With just a few weeks to go until the end of the year, it’s inevitable that thoughts start turning to portfolio housekeeping and making new investment resolutions for 2018.
Overall, it’s been a strong year for equities. Strategies that target small-cap growth companies have done particularly well, and we’ve seen noticeable strong returns in higher quality value strategies, too.
But the consequence of these kinds of trends is that they can leave some portfolios drifting well away from their intended investment target. If you were an investor in small GARP (growth at a reasonable price) shares in early 2017, you might now be holding a group of larger and more expensive looking stocks. While that’s clearly a good thing, your exposure to that successful small-cap GARP strategy would have drifted away. To continue with that investment style you’d need to tackle the thorny issue of rebalancing.
Why rebalancing causes confusion
Even if you do nothing with a portfolio, its initial weights will slide out of balance over time as valuations change. The idea with rebalancing is that it cuts the risk of being overexposed to a small number of large positions, where an unexpected disaster could be seriously damaging.
Yet rebalancing is one of those subjects that rankles with some investors. That’s because, conventionally, it means trimming back successful holdings and feeding funds into lagging stocks. This kind of trading is counter-intuitive to many investors because it racks up trading fees, spread costs and potentially even taxes. Plus it doesn’t sit well with the idea of running winners and selling losers. All these reasons are enough to send rebalancing to the bottom of the list of priorities.
Indeed, rebalancing not only has disadvantages, but it’s arguably unnecessary for some types of investors. In Stockopedia’s Four Investor Suits, active traders and stock market ‘hunters’ (like our own Paul Scott) build and weight portfolios based on detailed analysis and conviction. In some ways, this kind of constant adjustment dispenses with the need for periodic rebalancing.
Staying focused on investment styles
But for more passive ‘owners’ and ‘farmers’, rebalancing can be a very important part of some strategies - especially those that aim to harvest powerful market premiums like value and momentum. For stock market ‘farmers’ who run portfolios based on these kinds of investment styles, there is a constant risk of style drift without rebalancing.
What this means…
