Rebalancing Options In Portfolio Management

By M. Isi Eromosele


Rebalancing is a vital strategy that can contribute to effective portfolio management and is an integral part of managing global investments. Rebalancing is the process of using cash flows or asset transfers to move a diversified portfolio back to its original target ranges. This helps investors to minimize their risk and improve their long-term returns. A systematic and calibrated rebalancing program keeps the characteristics of the investment portfolio aligned with an investor’s expectations.


When managing a diversified portfolio of multiple asset classes, rebalancing becomes a key issue. Investment gains or losses cause portfolio asset allocations to change over time. Consequently, rebalancing needs to be implemented to bring the portfolio back to its original target allocation.


Benefits Of Rebalancing


There are two major advantages to rebalancing diversified portfolios:

  • Rebalancing helps deliver a portfolio that meets expectations.
  • Investment risk and return surprises can be mitigated by rebalancing

Some commonly used approaches to be used in rebalancing include the following:


  • Automatic schedule. While this approach is simple, it does not compare the cost of the benefits. As a result, rebalancing may be conducted when it is not cost effective to do so and it may not be conducted when it is most prudent to do so.
  • Ad Hoc. This approach allows emotion to tempt the decision maker into “market timing” the rebalancing decision, which usually involves attempting to predict future market directions. Utilizing this method can cause rebalancing to be implemented at inopportune times.
  • Predefined Rules. This is the most effective alternative because it takes emotions out of the process and if done correctly, will be conducted at appropriate times. It is not as regimented as an automatic schedule, so several decisions need to be made. For example, in a simple balanced fund comprised of stocks and bonds, one can define the allowable range of stocks and bonds within the portfolio. This is the best approach, if done properly. However, it does require a certain level of expertise.

Choosing The Best Source For Rebalancing


Rebalancing can be accomplished in one of two ways: using cash flows (a positive or negative flow of cash) or asset transfers.


Rebalancing using cash flows is preferable to rebalancing using asset transfers because cash flows are free (i.e., the cash needs to be invested and does not cause unnecessary turnover). However, to be effective, cash flows need to be both positive and predictable on a consistent basis. Positive cash flows invested at target weights slowly bring portfolio weights back to target. Negative cash flows move a portfolio away from target at an increasing rate.


Let major asset classes drive rebalancing, not minor asset classes. A minimum small cap stock weight was observed over a period of time. The maximum weight was 15.2 percent. To se the impact this weighting had on the overall portfolio, the risk and return of portfolios was compared with small cap stock weights of 6 percent, 10 percent (our target) and 15.2 percent. The overall difference in portfolio risk and return was minimal.

The story was different when focus was put on major asset classes, such as equities versus bonds. For this scenario study, a portfolio with a target of 60 percent stocks and 40 percent bonds was compiled. The minimum weight to stocks during a set period of time was 34.7 percent; the maximum weight was 78 percent. When the risk and return of a portfolio with a constant 60 percent weight to stocks was looked at versus the minimum and maximum weights experienced, there were large differences in risk and return.


Rebalancing is an important part of the investment management process when working with a diversified portfolio. Developing and maintaining a rebalancing program requires thoughtful planning and active management. When done correctly and on a consistent basis, rebalancing can be cost-effective while keeping returns, risks and portfolio characteristics in line investors’ expectations.


M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance


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