Why financial year-end portfolio rebalancing matters and how to go about it

Unless deviation from the original portfolio is drastic, rebalance by buying more of the underperforming asset class, to avoid tax and exit load

The end of the financial year is an ideal time to review and rebalance your investment portfolio. Doing so helps ensure that the portfolio becomes realigned with your financial goals and risk appetite.

 

How asset classes performed

 

Equity funds delivered modest returns this year. Large and small cap funds recorded single-digit gains, while mid-cap funds averaged around 11 per cent (see table). “Despite taking higher risks, investors in mid- and small cap funds did not receive proportionately high returns this year,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors. He adds that global equities outperformed Indian equities.

 

“Among sector-specific funds, pharma, infrastructure and banking showed strength, whereas IT and consumption-oriented funds lagged,” says Atul Shinghal, founder and chief executive officer, Scripbox.

 

Debt fund returns were attractive, ranging from 7.18 per cent in liquid funds to 8.98 per cent in gilt funds, supported by a softening interest rate environment in the second half of the financial year. “The inverse relationship between bond yields and prices worked in favour of bond investors,” says Ajay Kumar Yadav, chief executive officer and chief investment officer, Wise Finserv.

 

Gold exchange traded funds (ETFs) delivered average returns of 29 per cent. “Gold funds stood out with exceptional returns, driven by global uncertainties and a weak rupee,” says Shinghal.

 

According to Yadav, this year reinforced the importance of diversifying across equity, debt and gold for balanced portfolio performance.

 

Asset class outlook

 

Despite subdued performance, mid- and small-cap valuations remain stretched. “Valuations in these segments may still exceed their long-term averages. Therefore, investors should avoid an aggressive approach towards these sub-asset classes,” says Dhawan.

 

Yadav notes that investors overweight on mid- and small-caps should pare exposure.

 

Large caps, however, are expected to do well. “Large cap funds offer relatively attractive valuations and stability,” says Shinghal.

 

Vaibhav Porwal, co-founder, Dezerv, highlights the importance of favouring fundamentally strong companies.

 

Investors whose United States (US) fund exposure exceeds 20 per cent of the equity portfolio may consider booking profits. “US large cap valuations are currently elevated and vulnerable to correction. Redeploying those proceeds into Indian large cap funds would be a prudent strategy, as this segment is reasonably valued on a relative basis,” says Yadav.

 

On the debt side, avoid overexposure to high duration or credit-risk categories. For the bulk of the portfolio, match investment horizon with the fund category’s average maturity. Lower-quality debt could underperform if the economy slows. Yadav advises sticking to quality debt instruments.

 

Gold allocation should not exceed 10 per cent.

 

Above all, avoid chasing asset or sub-asset classes that have shown strong monetum in the recent past. In the context of FY25, these would be US funds, gold, silver, and long duration debt funds.

 

Why rebalancing is essential

 

Market movements distort an investor’s strategic asset allocation over time. Rebalancing helps to restore the original allocation. Shinghal points out that this process reduces portfolio risk by correcting overexposure to overpriced assets.

 

“Rebalancing ensures that your portfolio stays aligned with your financial goals and risk profile, especially amid macroeconomic shifts,” says Yash Sedani, assistant vice president of investment strategy at 1 Finance.

 

It also enables investors to take advantage of mispriced assets. “Rebalancing helps investors capitalise on shifts by exiting expensive assets and reallocating money to more affordable segments,” says Dhawan.

 

Rebalancing brings in discipline and counters behavioural biases. “Investors tend to hold on to asset classes that are doing well or not invest in those that are performing poorly,” says Dhawan.

 

Investors nearing a financial goal should gradually shift to safer asset classes.

 

How to go about it

 

Ideally, rebalancing should be done using fresh capital to minimise taxes and exit loads. “However, if an investor is significantly overweight on a particular asset class, then reallocating purely through fresh investments may not be sufficient. In that case, selling the outperforming asset class may be required,” says Dhawan.

 

If additional investments can help restore the target allocation within a year, direct fresh capital to underperformers. If not, partial profit-booking in outperformers may be necessary.

 

“An in-depth review of investments and alignment with goals, risks and return expectations must also be carried out,” says Porwal.   (The writer is a Mumbai-based independent financial writer)