Rebalancing or not rebalancing?

Robo adviser

Robo-advisers help clients construct portfolios with different asset class allocations based on the client’s personal circumstances. But markets will go up and down, and this will change the market value of the investments in a client’s portfolio and thus the asset allocation split. For example, a 60/40 initial allocation split (by value) between equity funds and bond funds in a portfolio recommended by a robo-adviser might gradually be weighted towards a level of 70% or even 80% by value in equities during a boom market. The risk level of such asset mix may deviate from the intended risk level of the original model portfolio.

Most robo-advisers offer an automatic rebalancing feature to help clients maintain over time the target asset allocation and the portfolio risk level appropriate for that particular client. In the above example, rebalancing back to the original 60/40 allocation (or the target asset allocation as determined periodically) will ensure that the portfolio remains suitable for the client over time.

There are different rebalancing approaches, e.g. some robo-advisers rebalance a client’s portfolio when it diverges beyond the desired allocation by a margin wider than the threshold, say 10%. Others rebalance according to a pre-defined schedule, say annually.

Rebalancing involves buying and selling of investments in the portfolio. Investors should understand how the rebalancing process operates including how and when the rebalancing will be triggered, any additional fees that may be incurred, and the associated risks, e.g. whether the rebalancing will occur regardless of market conditions and lead to a loss of capital.

In case the robo-adviser offers the flexibility to opt-out of automatic portfolio rebalancing, investors should understand the potential risks and consequences of opting-out. For example, the original portfolio that a client invested into, according to the robo-adviser’s recommendation, could become unsuitable for the client as a result of the opt-out. Also, by choosing to opt-out, the client is effectively deciding to receive a new service from (i.e. different from the one originally provided by) the robo-adviser. In such cases, the client should agree with the robo-adviser on the change of scope and new terms of services going forward.


4 April 2019