Portfolio rebalancing – the buying or selling of assets to maintain an original or desired level of asset allocation or risk within an investment portfolio – has always played a role in ultra-high-net-worth individuals (UHNWIs) and family offices' investment strategies but never more so than in the past 18 months and quite possibly, for years to come.

The golden gains can quickly disappear when not paying attention to rebalancing./Photo by Pineapple Supply Co on Unsplash

As global markets move from recovery to growth, it is evident that the COVID-19 pandemic has reshaped the world's economies, individuals' fortunes and how investors build and maintain their portfolios. From now on, Chief Investment Officer for Merrill and Bank of America Private Bank, Chris Hyzy, believes, "Investors will need a higher level of diversification, more frequent portfolio rebalancing and exposure to newly developing themes."

This sentiment is shared by Thomas Rappold, CEO of Divizend and co-founder of the Swiss unicorn, Numbrs, who points out that we were in a similar situation 20 years ago. Within financial markets, certain assets were valued more highly than others - back then it was tech, media & telecoms and today crypto is the the big disruptor. When the Nasdaq at 5000 lost 80% of value its value, people who didn't actively rebalance lost a lot of money.

"Rebalancing is a missed opportunity. Even though it's mathematically really simple, in practice this is still a hassle, especially for retail investors that don't have their portfolios aggregated."

With this in mind, it seems an opportune time to explore portfolio rebalancing and the reasons to consider it, when to do it, its benefits and best practices.

What is portfolio rebalancing, and why consider it?

When UHNWIs and family offices invest, portfolios are strategically created with their financial position and particular goals, time frames and a risk profile in mind. Asset allocations, often in the form of stocks and bonds, provide a targeted mix of investment categories to balance risk and return on investments. These are designed according to the investors' risk tolerance.

Over time, initial investment positions are ultimately affected by market movements that change the weighting of the portfolio, increase risk and cause overexposure in certain asset classes or stocks. When this occurs, a review and rebalance becomes necessary. Applying modern portfolio theory may be considered to ensure an optimally structured portfolio based on risk appetite.

Rebalancing a portfolio is the act of adjusting its asset weights through the buying or selling of assets to restore target allocations or risk levels over time. In essence, the practice advocates the "sell high, buy low" investment rule - taking the gains from high-performing investments and reinvesting them in those that haven't yet experienced notable growth. Rebalancing is always more about keeping risk to tolerable levels than maximizing returns.

Beyond asset allocation, risk management and diversification, strategic rebalancing also helps to ensure that investments remain aligned with the ultra-high net worth individual (UHNWI) or family office's short and long-term objectives despite market movements.

It is, however, vital to remember that rebalancing is not without cost. Not only is it a time and labor-intensive exercise, but trades are also subject to transactional fees while the sale of assets generally incurs taxes. For this reason, it is necessary to perform purposeful, diligent rebalancing only when required.

When to rebalance?

Vanguard research shows that there is no optimal frequency or threshold for rebalancing. The "how often, how far, and how much" defined within a rebalancing strategy boils down to investor preference. As such, most portfolios are traditionally reviewed and rebalance semi-annually or annually. However, significant global or granular events (or both) may necessitate reviewing and rebalancing an investment portfolio outside of traditionally accepted timeframes.

For example, in 2020, the COVID-19 global pandemic sparked a marked uptick in portfolio rebalancing in the first and second quarters. At the beginning of the year, 69% of families surveyed for the UBS Global Family Office report did not plan to change 2019's asset allocations. However, 55% had rebalanced their portfolios between March and May to maintain their long-term strategic asset allocations amid pandemic turbulence. Significantly, 65% of family offices traded up to 15% of their portfolios to tactically leverage opportunities that would present themselves. In addition, those that remained in the market benefitted from the S&P 500 16.26% annual gain, which would necessitate further rebalancing as a result.

At the same time, millions across the globe became millionaires, while the world's billionaires increased their wealth by 27.5%. Undoubtedly most, if not all of these HNW and UHNWIs had some serious rebalancing to do. Although economic recovery from the pandemic is already evident, it is likely to take some time and will undoubtedly be subject to volatility and periodic setbacks. Hyzy advises investors to "Review portfolios more frequently to ensure that strategic allocations haven't inadvertently shifted and rebalance where necessary." Rebalancing may also include capitalizing on new investment opportunities as they emerge.

Global events aside, more granular occurrences may also drive the need to rebalance. For example, organizational shifts from private to listed companies may affect the balance of a founder or shareholder's portfolio. Despite the company's immediate success, this may necessitate the sale of a portion of shares to restore balance or curb unwanted risk exposure. This may well have been the case with Coinbase's CEO Brian Armstrong selling less than 2% of his COIN stock shares shortly after IPO and will have been an issue for many Bitcoin billionaires.

Personal life changes or events such as the retirement of a family office patriarch, a marriage or divorce may also trigger changes in risk tolerance that necessitate portfolio rebalancing. The latter was almost certainly a consideration for both Bill and Melinda Gates after their high-profile divorce.

Essentially, the answer to the question, "when should a portfolio be rebalanced?" is - when it is necessary, and the costs are justifiable.

Benefits of portfolio rebalancing

Successful investing requires investors to adhere to their investment plan despite changes in market conditions. Rebalancing helps to maintain risk at an acceptable level to achieve this while also encouraging investor discipline that perpetuates adherence to the original asset allocations and risk tolerance levels to achieve long-term goals.

Rebalanced portfolios may also retain their portfolio-level risk characteristics better than buy-and-hold portfolios in times of high volatility.

In today's fragile markets, it is easy for UHNWIs and family offices to take too many risks or avoid these altogether, missing out on lucrative opportunities. Therefore, it is vital to adhere to long-term objectives, investing and rebalancing with intent and purpose to achieve these despite market volatility.

By Francois Botha, Contributor

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Aaron Fransen, CFP®, CHS
Fransen Financial Inc.
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