Rebalance Your Portfolio with Care

Value-driven investing can produce significant returns - but take care when rebalancing your portfolio to avoid value traps

Dan Kemp 22 February, 2017 | 2:57PM

Even if an investor has the perfect valuation-driven asset allocation model, there is still scope for error when it comes to execution. One of the key elements that any investor must consider when managing a portfolio is when and how frequently to ‘re-balance’ back to ‘target’ weights. While this subject is both important and hotly debated, we have found no academic work to support the view that there is an optimum rebalancing period. Therefore, while we remain open to the discovery of a reliable systematic approach to rebalancing, we believe that rebalancing requires significant thought and a best execution policy should be open to change.

Rebalancing Principles and Warren Buffett

The key element of a diversified portfolio is the fact that asset prices move in different directions, especially when allocating between negatively correlated assets such as equities and bonds. This aspect of capital markets can help reduce the volatility of a portfolio that is broadly spread across asset classes, although does reduce our exposure to our best ideas. By virtue, this can lead to a misalignment between the desired asset allocation and reality.

Rebalancing is therefore an essential part of a valuation-driven philosophy. Left unchecked, our exposures will not resemble our best ideas. Yet, executed too aggressively or regularly and we expose the portfolio to unnecessary turnover, such as taxes and fees, and the potential for drag. We have witnessed this in practice, with Warren Buffett a master but countless others failing miserably as they seek to top-up positions that are in structural decline.

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About Author

Dan Kemp

Dan Kemp  is Chief Investment Officer, Morningstar Investment Management EMEA

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