In the past few months, I have spent quite a lot of time at the London School of Economics library, working on my postgraduate studies. Apparently, the library has over 50km of shelving and houses over 4.5 million items.
But for me, its most impressive feature is the wide spiral staircase in the atrium that most students use to traverse up and down the study spaces. Each stair is wide enough for an adult to take two steps, meaning that only one leg does the heavy lifting. My unfit self was often slightly off balance after several flights leading with my right leg, until a friend suggested a "revolutionary" tip: after each flight, take a moment to pause and start the next one with the opposite foot. A blindingly obvious suggestion, maybe, but one that serves as a good reminder when it comes to rebalancing.
Rebalancing is the process of periodically adjusting the weightings of a portfolio by buying or selling assets. Active rebalancing is particularly important when large price moves affect the assets in a portfolio.
Changing or maintaining the weights will help maintain an original asset allocation. This applies regardless of asset allocation, whether the target allocation is 50/50, 70/30 or any other composition.
Let’s say you want to have a moderate asset allocation consisting of 60 per cent stocks and 40 per cent bonds. Over the next six months, the equity market rallies, but the bond market weakens. At the six-month mark, you have 66 per cent stocks and 34 per cent bonds, because your stocks have been more profitable than your bonds in this example. To rebalance, you would sell 6 per cent of your stocks and buy 6 per cent in bonds to bring your allocation back to 60/40.
Different investors have different profiles, and each individual investor will also have different risk appetite and return objectives over his or her lifetime. Many investors prefer to invest more aggressively at younger ages and more conservatively, or with an income-orientated approach, as they near retirement age.
Rebalancing gives investors the opportunity to sell high and buy low. This allows an investor to benefit from the gains from high-performing assets and reinvesting them in areas that have not yet seen the same high growth.
Let's say an investor begins the year with a 20 per cent allocation to European equities and over the course of the year, European equities massively outperform other asset classes and grow to 30 per cent of the portfolio.
This means the other assets in the portfolio have reduced in weight, thus representing a different underweight and overweight blend to the other regions and assets. Selling those gains in European equities and buying other assets that are even cheaper given the outperformance from Europe.
Selling and buying to get a multi-asset portfolio to your desired allocation can be achieved via funds, but also within a multi-asset or multi sector fund. The next level of rebalancing can be done via factor, or beta strategies, which we’ll discuss in detail later this year.
