Threshold-based rebalancing

A portfolio drifts from its target mix every day, just from ordinary price moves. One way to fix this is to check the calendar. Threshold-based rebalancing checks the numbers instead.

Under this approach, the manager sets trigger points — an upper and a lower bound around each asset class's target weight. The portfolio is left alone as long as it stays inside that band. The moment it breaks out, on either side, a trade brings it back.

This gives tighter control than simply rebalancing once a quarter. The trade-off is that the portfolio needs to be watched constantly, not just checked on a fixed date.

The workbook's own worked example (section 21.3.1): a balanced (hybrid) portfolio has a 60% target allocation to equity. Trigger points are set at 50% and 70%. The portfolio is rebalanced only when equity's value falls below 50% or rises above 70% — that 50–70% range also doubles as a corridor for deliberate tactical asset allocation.

The workbook lists what setting the trigger points actually involves: deciding tolerance levels, and accepting the need for frequent monitoring, since a breach can happen on any date, not a scheduled one. It also links corridor width to two asset characteristics: assets with higher transaction costs normally get wider tolerance bands, while assets with higher volatility usually get narrower ones, since they drift further and faster if left unwatched.

Following the workbook's own 60/50/70 figures. A Rs 2,00,00,000 balanced portfolio targets 60% equity (Rs 1,20,00,000) / 40% debt (Rs 80,00,000), with trigger points at 50% and 70%.

A six-month rally takes equity to Rs 1,68,00,000 while debt grows only to Rs 82,00,000. Total portfolio = Rs 2,50,00,000; equity weight = 168 ÷ 250 = 67.2% — inside the 50–70% band, so no trade yet.

A further rally takes equity to Rs 2,00,00,000 against debt of Rs 83,00,000 (total Rs 2,83,00,000); equity weight = 200 ÷ 283 = 70.7%, breaching the upper trigger point. The manager now sells roughly Rs 30,20,000 of equity to bring the mix back to 60:40 — a trade the calendar-based approach would not have made until its next scheduled date, however far the drift had gone by then.

Chapter 21 (Portfolio Rebalancing), section 21.3.1 (Time versus threshold based rebalancing), gives the 60%/50%/70% example directly and contrasts threshold-based rebalancing with the calendar-based approach. Expect a question computing whether a stated equity weight breaches given trigger points, and one on which asset characteristic widens or narrows the tolerance band.

• Threshold-based rebalancing needs frequent monitoring; time-based (calendar) rebalancing does not — this is the workbook's central contrast between the two policies.
• Higher transaction costs widen the band; higher volatility narrows it — these two rules point in opposite directions and are easy to swap under exam pressure.
• A breach triggers a trade back to the target weight (60%), not merely back to the nearer trigger point (50% or 70%).
• The trigger points also double as a corridor for deliberate tactical asset allocation — a manager can drift within the band on purpose, not only by accident.