Rethinking rebalancing – a strategic approach for advisers

In portfolio management, rebalancing was often treated as a routine task – something to be done every six months or 12 months. Following the Global Financial Crisis (GFC), interest rates were slashed to record lows to stimulate economic growth, creating an environment where investing was relatively straight forward and plain sailing.

But in recent years, markets have entered a period of increased volatility – events like Brexit, Trump’s presidencies, the Covid-19 pandemic, the cost-of-living crisis and geopolitical conflict have all contributed to increased uncertainty and more volatile markets. With a more complex environment, advisers may need to rethink rebalancing schedules and a more nuanced approach is essential.

The myth of scheduled rebalancing

Many advisers rely on calendar based rebalancing schedules, assuming that regularity ensures discipline. However, some experts suggest monthly or quarterly rebalancing can be too frequent and detrimental to clients’ portfolios, leading to unnecessary costs. On the other hand, rebalancing every two years may allow the portfolio to drift away too much from its target asset allocation.

Ultimately, no-one can accurately time the peaks and troughs in economies and markets so there’s not necessarily a right or wrong time to rebalance. However, it’s not a tick box exercise and advisers need to develop a more thoughtful, flexible and tailored approach to rebalancing clients’ portfolios, ensuring it’s delivering a good investment outcome by preserving value and building trust with their clients.

Market turmoil: a time for caution not reaction

During periods of high volatility, such as the COVID-19 pandemic or the more recent tariff-induced turbulence, rebalancing can be extremely risky. Trading in dislocated markets might lock in losses or expose portfolios to further volatility.

At the same time, higher levels of volatility can lead to portfolio quickly become out of quilter with its long-term investment strategy. Some investments will have done better than others, changing what your portfolio looks like. This is a good thing – it shows a portfolio is diversified and that different investments are exposed to different risks. However, it can also put risk on or take risk off the table.

For example, a 60/40 portfolio split between shares and bonds from 1989 to 2021 showed that without rebalancing, equity exposure could drift to over 80%, significantly increasing risk. However, rebalancing during a downturn without considering market conditions can result in selling low and buying high, the opposite of what’s intended.

The hidden costs of overtrading

Rebalancing a portfolio is an art. And there’s a fine line to tread between rebalancing a portfolio regularly and trading too much.

For example, rebalance on a monthly basis means you might spend too much on trading costs. Anything less than once a year risks allowing your clients’ portfolios to drift too far from the original strategy.

Frequent rebalancing can reduce returns through:

• Transaction costs: even with low-cost platforms, these add up. You also need to consider things like FX charges, stamp duty and bid/offer spreads.
• Tax implications: realised gains can trigger capital gains tax (CGT) liability.
• Indirect costs: like the cost of missing investing opportunities from being out of the market, sometimes called the ‘opportunity’ cost.

There’s a trade-off between sticking close to your strategy and transaction costs. The closer you set the limit to the target weight, the more trading costs you’ll incur. The further you set the limit from the target, the more your portfolio will drift away from its targets. For investments held outside of an ISA or pension, advisers need to think about any tax implications of trades.

A principles-based approach

Rebalancing should be guided by principles, not prescriptions:

• Client goals come first: align rebalancing with the client’s risk tolerance and life events.
• Minimise friction: avoid unnecessary trades that don’t materially improve portfolio alignment.
• Communicate clearly: help clients understand the rationale behind rebalancing decisions, especially during volatile periods.

Partnering with Charles Stanley

We have a long history of working with financial advisers who value our investment expertise and service excellence. Our Managed Portfolio Services (MPS) do not have a fixed rebalancing schedule. However, we regularly monitor each model and input dynamic changes to our fund selection or asset allocation to take advantage of opportunities in the market. This removes the need and complications of regular rebalancing.

To discover how our Managed Portfolio Services can enhance the investment outcomes for your clients, reach out to us today.

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