A is for active rebalancing. Don’t underestimate that value.
If there were ever a year in which the benefits of rebalancing were clear, 2020 was it.
We’re still immersed in the middle of a market, economic and societal event like none of us have ever experienced. We’ve all been impacted —if not directly to our health, then by changes to the way we work, the way we connect to each other and certainly by the way we think about financial security.
At Russell Investments, we believe in the value of an advisor. And this year, we believe advisors are more valuable than ever. The global pandemic upended all of our lives— and for many of us, caused us to reassess our values, outlook and lifestyles. The market volatility may also have had investors reconsider their risk tolerance or their portfolio mix. These are the circumstances in which advisors are called to play many roles: behavior coach, family wealth advisor, investment manager, product specialist, and more.
My colleagues and I will be discussing those various roles, and the potential benefits each brings to clients, in five deeper dive articles, looking in greater detail at our annual study on this topic. This is our first of those five, in which we look closely at active rebalancing.
When markets are rising calmly, it can be easy to underestimate the importance of disciplined rebalancing. But when markets gyrate wildly—as they did in March last year as the pandemic shuttered many aspects of the global economy— then the value of active rebalancing can’t be understated.
Minimize the drift
As the chart below demonstrates, a balanced portfolio of 60% stocks and 40% bonds that had not been rebalanced since the last major bout of market volatility during the Global Financial Crisis would have ended 2020 looking more like a growth portfolio, and would have exposed the investor to unintended risk. Indeed, without rebalancing, by the end of December 2020, this hypothetical portfolio’s exposure to U.S. equity would have risen from 20% to 34% and the exposure to fixed income would have fallen from 40% to 30%—an unintended shift from a 60% equity / 40% fixed income portfolio to a 70% equity/ 30% fixed income portfolio.
We all know the important role fixed income plays in smoothing out portfolio returns. More importantly, the portfolio would have a strong tilt to U.S. large cap growth—increasingly dominated by technology names. That tilt could be a concern if that sector were to suddenly reverse.
Click image to enlarge
For illustrative purposes only. Not intended to represent any actual investment. Source: Morningstar, Russell Investments. Analysis based on quarterly data from 12/31/2005 - 12/31/2020. Initial asset allocation: 20% S&P/TSX Composite Index (Canadian equity), 20% S&P 500 Index (US Equity), 20% MSCI EAFE Index (Foreign Equity), and 40% FTSE Canada Universe Bond Index (Fixed Income). Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
Markets turn fast. Is now the right time to rebalance?
2020 was a textbook example of how quickly markets can turn. The chart below shows just how dramatic the shift in sector performance was over the past year. As of September 2020, traditional value-oriented sectors such as financials and energy have outperformed.
Click image to enlarge
Sector Performance
Source: Morningstar. S&P/TSX Capped indices. In CAD. Indexes are unmanaged and cannot be invested in directly. Past performance does not guarantee future performance.
How are you talking to your clients about the importance of regular rebalancing?
The value communication gap
Do your clients recognize the value of what you do? Articulating the value of all the good things that advisors do—including rebalancing—is dependent on good communication, especially now that most of our interactions are virtual. This communication should include what you write—via client emails, your online presence, or via traditional mail—but should also include what you say when you’re on the phone, in a webinar or on video chat with clients.
We consistently find there’s a big gap between what investors believe advisors do and what advisors actually do. In other words, there’s a value communication gap between advisors and their clients. Advisors don’t always know what their clients really value. But what if you could tell your clients that by regularly rebalancing their portfolio, you have maintained their asset allocation in line with their goals, helped smooth out returns and maintained their desired risk profile?
We believe that rebalancing is one of the five most vital functions advisors provide. But the value of it is often downplayed. And when it comes to devaluing this vital service, advisors may be the main culprit. Why? Because it’s something they do every single day. It’s like breathing for advisors, and most of their clients don’t think about the impact of doing it or not doing it.
Unless you clearly communicate the value of rebalancing, don’t expect your clients to appreciate it. We believe that without the help of advisors, clients are more likely to make serious mistakes, such as buying high, selling low, or running to cash at precisely the wrong time. Indeed, many investors did flee the markets in March 2020, when the initial pandemic shock hit, and may have then missed out on the subsequent rebound.
How to tell the rebalancing story
Do your clients recognize the value of annual rebalancing and how it’s a vital part of wealth management? We recommend four simple touchpoints to make the communication both easy for you and meaningful for your investor clients.
To help your clients understand the value of active rebalancing, make sure you let them know:
- The benefits of a systematic rebalancing policy
- What the strategic rebalancing policy is
- How frequently the portfolios are rebalanced
- Your approach to strategic rebalancing during periods of market volatility
The bottom line
Rebalancing may have been more obviously valuable over the past year than ever before. But just because you recognize its importance, don’t assume your clients do. For them to understand the value of an active rebalancing process, you need to talk about it. This doesn’t have to be a complicated conversation—in fact, just showing them the charts above should help them see how the process can keep their plans on track. But we believe you should articulate your active rebalancing philosophy, because rebalancing is a key part of helping your investors achieve the financial security that matters so much to them.