What does “rebalancing” mean?

Shaun Port


2 min read

Automatic rebalancing is a feature of all Nutmeg’s portfolios – both fixed allocation and fully managed. But what exactly does it mean?

It’s all about keeping things in proportion

The purpose of rebalancing is to keep the assets in a portfolio in proportion to one another.

Over time, as the value of each individual holding in a portfolio rises or falls in value (because of market performance), it will come to represent a larger or smaller proportion of a portfolio. For instance, imagine a portfolio that contained 60% equities, 40% bonds. If the equity market rose in value while bonds stagnated during 2017, that 60:40 ratio would have changed – perhaps to 55:45, for example.

The purpose of rebalancing is to buy and sell assets within a portfolio to retain the right proportion – or ‘weighting’ – of different assets in the portfolio. Correcting the weightings when they have moved too far is known as rebalancing.

An example of the asset allocation in a Nutmeg portfolio

An example of the asset allocation in a Nutmeg portfolio

Why rebalancing matters

As a portfolio deviates from its original weightings, the risk of the portfolio changes too. And because higher returning assets tend to be higher risk, over long periods your holdings in higher risk investments are likely to become an ever greater part of your portfolio, raising your risk above where you started from.

In our fully-managed portfolios, we monitor portfolios continually. This is to make sure we have the right level of risk in portfolios, whatever the prevailing market and economic conditions. We adjust holdings in your portfolio when we believe it is right to do so.

In our fixed allocation portfolios, we do not make any on-going strategic changes to the portfolios, whatever the weather, so it is important to prevent the risk levels of these portfolios drifting away from its starting point.

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How we differ from our competitors

Many wealth advisors will rebalance a client’s portfolio annually, buying and selling most of the holdings to move the weights for each investment to bring it back to its starting point.

We believe our automated approach is more efficient, rebalancing as and when necessary.

We run a regular test on each individual client account to check whether the portfolio as a whole has drifted too far away from the original weights.[i] If it has, we rebalance the portfolio back to the original weightings. We don’t wait for a year to pass if your portfolio needs rebalancing now, and if it doesn’t need rebalancing after a year has passed, we won’t rebalance for the sake of it.

This means that in some years, we could rebalance your account more often than annually, while in others we would do so less often.

Moreover, if you add contributions to your portfolio a full rebalance is less likely to be needed, as all new cash is invested in such a way to move the portfolio back toward the original fixed weightings, providing some degree of rebalancing.

Risk warning

Your capital is at risk. The value of your investment, and the income you get from it, can go down as well as up. As with any investment, there is a chance you will get back less than you originally invested.

[1] We run an algorithm that tests the divergence of each holding and then rebalances if the threshold for the entire portfolio is too high. Based on our simulations over the past 30 years on a medium risk portfolio, this would typically have rebalanced the portfolio when the broad equity weight was around plus or minus 3% away from the starting fixed point (57%).

 

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Shaun Port

Shaun Port

Shaun is the chief investment officer at Nutmeg. He has over 25 years’ experience developing and implementing investment strategies for clients ranging from central banks to pension schemes to charities and private individuals. Shaun holds a degree in Mathematical Economics from the University of Birmingham and is a Chartered Alternative Investment Analyst. He can be found tweeting @ShaunPort.


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