Rebalancing

An investor decides on an asset allocation — say 60 per cent equity and 40 per cent debt — after thinking about goals, time horizon and risk appetite. Then markets move. Equity and debt do not move together, and even when they move in the same direction they do not move by the same amount, so a year later the portfolio is no longer 60:40.

Rebalancing is the act of putting it back. Sell a part of whatever has grown beyond its target share, and use the money to top up whatever has shrunk below it.

The workbook's argument for doing this is simple. The target was set from an analysis of the investor's needs and risk appetite. If the risky asset has grown to a bigger share, the investor is now carrying more risk than that analysis allowed. If the asset with higher return potential has shrunk, the goal is now at risk. Either way the portfolio has stopped matching the person who owns it.

The side-effect is the attraction: rebalancing makes the investor buy low and sell high, automatically, without ever having to forecast the market.

The workbook's own illustration uses a 50:50 target between asset categories A and B, with Rs 1,000 in each. A year later A is up 20 per cent to Rs 1,200 and B is down 5 per cent to Rs 950. The portfolio is worth Rs 2,150 and is now split 55.81 : 44.19.

Restoring 50:50 means each side should hold Rs 1,075. So Rs 125 of A is sold and the proceeds buy B. The asset that went up is trimmed; the asset that went down is added to.

Two triggers call for rebalancing:

Rebalancing is required under both strategic and tactical asset allocation. The workbook adds that the approach works very well over years in which asset categories go through many cycles of ups and downs.

A separate rule applies to schemes, not investors. If a scheme's portfolio deviates from the asset allocation mandated in its SID because of a passive breach — one not arising from the AMC's omission or commission — SEBI's mandated rebalancing period is 30 business days for all schemes other than index funds and ETFs. The mandated period does not apply to overnight funds.

Anjali, 38, holds Rs 20 lakh at a target of 70:30 equity to debt. The numbers below are illustrative, and ignore exit load and tax.

Year 1 — equity falls 25 per cent, debt earns 6 per cent.

The split is now 62.28 : 37.72. Restoring 70:30 means equity should be Rs 11.802 lakh, so she moves Rs 1.302 lakh from debt into equity — buying equity right after it has fallen, which is exactly what fear tells her not to do.

Year 2 — equity rises 30 per cent, debt earns 6 per cent.

The discipline added about Rs 31,248. The reverse sequence — a rally followed by a fall — works the same way: rebalancing would have trimmed equity near the top.

In practice each move between schemes is a switch, which is a redemption from one scheme and a purchase into another, so exit load and capital gains tax can apply. That is why many investors rebalance by directing fresh SIP money to the under-weight asset first.

Chapter 1 (Investment Landscape), section 1.8, explains rebalancing with the Rs 1,000 / Rs 1,200 / Rs 950 illustration, and states that it applies under both strategic and tactical asset allocation. The same section carries the SEBI 30-business-day rule for passive breaches. Expect a calculation of how much to sell to restore a target, a conceptual question on what rebalancing achieves (buy low, sell high without a market view), and recall of which schemes the 30-day rule does not cover.

• Rebalancing restores the target; it does not change it. Changing the target to exploit a market view is tactical asset allocation.
• Rebalancing is needed under both SAA and TAA. An option saying it applies only to strategic allocation is wrong.
• It sells the winner and buys the loser. An option describing it as "adding to the best-performing asset" is the reverse.
• A change in the investor — not only the market — is a trigger. New goals or a changed risk appetite call for a fresh target.
• The 30-business-day window is for schemes on passive breaches, not for investors. It excludes index funds and ETFs, and does not apply to overnight funds.
• Rebalancing through switches has costs — exit load and capital gains tax — because a switch is a redemption plus a purchase.