Rebalancing Mutual Funds
Even if you’re a buy-and-hold investor, you would need to maintain your mutual fund portfolio on a regular basis once you’ve finished constructing it. Rebalancing a mutual fund portfolio is mainly the process of reverting current investment allocations to their original positions. To bring the allocation percentages back into balance, rebalancing will entail purchasing and/or selling shares of some or all of your mutual funds. In other words, rebalancing is a crucial part of maintaining a mutual fund portfolio, even an oil change or tune-up is to your car’s regular maintenance.
Rebalancing is a fundamental concept, but the time and frequency with which it is done can add some strategy to the process. Many investors make rebalancing more difficult than it has to be. When it comes to how often an investor should rebalance, financial advisors and investment firms sometimes disagree. Should it be done monthly, quarterly, annually, or in some other way?
It’s critical to analyse why investors rebalance their portfolios in the first place. Over time, certain index funds or mutual fund types will often perform better than others. Assume that your stock funds do extremely well over a year, but your bond funds perform horribly. To rebalance your mutual funds, just execute the necessary trades to return them to their target allocations. Returning to our five-fund portfolio example, you would purchase and sell shares of the relevant funds to restore each fund’s original 20 per cent allocation.
If your starting allocation was 80 per cent stocks and 20% bonds, your end-of-year allocation may be 90 per cent stocks and 10% bonds. You’ve lost your equilibrium, and this new, more aggressive allocation may put you at risk. If stocks perform badly and bonds perform well, you may be assuming less risk the following year and missing out on stock market profits.
Rebalancing does not have to be done often because major changes in the financial markets are unlikely to cause your mutual fund portfolio to drastically modify its initial allocation proportions. If you put 20% of your money into one fund, it’s unlikely that it will move more than 3 or 4 % points out of that allocation in the given year. Additionally, there may be fees connected with purchasing and selling funds. As a result, rebalancing too regularly might reduce the benefits of doing so. Rebalancing your mutual fund portfolio every year is adequate. Many people do it towards the end of the year, when there are other year-end measures to consider, like tax-loss harvesting.
SEBI defines timelines for rebalancing mutual fund portfolios
The capital industry regulator, the Securities and Exchange Board of India, has published a circular that clearly explains the regulations regulating the rebalancing of portfolios of mutual fund schemes. In the scenario of a divergence from the mandatory asset allocation indicated in the scheme information document (SID) owing to passive breaches, all schemes will have a compulsory rebalancing period of 30 days, except overnight funds. Passive breaches are those that do not occur according to the result of the fund manager’s activity. These adjustments include those resulting from changes in the pricing of the assets owned.
For example, an assertive hybrid fund may have mandated that at least 65 per cent of its assets be invested in inequities. If the prices of the equities in the scheme’s portfolio decline, this allocation may fall below 65 per cent. In this scenario, the fund managers must act within 30 days after the date of the deviation to reestablish the allocation following SID. If the fund manager fails to do so, the investment committee must be given written reasons, including details of the attempts made to rebalance the portfolio. The asset management company’s investment committee may prolong the rebalancing period for up to 60 working days after the mandatory rebalancing period has ended.
The guideline provides consistency to the timetables for portfolio management and should benefit investors. The asset diversification prescribed in the schemes’ SID will be enforced by fund managers. This establishes discipline, and investors can invest in the portfolios outlined in the SID. According to G. Pradeepkumar, CEO of Union Mutual Fund, this is in the best interests of investors.
Whereas most institutional investors have been careful and aggressive in aligning products with stated asset allocation requirements, the timescales have been rather different across AMCs, according to Nirav Karkera, Fisdom’s Head of Research. This poses difficulties for advisers and investors, evidenced by the offered products diverge from the regulated structure. Problems with products that aren’t quite true-to-label include getting stuck with diverged allocations, lack of alignment with a wider investment strategy, unplanned risk exposure, and non-comparability of achievement between products in the same category, he adds.
The circular aimed to address all of these concerns raised by investors. The regulator even said that if an AMC fails to rebalance a scheme’s holdings, the AMC would be barred from launching new schemes or charging an exit penalty on redemptions.
The trustee has encouraged the fund firms to keep him informed regarding any changes in the asset allocation of the portfolios. If the divergence surpasses 10% of the assets under management in the scheme’s main portfolio, the fund house must surely notify the investors, including the specifics of the portfolio that has not been rebalanced. When portfolios are rebalanced, investors must be informed. The fund house shall report any form of deviations from the portfolio’s specified asset allocation together with portfolio disclosures. These rules apply to the schemes’ primary portfolios, but not to segregated portfolios. They will be implemented on July 1, 2022.