Babar Zaidi: Asset allocation is a boring term that goes viral when markets crash. But it should not be that way, because asset allocation and periodic rebalancing control the portfolio risk and ensure stability of returns in the long term. That's not merely a theory-rebalancing really works. We back-calculated and found that if an investor had put 60% in stocks, 30% in fixed income and 10% in gold in 2006 and not touched the investment, his portfolio would have earned overall returns of 10.1%. However, if he had rebalanced the portfolio every year in January, his returns would have been higher at 12% (see graphic).
1. Initially, the rebalanced portfolio fell below the static portfolio because stocks gave very high returns in 2006 and 2007.
2. But the deep correction of 2008 saw the static portfolio falling harder than the rebalanced one. It never managed to get ahead after that.
3. In 10 years, the returns of the two portfolios have a difference of 190 basis points. This gap only widens over the years.
Rebalancing is necessary because the returns from different asset classes can vary. The Nifty shot up 31% in 2014, but closed 2015 with a 4% loss. While returns from fixed income have been largely stable, gold has given volatile returns in the past 10 years. Over time, the differential returns can significantly change the asset mix of your portfolio. Rebalancing restores the portfolio to the original asset allocation, thereby controlling the risk and the returns it will generate.
ET Wealth reached out to financial planners from across India to know how small investors can rebalance their portfolios. Nearly all of them agreed that rebalancing controls the risk and enhances returns. This makes rebalancing critical in the larger context. "Only if they get reasonable returns, will small investors increase their equity investment in future," says financial planner Pankaaj Maalde.
What's your asset allocation? The first step in the rebalancing exercise is determining your asset allocation. Most investors don't do this. More than half (53%) the 1,436 respondents to an online survey conducted last week said they have either not fixed their asset allocation or don't follow it. "The first challenge is to work out a strategic allocation for yourself," says financial planner Prakash Praharaj.
1. To rebalance, you must know your allocation to different asset classes. Portfolio trackers like that from Value Research can be very useful.
2. Investors in balanced funds and asset allocation schemes need not rebalance. The fund manager will automatically do the needful.
Deciding the asset allocation may appear simple, but is actually a complex exercise that takes into account your income profile, risk tolerance and financial goals. The average Indian investor is risk-averse and has too little equity exposure. Even young investors who earn well prefer ultra-safe investment options even though their capacity to take risks is significantly high.
Only 11% of the respondents to the online survey chose preferred assured returns even if they were low. But more than 50% of these ultra-safe investors were aged below 40 years and 22% of them earned over Rs 1 lakh a month. "A qualified investment adviser can do a proper risk profiling of the individual and suggest the asset allocation that best suits his financial situation and investment objectives," says financial planner Vivek Rege.
How often should you rebalance? Most financial planners we approached said a portfolio should be rebalanced once a year. A more frequent rejig not only leads to higher transaction costs but also results in tax implications. If debt mutual funds are sold early or fixed deposits are broken prematurely, the investor is slapped with exit loads and penalties. If stocks and equity mutual funds are sold within a year, there is a 15% tax on the capital gains made. "If an investor is not disciplined, he might end up rebalancing his portfolio too frequently," says financial planner Ayush Bhargava.
Add to this the effort an investor will have to put in for rebalancing the portfolio. Rebalancing is not possible unless you are tracking your portfolio. Portfolio trackers offered by financial portals such as Value Research can be immensely useful here. They give the investor a holistic view of his portfolio, and tell him precisely how much is allocated to various asset classes.
They can just import the consolidated mutual fund statement from the registrar and transfer agents like Karvy or CAMS into their portfolio. Similarly, they can import the stock holding statement from their broker into the portfolio. All the historical transactions and other details are automatically incorporated into the portfolio, saving you the trouble of keying them in.
Can you do it yourself? The rebalancing decision is not very easy because it requires you to take a contrarian call. You have to sell the assets that are doing well, and buy those that are in the doghouse.
That's easier said than done. How many investors would have reduced their equity exposure when the markets were making new highs between 2004 and 2007? But if they had, their portfolios would not have bled so much in 2008. Similarly, how many would have mustered the courage to put more in equities after the bloodbath? Those who did, made good gains when the markets bounced back in 2009. The rebalanced portfolio shot ahead of the static portfolio after that period because it suffered less in 2008 ..
Financial planners say that small investors have neither the discipline nor the emotional maturity to make critical investment decisions. "There could be a lot of bias in an investor's own assessment of her own investments. A professional can bring in discipline and objectivity," says financial planner Malhar Majumder. "Small investors tend to resist booking profits. They may not be take into consideration some complex factors involved in rebalancing," says financial planner Ninad K. Patil.
Also, the rebalancing cannot be done with eyes wide shut. It must take into account the market realities.
"After a prolonged depressed market, there can exist a possibility of outsized long-term equity returns. In such a situation, a text book rebalancing approach could result in reducing one's equity holdings early, thereby severely affecting portfolio returns," says financial planner Parag Telang.
Some fund managers do it for you For some mutual fund investors, rebalancing is not required. "Dynamic asset allocation funds are structured to buy low and sell high," says Nimesh Shah, Managing Director and CEO of ICICI Prudential Mutual Fund (see guest column).
Balanced funds, which invest in a mix of stocks and debt, also don't need to be
rebalanced. They have given better returns than large-cap equity diversified funds in the past 3, 5 and 10 years (see table).