what it costs to bring it back, calendar versus threshold rebalancing, and the three strategies the workbook compares: buy and hold, constant mix and CPPI.

11 min read · Worth 3% of the paper · Written from pages 396–402 of the official NISM workbook · Updated 18 September 2026

A portfolio does not stay where you put it

Building a portfolio is not the end of the job. The workbook is clear: portfolio management is a dynamic process. After construction, the portfolio needs monitoring and rebalancing.

The need for rebalancing arises from two sources:

Changes in market conditions that affect the risk-return forecasts of assets.
Changes in the circumstances of the investor.

Why markets push a portfolio off course

Prices of different assets do not move by the same proportion. High-return assets change faster than low-return assets. So over time the asset mix drifts away from its target weights.

Here is the catch. High-return assets usually carry high risk too. If the portfolio is not rebalanced:

its risk exposure changes from what was agreed,
it becomes more concentrated than intended, and
the desired level of diversification is undermined.

Picture a 60% equity portfolio after a long bull run. Equity is now a much bigger slice. The investor never agreed to that level of risk — the market simply handed it to them.

Why investors' lives push it off course

For individuals, the workbook lists changes in employment, marital status and the birth of children. These can change the goals, the amount of money available to invest and the liquidity needs.

That is why the workbook says the Investment Policy Statement (IPS) should contain a well-defined rebalancing policy covering two issues:

Adjustments to target asset-class weights when the investor's needs, circumstances and risk appetite change.
The set of rules for restoring the portfolio's original exposures when capital market expectations change.

Rebalancing has a cost — and a benefit

The workbook defines rebalancing as the process of aligning portfolio weights to the strategic asset allocation. It calls it an important step in the portfolio management process.

The benefit: it reduces the present value of expected loss from not rebalancing — that is, from drifting away from the optimal strategic asset allocation.

The costs:

Cost	What the workbook says
Monitoring and valuation	The portfolio must be watched and valued frequently
Transaction costs	Different assets have different costs; international equity costs more to trade than domestic equity
Illiquidity	Private equity and direct real estate are far harder to rebalance than listed equity
Taxes	Rebalancing means selling appreciated assets, which attracts tax

So a rebalancing policy is always a trade-off between costs and benefits.

How often? Calendar or threshold

Time-based (calendar) rebalancing

The simplest approach. Rebalance on a fixed schedule — monthly, quarterly, half-yearly or annually.

Quarterly is a popular choice.
It does not require monitoring between rebalancing dates.
Drawback: it ignores what the market does in between. On the rebalancing date the portfolio may be very close to target (so rebalancing costs more than it saves) or very far (so it has spent the period exposed to the wrong risk).

Threshold-based rebalancing

Set trigger points and rebalance only when a weight crosses them.

The workbook's example: a balanced (hybrid) portfolio with a 60% equity target and triggers at 50% and 70%. Rebalance only if equity falls below 50% or rises above 70%.

It gives tighter control of the asset mix than calendar rebalancing.
It needs frequent monitoring, and rebalancing can happen on any date.
The range also acts as a corridor for tactical asset allocation by the manager.

How wide should the corridor be? Two rules:

Asset feature	Corridor
Higher transaction costs	Wider tolerance
Higher volatility	Narrower tolerance — it drifts faster if left alone

Three strategies

Buy and hold — "do nothing"

A passive strategy. Decide the strategic mix, then do nothing about it afterwards. The mix drifts significantly over time.

Some money goes into safe assets to provide a floor value, since they do not fluctuate much. The rest goes into risky assets for appreciation. The portfolio's value becomes a function of the risky assets' performance, with no limit on the upside.

Constant mix — "do something"

Constant mix is actually the rebalancing process. Once the strategic mix is set, the manager trades periodically to reset it and avoid drift.

Its benefit: it maintains the intended market risk exposure, whereas buy and hold generally increases market risk over time.

Constant Proportion Portfolio Insurance (CPPI)

CPPI is an actively managed rebalancing strategy that splits money between risk-free assets (such as government bonds) and risky assets (such as stocks). It aims to give the upside of risky assets with the downside protection of the risk-free asset.

Three building blocks:

Floor — the value below which the portfolio should not fall. It is the present value of the desired level of capital protection. To protect ₹100 at the end of a 3-year product, the floor is ₹100 ÷ (1 + r)^3.
Cushion (or gap) — portfolio value minus floor.
Multiplier (m) — a fixed constant that sets how many times the cushion goes into risky assets. It defines the leverage.

The workbook's example: portfolio ₹100, floor ₹90, cushion ₹10, multiplier 5. Risky assets = 5 × 10 = ₹50. Risk-free = ₹50.

If the risky assets fall to ₹40, the portfolio is ₹50 + ₹40 = ₹90 — exactly the floor. Any further fall threatens capital protection.

That is why the multiplier is chosen only after studying worst-case scenarios — how far the risky asset could fall, for example in a single day. A higher multiplier means more upside, but also a higher chance of hitting the floor. In practice, multipliers are in the range of 3–5. The risky exposure must be rebalanced so capital protection does not take a hit.

Why the name? Because of the constant reference to the floor when resetting the split between risky and riskless assets — a constantly preserved rule for how much goes into equity and how much into cash.

Beyond the book

Indian investors meet these ideas outside PMS too. Balanced advantage funds, for example, move money between equity and debt under a stated model instead of leaving the mix to drift. The idea is the same: a rule decides when the mix changes, not the investor's mood on a given day. The exam, however, tests only the workbook's definitions — learn those words exactly.

Think of it like this

Calendar vs threshold rebalancing is servicing your scooter

Some people take their scooter for servicing every three months, whether it needs it or not. It is easy to remember and needs no attention in between. But sometimes the mechanic finds nothing wrong — you paid for nothing. Other times a problem started the week after the last visit, and you rode with it for months.

Other people go the moment the engine light comes on. That catches problems early and avoids pointless visits — but you have to keep an eye on the dashboard all the time.

The first is calendar rebalancing: simple, no monitoring, but blind to what happens in between. The second is threshold rebalancing: tighter control, on any date, but it needs frequent monitoring.

Buy and hold is an untended kitchen garden

You plant tulsi, chillies and a money plant in equal parts on your balcony and then leave for a year. The money plant grows fastest. By the time you return it has taken over the balcony and shaded out the others.

Nothing went "wrong" — the fastest grower simply won. But your balcony is no longer what you planned.

That is buy and hold. The fastest-growing assets are usually the riskiest, so doing nothing quietly raises the portfolio's market risk. Constant mix is the gardener who trims back every quarter so each plant keeps its planned share.

CPPI is the rope on a trekking climb

A trekker is tied to an anchor point on a slope. The anchor is the floor — the lowest point she can ever slide back to. The distance between where she is standing and that anchor is her cushion.

How much rope does she let out to climb higher? If a slip on this rock can never be more than a couple of metres, she can safely climb several times her cushion. That "several times" is the multiplier. More rope means higher views — and a bigger chance of a slip carrying her all the way down to the anchor.

As she climbs, the cushion grows and she can let out more rope. If she slips, the cushion shrinks and she must shorten it. That constant adjustment against a fixed anchor is exactly why CPPI keeps rebalancing and why multipliers are set only after looking at the worst-case fall.

Why wide corridors suit costly assets: the toll road

Imagine every lane change on a highway cost you a ₹200 toll. You would not change lanes for a small gap in traffic. You would wait until your lane was really crawling.

On a free city road, you might change lanes much more often.

Rebalancing works the same way. For assets with high transaction costs — the workbook's example is international equity versus domestic — each trade is a toll, so the manager sets a wider tolerance band before acting. For highly volatile assets, which can drift far very quickly, the band is kept narrower.

Key terms in this chapter

Buy and hold strategy: A passive "do nothing" strategy: set the mix once and leave it. The mix drifts, market risk generally rises, and upside is unlimited.
Constant mix strategy: A "do something" strategy of trading periodically to reset the asset mix to target. It keeps market risk exposure steady; the workbook calls it the rebalancing process itself.
Constant Proportion Portfolio Insurance (CPPI): An actively managed rebalancing strategy that invests a multiple of the cushion above a floor in risky assets and the rest in risk-free assets, aiming for upside with downside protection.
Corridor (tolerance band): The range between the trigger points. Wider for assets with high transaction costs, narrower for highly volatile assets; also gives room for tactical allocation.
Cushion (gap): In CPPI, the portfolio value minus the floor.
Drift: The movement of asset weights away from their targets because different assets' prices change by different proportions.
Floor: In CPPI, the value below which the portfolio should not fall — the present value of the desired capital protection.
Multiplier: In CPPI, the fixed constant that sets how many times the cushion is invested in risky assets. It defines leverage; in practice 3 to 5.
Rebalancing: The process of aligning portfolio weights back to the strategic asset allocation after they drift.
Rebalancing policy: The part of the Investment Policy Statement that sets how target weights change with the investor's circumstances and the rules for restoring original exposures.
Risk-free assets (CPPI): Assets such as government bonds that provide downside protection. Investment = portfolio value − risky investment.
Risky assets (CPPI): Assets such as stocks that provide upside potential. Investment = multiplier × (portfolio value − floor).
Threshold-based rebalancing: Rebalancing only when an asset's weight crosses a pre-set trigger point. Tighter control, but needs frequent monitoring.
Time-based (calendar) rebalancing: Rebalancing to target weights on a fixed schedule — monthly, quarterly, half-yearly or annually. Simple, needs no monitoring in between.
Trigger point: The weight at which threshold rebalancing is set off.

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Original explanatory writing based on the official NISM workbook for Series XXI-B, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

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