Asset allocation is the most important decision in your portfolio management. It is almost impossible to get what is called an ‘optimal rebalancing’. And if you have a fairly sophisticated portfolio, 2-3 items of 7-8 HAVE TO BE IN THE NEGATIVE. If that is not happening, you are not diversified enough.

Rebalancing too often increases transaction costs – more in terms of taxation – we do not have entry exit loads in India. With so many years of investing experience I am still not sure about reinvesting and asset allocation. I realize that if there is no asset allocation between a volatile asset and a non volatile asset, the returns may not be commensurate with the RISK TAKEN. So by doing asset allocation, you may not increase returns but you will surely reduce risk. If asset allocation is not done higher-risk investments that have higher long-term returns would become over-weighted by out-compounding the lower-risk lower-return positions in the portfolio. So a portfolio without reallocating could go from a 65 equity and 35 debt to 85:15 and may have also given a sub par performance.

I prefer a different re-balancing methodology is to allow portfolio allocations to go a little ahead of the ‘planned’ ratio – just let it drift slightly. I prefer triggering a trade only if a target threshold is reached.  At that time if the client has increased his own provident fund or Public provident fund in a big way, I may even postpone the trigger. Also at a slightly higher TOTAL ASSETS, I may allow the drift to be more favoring equity. If the investments grow in line and the relative weightings don’t change, no re-balancing  trade is triggered. However, if these “re-balancing tolerance bands” are breached, or the client gets jittery – when the amounts go up some people get MORE VOLATILITY AVERSE – the investment –  that crosses the line, is then bought or sold  to keep it in line.

The one important caution to the process of tolerance band re-balancing is that it requires some active monitoring of the portfolio itself, to ensure that you realize a threshold has been reached. Fortunately, though, electronic record keeping and software with triggers are available and they suggest the trade too. I prefer doing the transaction myself..with the client’s consent.

In the short term, re-balancing presents a chance to generate better returns – REMEMBER IT IS RISKY – particularly when re-balancing among investments with similar long-term return potential –as the process of selling what has become overweight and buying is underweight can TECHNICALLY help investors to sell high and buy low. The example is say shifting from mid cap to large cap because mid cap has gone up too fast. The worry is if the client says NO, and you force him too, you can look foolish after a couple of months – you may be right after 5 months, but your client would have felt that you re-balanced too early!!! So some triggers should be NON NEGOTIABLE. Tough, especially if you are a young IFA or a young (new to investing) client stuck with a stubborn IFA

The goal is to find investments that have moved to new highs (or lows) and trigger a re-balancing trade that buys/sell the investment just before it “comes back” and reverts towards its long-term average!! Equity share portfolio re-balancing is very difficult to manage. I did not sell Cholamandalm during its journey from 65 to 1014, and I look smart. If I had not sold GMR and Crest Animation when it fell I would have looked like an idiot.

So should I re-balance at the top (Equity vs Debt) or should i also re-balance groups (Murugappa group concentration is a serious worry in my wife’s portfolio), Midcap: Large cap: Micro cap…are questions which big portfolio managers grapple with.

I am doing a session for some managers on all these topics. I hope they do not kill me with such questions. Ultimately it is difficult to answer…many of these questions..you go with the flow….