Rebalancing of Portfolio

Portfolio rebalancing is the systematic process of buying or selling securities so that the actual weight of each asset class matches the pre‑determined target allocation. The target allocation is set during the portfolio construction phase based on the client’s risk tolerance, investment horizon and return objectives.

Over time, market movements cause some assets to grow faster than others. As a result, the portfolio drifts away from the original mix. For example, a 60% equity – 40% debt portfolio may become 70% equity – 30% debt after a strong equity rally.

Rebalancing does not aim to time the market; instead it restores the intended risk profile. The NISM syllabus stresses that rebalancing is a risk‑control tool, not a performance‑enhancement gimmick.

• It is distinct from tactical asset allocation, which deliberately over‑weights a sector based on short‑term outlook.
• It is also different from portfolio restructuring, which may involve changing the overall strategy.

First, rebalancing preserves the risk profile that the client agreed to. If equities become a larger share than intended, portfolio volatility rises, potentially breaching the client’s risk tolerance and SEBI’s suitability requirements.

Second, by selling assets that have appreciated and buying those that have lagged, the portfolio follows a “buy low, sell high” discipline. Empirical studies cited in the NISM material show that systematic rebalancing can add 0.5‑1% annualised return over a buy‑and‑hold strategy.

Third, regular rebalancing simplifies compliance monitoring. SEBI’s Investment Adviser Regulations require advisers to maintain the portfolio in line with the disclosed investment policy statement. Failure to rebalance may be viewed as a breach of the advisory contract.

Finally, rebalancing helps in tax planning. In India, long‑term capital gains on equity‑listed securities held >1 year are taxed at 10% (plus surcharge). By timing sales when gains are long‑term, the adviser can reduce tax outflow.

Two practical triggers dominate the industry:

• Percentage‑tolerance band: If the actual weight of any asset class deviates from its target by more than a pre‑set tolerance (commonly ±5% or ±10%), a rebalance is initiated.
• Calendar‑based schedule: Some advisers rebalance quarterly, semi‑annually or annually regardless of drift, to keep operations simple and to align with reporting cycles.

Both triggers can be combined – e.g., “rebalance annually or when drift exceeds 5%”. The exam often asks you to pick the most appropriate trigger for a given client profile.

It is essential to consider transaction costs and tax impact before deciding. A tiny drift may not justify the cost of buying/selling, especially in mutual‑fund portfolios where exit loads apply.

There are three widely taught methods:

• Full Rebalancing – bring every asset class back exactly to its target weight. This yields the cleanest risk profile but may generate higher transaction costs.
• Partial (or Threshold) Rebalancing – only the asset classes that have breached the tolerance band are adjusted. This reduces costs while still controlling drift.
• Cash‑driven Rebalancing – use newly added cash or dividend inflows to purchase under‑weight assets, avoiding sales altogether. This method is tax‑efficient but works only when cash is available.

Advisors choose the method based on client preferences, cost sensitivity and tax considerations. The NISM exam may present a scenario and ask which method is most suitable.

Step 1 – Calculate current weights. Use the latest market values of each holding and divide by the total portfolio market value.

Step 2 – Compare with target weights. Identify assets whose drift exceeds the tolerance band.

Step 3 – Determine the rebalancing amount for each breached asset using the formula presented later. This tells how much to buy or sell.

Step 4 – Check transaction costs, exit loads and tax consequences. If costs outweigh the benefit, consider a partial rebalance or defer to the next calendar date.

Step 5 – Execute trades through the broker or mutual‑fund platform, ensuring that the execution price is close to the NAV to avoid slippage.

Step 6 – Update records and inform the client. The updated allocation must be reflected in the portfolio statement and the advisory log for SEBI compliance.