Rebalancing is a term mostly used in association to the management of liquid assets that make up a portfolio.
Hedge fund managers, including those managing the financial assets of insurance companies, typically state upfront to their stakeholders what is the allocation of funds to particular classes of assets.
Investors who put up their own capital into these funds will need to know the details of these allocations so that have the knowledge of where their funds are going to.
If you don’t like the world of cryptocurrencies for instance, then you wouldn’t want to get into a fund that has a huge allocation to crypto. And thus, would prefer to invest in something else that you are more comfortable with like maybe emerging markets.
An example of asset allocation might be something like 50% in high technology stocks and 50% in startup internet companies.
During the course of the year, these allocations can swing wildly.
At the end of the financial year, the performance of such a fund will be reviewed. And deviation from the pre-determined allocation ratio will have to be reinstated. To do this the fund manager has to enter the market to buy and sell appropriately to rebalance the portfolio.
Continuing with the previous example, let’s say for instance that high tech equities explode during the year while startup companies remained the same. Because of the exponential growth in value of high tech stocks, the total value of the portfolio might be skewed to 70% high tech and 30% startup.
The rebalancing occurs when the high tech stocks are sold in the market, and the funds generated are used to buy startup stocks.
The target here is to rebalance the ratio of these two components back to a 50/50 allocation.
It is often said that active investment strategies are too hectic for the average investor. And passive strategies would suit those who wouldn’t want to be actively tracking the markets.
Rebalancing is a key aspect of passive investing strategies as it is engaged annually.
With that said, it is also not uncommon for managers to review rebalancing bi-annually. This can depend on the investment horizon in play.
Adhoc unplanned actions of this kind can be referred to as interim rebalancing. And is usually conducted when the market experiences some sort of shock that required immediate action.
In the open market, sometimes authorities can observe strange trading activities and call a halt to trading via a circuit breaker. This is so that it allows time for investors to catch up with latest news and announcements and make a decision of whether to enter or exit a market.
This is an event implement for the purpose of open market rebalancing.