The overstretched valuations in the equity markets have prompted many investment strategists to strongly recommend portfolio rebalancing.
Experts say portfolio rebalancing is necessary since with time different rate of returns of different classes of assets tend to shift the balance of portfolio towards any particular asset which may be detrimental to the goal of the investor. (Picture Credit: depositphotos)
Portfolio rebalancing refers to the adjustment of one’s investment portfolio through buying new assets and selling old ones to set the weight of each asset class in accordance with some pre-determined allocation.
Shift from original pattern
One might need to rebalance your portfolio after a certain time period since different assets classes tend to fetch different returns over time. This can take the overall character of one’s portfolio away from some preferred allocation pattern. This drifting from the original path can both increase risk and affect returns. Portfolio rebalancing helps readjust allocation in sync with original design.
Extreme conditions in equity
“Extreme conditions are prevailing in the equity market right now and portfolio rebalancing is necessary because investors are over-exposed to a particular asset class – equity. This means they have very little exposure to fixed income,” said Nilanjan Dey, investment strategist and director Wishlist Capital.
“The merits of Portfolio Rebalancing are many. Chief among them is its impact on returns. Positive impact during overheated conditions,” added Dey.
Needed as a matter of routine
“Why don’t we do it as a matter of routine? We are not disciplined enough, so the need to rebalance is not universally accepted. Few people actually do it as a standard practice. But it is highly desirable,” he asserted.
Any portfolio must conform to the risk appetite of the investor and his/her financial goals. Also, the risk appetite of an investor can vary over time, especially over long periods.
Example of a shift
For example, an investor could have started out with a 75:25 ratio between equity and debt. But over a few years, due to higher valuations of equity, the ratio might get heavily skewed in favour of equity. It could even be 9:1 in favour of equity.
In this situation, the investor has to sell some equity and buy some debt assets to restore the balance of his/her portfolio.
Rebalancing in equity itself
The need to rebalance does not stop here. Even the proportion between large, medium and small cap equities might shift since they usually grow at different rates during any given period of time. If the shift between large, mid and small-cap funds happens by a significant extent, one needs to sell or buy units of certain funds to restore the intended balance.
(Disclaimer: This article is only meant to provide information. News9live.com does not recommend buying or selling shares or subscriptions of any IPO and Mutual Funds.)
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