Partner Series

To rebalance, or not to rebalance?

The ETF Securities Partner Series joins with Australian and international investment professionals to discuss the big issues of the day and what these mean for investors.

Rebalancing portfolios to strategic or tactical asset allocation weightings is a standard part of portfolio construction but in light of recent market volatility, many investors may be considering whether or not now is the time to rebalance.

Kanish Chugh, Co-Head of Sales at ETF Securities, spoke to Zach Riaz, Investment Manager and Director for Banyan Tree Investment Group, and Chris Brycki, CEO and founder of Stockspot on the topic, To rebalance, or not to rebalance?.

What is rebalancing?

Rebalancing relates to overall strategy and the identified asset allocations the investor or investment manager believes will assist in achieving their strategic goals. As investments gain or lose value, the portion of the portfolio they represent may start to vary, so periodically investors may rebalance back to their determined asset allocations by selling or buying assets.

“Portfolio rebalancing is all about making sure the portfolios that our clients have remain suitable for their investment risk capacity, as well as their investment time horizon… Rebalancing is about selling assets that have performed well and grown into too large a portion of the portfolio back towards their target rates and using that money to redeploy into assets that have shrunk,” says Mr Brycki.

A recent example of this comes from the COVID-19 volatility.

Government bonds and physical gold grew in value while equity markets fell in value, changing the asset composition for portfolios. Mr Brycki sold some of the gold and bond assets and reinvested in equities to restore the portfolios to their original asset allocation targets.

The trigger points to rebalance

It’s easy to let emotion cloud investment decisions, but in the case of rebalancing, it is important to focus on data instead.

Mr Brycki says, “our triggers for rebalancing are when assets move a certain distance from their target weights… The evidence suggests that around 25-30% in terms of the move an asset needs to make against its target allocation has historically been around the optimal.”

Both Mr Brycki and Mr Riaz recommend against rebalancing too frequently, such as on a daily or weekly basis or when moves are only small, to manage costs like brokerage or tax from capital gains.

“Every time you rebalance, you’re likely to be realising capital gains tax, unless you’re in a structure that you’re not repaying a lot of capital gains tax for. That’s going to become a big drag on your long term performance… For us, it’s a very systematised process and we think if something’s moved, lets say 30% from its target weight, that the benefit of rebalancing definitely outweighs the cost at that point,” says Mr Brycki.

Rebalancing in the current environment

In the current market volatility, some investors may have taken the chance to rebalance, while others may have held back.

“In the current environment, you’ve got to also look at rebalancing as an opportunity-cost… We’re a lot more defensive heading into it. We should be looking at this sell-off as an opportunity to…add on extra risk. And certainly, we’re looking to do that… This is a good reset period for investors to just re-check what the next 12-18 months look like, because… the market has changed and there will be opportunities to take advantage as a consequence of that,” says Mr Riaz.

In terms of rebalancing within asset classes, investors should also be mindful of what or how they are rebalancing – it might not always make sense to rebalance.

For example, in a portfolio of direct shares, it might not make sense to rebalance out of high performing shares into low performing ones, or high performing sectors into lower performing ones. Investors may also need to be conscious of asset characteristics like liquidity which could make it harder to rebalance.

Investors in ETFs will also find rebalancing is done at regular intervals to replicate the indices they track, without any additional action required by the investor.

To rebalance or not to rebalance

Both Mr Riaz and Mr Brycki view rebalancing as an important activity, done sparingly, and one which should be done mindfully and with data on hand to back decisions.

“You don’t need to rebalance all the time but be dedicated to rebalancing based on whatever the strategy you’ve decided is,” says Mr Brycki.

Mr Riaz agrees and says, “you’ve just got to follow your investment process, and follow what’s worked for you in the past.”

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