Rebalancing is the process of returning portfolio weights to the original target weights.

It is important to understand the distinction between traditional securities portfolios and portfolios with a strategic target allocation.

Rebalancing example

We have a portfolio of securities in which the value of the first investment instrument has performed better (or less badly) than the value of the other two investment instruments. As a result, the share of the first security in the total portfolio has changed. It is now 2.2 percentage points more than intended.

Investment instrumentTarget weighteffective weightDeviation in percentage points
Investment instrument 125 %27.2 %+ 2.2
Investment instrument 245 %44.1 %– 0.9
Investment instrument 330 %28.7 %– 1.3
Total100 %100 %
Example of a strategic portfolio allocation

Rebalancing realigns the portfolio. In our example, the following transactions are necessary:

  • Sell investment instrument 1
  • Buy investment instrument 2
  • Buy investment instrument 3

How much of the individual securities must be bought or sold depends on the price of the securities. Or, to put it another way, the price can be used to calculate the number of securities that must be bought or sold in order to restore the target weights of the portfolio.

However, because prices fluctuate continuously, it will never be possible to map the target weights exactly in practice (unless you also do continuous rebalancing).

Rebalancing triggers

There are two common triggers that can lead to rebalancing, time or deviation from target weight.

Time
After a certain time has elapsed, rebalancing is performed.

Deviation
Deviation means the difference between the effective portfolio weight and the strategic target weight. As soon as this deviation is greater than a predefined measure (e.g. 1 percentage point), rebalancing is performed.

Combination

In finpension’s offerings, the two triggers are combined: Monthly it is looked how high the deviations between portfolio and target weights are. If the deviation for an instrument is higher than the specified level, rebalancing is performed, otherwise not.

Securities solutions with and without rebalancing

Securities solutions without rebalancing

Conventional securities solutions usually function without rebalancing. With securities solutions, you decide how much money you want to invest in a single security or fund.

Example:

Investment instrumentInvestment
Investment instrument 110’000
Investment instrument 215’000
Investment instrument 3 5’000
Total30’000
Securities portfolios without strategic target weights.

If you want to invest more later, you decide whether to buy from an existing stock or to add a new stock to the portfolio. When selling, it is the same, just in the opposite direction.

Securities solutions with rebalancing

Securities portfolios with strategic target weights work differently. They do not determine the amount of investment per security, but the share of the total portfolio that a security should have.

Example:

Investment instrumentTarget weight
Investment instrument 125 %
Investment instrument 245 %
Investment instrument 3 30 %
Total100 %
Example of a strategic portfolio allocation

Only in a second step you decide how much you want to invest. The money that you put into the pot is then invested in the securities, as you have specified with the target weights.