Getting the right (re-)balance

03.07.2020

Call me old-fashioned but every now and then I like to see a bit of evidence that investment disciplines do actually work.

One discipline which has been long proven is that of re-balancing portfolios. This is the process of bringing a portfolio back to its original allocations on a regular basis. This could be quarterly, half-yearly or once a year. In the long term it makes little difference as long as you actually do it.

When we created IronBright, we took the decision to re-balance all of our client portfolios half-yearly and have stuck to this discipline ever since.

The primary goal of re-balancing is to maintain the risk and return characteristics of any given portfolio over time. In simple terms: if you buy a portfolio of 2 funds; in equal weightings; with one representing stockmarket (growth) assets and the other fixed interest (defensive) assets and do nothing the likely long term performance of the stockmarket component will mean that a 50/50 investment will start to drift to 60/40, 70/30 or beyond.

This leaves a client in a totally different asset allocation (and hence risk and return trade off) than they are comfortable with. The result of this is that, if the stockmarket takes a temporary dive as it did in March this year then the investor suffers significantly more volatility than they were originally comfortable with.

Regular re-balancing makes sure the weightings never drift too far apart and the portfolio continues to act as expected over time.

The nature of re-balancing also means you are, by definition, selling things that have done well and buying those that have done less well. This is selling high and buying low – the nirvana of investing!

Long-term this can also serve to enhance the returns of a portfolio and our most recent rebalance at the end of March serves to illustrate this point. Due to the significant market movements in March this is an exaggerated version of what we usually see but hopefully will demonstrate the principle.

For ease, I have chosen our IronBright 50 (Passive) portfolio as it is evenly weighted between ‘growth’ and ‘defensive’ (or Equity and Fixed Interest) funds.

Between the previous re-balance in November 2019 and the latest one at the end of March the Fixed Interest part of the portfolio actually increased by 1% while the Equity component dropped by 20%. This led to the portfolio becoming overweight in Fixed Interest funds. The re-balance prompted the ‘profit’ from this element to be realised and reinvested into the Equity funds which were temporarily suppressed. From the end of March to now the Fixed Interest element has grown by just 6% while the equity funds have grown by 14%.

Given the risk and reward characteristics of the IronBright 50 portfolio, a rebalance like this will have served to enhance the returns for our clients over and above a portfolio that was not rebalanced.

It is important to note that, like all areas of investing, discipline is key. That is why we have always rebalanced and will continue to do so on a regular basis.

Dan Hiles
Financial Planning Manager