Mutual Fund Rebalancing

Recently the SEBI has issued the guidelines for the mutual fund rebalancing, in which they have ordered the mutual fund to rebalance the portfolio deviation back to the desired result and asked for a written justification in case of the inability.
So let's understand what is rebalancing the portfolio and how it helps the investors.

 

 

What is Rebalancing?

Rebalancing is a kind of process in which realigning the weightings of a portfolio of assets. Under this process buyer and seller trade assets on a regular basis in order to maintain a real or intended level of asset allocation or risk. A basic strategy to achieve this is to divest underperforming assets and to invest in those that have the potential to grow.

 

 

What is the significance of rebalancing a portfolio?

Rebalancing your portfolio can assist you to maintain your original asset-allocation strategy and permit you to implement any changes you create to your finance method. Moreover, re-balancing will facilitate you to hold on with your investing arrangement in spite of what the market does, serving you to stay at your risk tolerance levels.

 

Example:

An XYZ may have specified to invest a minimum of 50 percent of the money in stocks. This allocation may go below 50 percent if the prices of stocks held in the scheme’s portfolio fall. In such a case the fund managers have to act within 30 days from the date of such deviation and reinstate the allocation in line with what is mentioned in IPS. If the fund manager fails to do so, then justification in writing, including details of efforts taken to rebalance the portfolio, shall be placed before the investment committee. The investment committee of the asset management company can extend this period for rebalancing up to 60 business days from the date of completion of the mandated rebalancing period.

 

How and when should the portfolio be rebalanced?

Generally, the portfolio is rebalanced according to the IPS (Investment Policy Statement) which is made before the assets allocation, the investment policy details, the ratio according to which the assets must be allocated to the portfolio, and the risk tolerance of the investors. Before going into the deep, let's understand the portfolio management process because all the technical terms which are mentioned above are related to the portfolio management process.

 

Let’s understand, first, that portfolio management is the art and science of allocating and overseeing a group of investments that meets the long-term financial objective and risk tolerance of a client, company, or institution. And now let's understand the process involved in the portfolio management which is as follows:

 

Step 1-Planning

In the beginning of this process, the portfolio manager generally does the analysis of the investors' risk tolerance, returns expectation, time horizon, tax exposure, income needs, and liquidity needs through a questionnaire.

 

Once the questionnaire form is filled by the investor then with the help of that questionnaire, a document is formed known as Investment Policy Statement, which contains the terms and conditions related to the investment process.

 

 

Step 2 -Execution

This process involves the analysis of risk and returns available among the various asset classes like equity class, fixed income class, commodity class, derivative class, or hybrid. Once the asset classes are determined, then the assets are allocated in the best asset class among the available, keeping in mind the IPS.

 

 

Step 3 -Feedback

With time the weight of the asset will change with respect to asset price, which results in the deviation from the desired assets allocation, so the manager must monitor these changes and adjust them according to the investment policy statement known as re-balance.

 

 

Purpose of re-balancing the portfolio

For an investor, rebalancing works as a risk-minimization strategy through which you can reduce your exposure to risk. As a way to ensure that your portfolio stays aligned with your investment strategy and risk profile, rebalancing is an important part of portfolio management. By periodically rebalancing your portfolio, you can ensure that your investment is aligned with your goals. Your risk tolerance or your investment strategies may change, in which case you can rebalance the weight of the asset class in your portfolio by reassessing and formulating a new asset allocation model.