What is rebalancing of portfolio

Portfolio rebalancing may mean a number of things, like rebalancing between debt and equity, rebalancing between long term and short term debt, rebalancing between large cap equity and midcap equity etc. There are also a variety of rebalancing techniques:-

1. Rebalancing asset allocation based on risk profile: For example, your risk profile may suggest 50:50 exposure to equity and debt. Over a period of time, equity value grows faster than debt and your asset allocation becomes 70% equity and 30% debt. To rebalance your asset allocation and bring it back to 50:50, you will sell equity and buy debt.


2. Rebalancing asset allocation based on relative valuations: If valuation (P/E ratio) of equity looks expensive, then you can rebalance your portfolio, reduce exposure to equity and increase exposure to debt. On the other hand if equity valuation looks cheap after a fairly deep market correction, then you can increase your exposure to equity and decrease exposure to debt. This may ensure superior long term returns for you.


3. Rebalancing between equity market cap segments based on relative valuations: If valuation (P/E ratio) of large cap stocks looks expensive relative to midcap stocks, then you can rebalance your portfolio, reduce your exposure to large cap and increase your exposure to midcap. On the other hand if valuation of large cap looks cheap relative to midcap, then you increase your exposure to midcap and decrease exposure to large cap. Some fund managers believe that, now the midcap valuations are higher than large cap.


4. Rebalancing between sectors: You can rebalance between sectors when relative valuations of some sectors seem high compared to others. Typically, at bull market peaks, the valuations of cyclical sectors (banks, automobiles, capital goods etc) look stretched relative to defensive sectors (pharma, FMCG etc). You can rebalance your portfolio between the sectors. In mutual funds, you can do this through sector / thematic funds.

These are just some examples of various rebalancing techniques. Your portfolio rebalancing strategy should be informed by investment goals and risk profile.

Coming to the second part of your question now, it is difficult to say whether the market is at its peak now. The Nifty is still 5% below its all time high, but valuations of quite a few stocks do seem a bit stretched, after the Nifty rally from 6,900 odd level to around 8,600. However, it is difficult to say, where valuations are at their peak because we are in a transitory phase as far as corporate EPS growth is concerned. Q4 2016 showed some improvement in earnings and we are, right now, in the middle of the Q1 2017 earnings season. But the initial set of Q1 results have shown improving top-line growth trend for second successive quarter. If earnings growth catches up with valuations, then they will not seem stretched. We think that, we should wait, at least till the expiry of August F&O series (August 25), to see how the market absorbs the Q1 results.

Finally, investors should make a distinction between their mutual fund portfolio and SIP, as far as investment strategy is concerned. Your mutual fund portfolio is the accumulated units of all schemes that you have invested in. Your SIPs are new investments that you make in schemes of your choice every month. If you think equity valuations are stretched, you can rebalance between equity and debt in your portfolio. At the same, when you think valuations are stretched and correction is imminent, SIP is your best friend because if the market corrects, you will be buying units at lower costs and will be able to earn higher returns in the long term. Therefore, even though it sounds counterintuitive, you should never stop SIPs when correction is imminent.

Since you want to maximize value from your SIPs, we suggest that you read our post, Is Mutual Fund Systematic Investment Plans really the Best Mode of Investing. Our back testing, as discussed in the post shared with you, shows that valuation based systematic investment plan can give you better long term results than a plain vanilla SIP. You should know that, mutual fund houses do not offer valuation based systematic investment plans, but you can create your own valuation based systematic investment plan if you are able to devote a little bit of time and effort every month, as discussed in the post.