Building a mutual fund portfolio starts with measuring risk tolerance and deciding on ideal or base asset allocation. Once the portfolio is built, it will need regular reviews and rebalancing. Rebalancing, too, could be tactical or strategic as per the situation’s needs.

Like everything else in life, your mutual fund portfolio needs a review from time to time. Financial markets are complex and dynamic systems. In personal finance, one size does not fit all. There will be a need to customise according to your circumstances and changing situations.  

The reasons to review your mutual fund portfolio periodically are:

• There can be improvements in the economic scenario leading to newer opportunities.
• There can sometimes be a deterioration of factors driving growth.
• Tax rules might change, and new instruments or options may become available.
• Your investment objectives may change, and sometimes we may have to make changes well before the exact date of your financial goal.
• Existing schemes may show underperformance which is not in sync with the underperformance of the broader markets or the benchmarks
• Newer schemes or investment opportunities may become available
• Your situation may change for better or worse

Only a timely review can keep your portfolio fresh and relevant. 

How often must you review your mutual fund portfolio? There is no one answer to this question. The correct answer is ‘as and when it’s needed.’ On the outside, ‘once a year’ is a kind of ‘must-do’ thing.

After the review, should there be a change in your asset allocation?  Not necessarily.  Rebalancing your portfolio should meet either both or one of the asset allocation needs, namely, Tactical Asset Allocation and Strategic Asset Allocation

While doing Tactical Asset Allocation, you will change the weights to the various components of asset classes your mutual fund portfolio may have.  For example, your hypothetical base asset allocation model could be:

Due to the war crisis in a far-off place, the domestic equity market has turned volatile and has lost a 10% valuation. You can now tactically use the cash available in your portfolio (10%, pre-drawdown) to add to Domestic Equity. 

In another example, let’s suppose the Government announces an incentive scheme for a particular sector of the economy to boost domestic production of an import substation product, lithium batteries.  You can tactically increase domestic/international equity allocation to this specific sector.

Such tactical allocation allows you to create extra value by taking advantage of a particular situation – in this case, a war in a far-off place or a change in government policy.

In Strategic Asset Allocation, your mutual fund portfolio is rebalanced when the original allocation differs from the initial allocation significantly due to the differences in the returns and the power of compounding.

Let’s suppose you had a mutual fund portfolio of Rs.1 Crore, and the following strategic asset allocation was implemented in the beginning:

After one year, you find that your portfolio currently looks as under:

To come back to the original (Strategic) Asset Allocation, you must take the following action:

*Note:  Tax and transaction costs are ignored

To overcome the adverse effects of taxation and transaction costs and to avoid frequent churning of the portfolio, portfolio rebalancing under Strategic Asset Allocation is done infrequently.

Are you interested to know more about investing in mutual funds?  Get in touch with us here.

Image Credit: “Asset Allocation” by Jon Scally is licensed under CC BY-NC-ND 2.0.